The Hindu Business Line : RBI's difficult prescription for economy

Even as it implies the criticality of the current upsurge being nurtured to realise the full industrial growth potential, the RBI annual report makes no bones about infrastructure bottlenecks. Here the subdued performance of the infrastructure sector, especially that of crude and petroleum refinery products, is an issue of concern.

THE Reserve Bank of India (RBI) released the Annual Report 2004-05 on the performance of the real sectors of the economy the last fiscal, and the prospects for the current one from the trends in the macroeconomic fundamentals during the first five months of this year.

With inflation tamed and the prospects of economic growth strong, the RBI report contends that maintaining macroeconomic and financial stability in a milieu of sustained high growth relies critically on "policies relating to oil prices, diversification of agriculture, improvement in urban infrastructure, determined measures for fiscal consolidation and, above all, on the continuation of the positive investment climate in the country".

Given a coalition government at the Centre, the prescriptions for rational energy prices, improved urban infrastructure through correcting policy-distortions and resolute steps for fiscal consolidation may appear a tall order. Yet, however unpalatable the formulations, they cannot but be quaffed, in order to ensure inclusive growth through sound policies.

Reviewing the performance of the economy, the report says, at the outset, that the real GDP growth at 6.9 per cent in 2004-05, despite a sharp slowdown in agriculture, propelled average growth to 6.5 per cent in the first three years of the Tenth Plan period (2002-07).

It exceeded by a full percentage point, the average real GDP growth of 5.5 per cent of the Ninth Plan (1999-2002), while being broadly in line with the average of 6.7 per cent in the Eighth (1992-97), the first flush of reform results India showed, following a major brush with bankruptcy in the early 1990s.

For the agriculture sector, the report notes that the experience of 2004-05 reiterates the risk of sole dependence on rain, warranting the need for stability to the farm income through diversification and value addition in farm operations.

The country has considerable export potential in dairy, sericulture, floriculture and horticulture. This is because these segments sustain a larger number of agro-industries which hold potential for non-farm employment, besides enhancing nutritional and livelihood standards.

The report advocates effective linkages of production systems with marketing, agro-processing and other value-added activities in the diversification of agriculture.

The report states that the State Agricultural Produce Marketing Committee (APMC) Act, amended in line with the Model Act (2003), would facilitate direct sale, promote public-private partnership in the management and development of agricultural markets, promote contract farming and introduce a negotiable warehousing receipt system for agricultural commodities.

While applauding the increase in bank credit to the agricultural sector in recent years, the RBI report calls for supporting policy changes and investment to enable agricultural diversification and value addition.

Heavy investments need to be made in establishing cold chains such as improving facilities for cold storage, transport, among others.

Newer forms of credit assessment and risk systems might have to be put in place, the central bank said in the report, adding that besides upgrading skills and changing attitudes, information technology must be used to transform various processes of rural credit.

On industry, the apex bank noted that the congenial policy regime in regard to mergers and acquisitions, including the liberalisation of policies about direct investment abroad, has consolidated industry and made possible economies of scale.

Even as this implies the criticality of the current upsurge being nurtured to realise the full industrial growth potential, the report makes no bones about infrastructure bottlenecks. The latter could affect competitiveness. Here the subdued performance of the infrastructure sector, especially that of crude petroleum and petroleum refinery products, is an issue of concern, given the sector's strong forward and backward linkages.

Second, the escalating demand-supply gap in the availability of power is becoming a critical issue in economic development.

"Inadequate power generation capacity, lack of optimum utilisation of the existing generation capacity, insufficient inter-regional transmission links, inadequate and ageing sub-transmission and distribution network, slow pace of rural electrification and inefficient use of electricity by the end consumer have exacerbated the absolute shortages," the report states.

As continuing problems in the power sector pricing policy suggest an urgent need for reforms to ensure payment security, the report urges priority for energy-saving measures that include appropriate pricing policies and spurs to invest.

The report also stresses the need to develop urban infrastructure — drinking water, sanitation, sewage systems, electricity and gas distribution, urban transport and primary health services — in the light of the breakdown of these facilities during the July rains in Mumbai and the rest of Maharashtra.

On services, which have emerged the drivers of growth, contributing more than 57 per cent of GDP, the RBI is quite sanguine about the export of business and professional services joint software exports as key foreign exchange earners.

However, the shift in the strategy of Information-Technology Enabled Services-Business Process Outsourcing aspect of the software sector towards higher value activitiescould yield rich dividends if duly backed "by preparedness to meet data security requirements and to fulfil the regulatory compliance requirements in the banking and financial services sector," the RBI counsels in the wake of breaches of data security by local firms for their clients abroad.

Referring to the key external sector, the RBI observes that there are "significant shifts within the balance of payments that suggest that the economy may be approaching a turning point".

First, the import-GDP ratio increased to 17.2 per cent in 2004-05, after hovering around 13 per cent for the last five years.

Second, export growth was robust, increasing by more than 20 per cent per annum for the third successive year in dollar terms. Third, the merchandise trade deficit reached 5.5 per cent of GDP with the non-oil trade balance turning into deficit after a gap of four years.

Yet more than four-fifths of the trade deficit was financed by the net invisible surplus. There was a turnaround of $17 billion in the current account balance during 2004-05 — a modest deficit of 0.9 per cent of GDP in 2004-05 from a surplus of 1.7 per cent of GDP in the previous year, 1.2 per cent in 2002-03 and 0.7 per cent in 2001-02.

Finally, positive aspects of these features and the strength of the reserves fostered a congenial environment for expanding foreign investment overseas.

On the fiscal policy, the recovery in economic activity, particularly in the industrial sector, has enabled an improvement in the tax toGDP ratio and central government finances.

With the gross fiscal deficit toGDP ratio at 4.1 per cent in 2004-05 (provisional accounts), the FRBM (Fiscal Responsibility and Budget Management) target of 3 per cent by 2008-09 appears to be `within striking distance'.

But with the revenue deficit at 2.5 per cent in 2004-05, the elimination of the revenue deficit by 2008-09 might be a formidable task, as it calls for "continued focused attention on containing expenditures, increase in tax revenues and reduction in tax exemptions".

Despite all efforts by the Centre, "low and shrinking capital outlays constraining the expansion of infrastructure and realisation of the full potential of the economy emerged as a key concern," the report says.

That is why, in addition to efforts to improve revenues, expenditure management involves enhancement of the effectiveness of the delivery mechanism for public services.

For the State governments, the RBI says, fiscal empowerment to augment resource mobilisation from non-tax revenues through appropriate user charges, cost recovery from social and economic services and restructuring of State PSUs is important.

Improving finances will enable States to step up their expenditure on education and health.

According to the report the health of public finances — Centre and State — will benefit from improvements in cost recovery of various public user charges and rationalisation of subsidies.

These remedieshave been repeated many a time, but with the political reality of coalition governance dictating policy, there is little room for manoeuvre.

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