The Hindu Business Line : Reconcile ideas on growth and finance

Of late, the government and regulatory authorities have been airing differing views on fiscal discipline, foreign institutional investment, use of foreign exchange reserves, SEZs and interest rates.

In recent months, a number of ideas aired openly by some arms of government and regulatory authorities seem to have raised concerns about the reform process and investor confidence in the economy.

The differences in viewpoints centre mainly around fiscal discipline, foreign institutional investment, use of foreign exchange reserves, Special Economic Zones (SEZs) and interest rates. Fortunately, there is agreement on the need to achieve what the Planning Commission has termed `faster and inclusive growth'.

The fiscal discipline issue boils down to four elements:

Improvement of the tax-GDP ratio through better tax compliance and expansion of the tax base;

Increasing the non-tax sources of revenue, particularly through divestment of public enterprises;

Containment and careful classification of what constitutes revenue expenditures; and

Effective implementation of schemes that create capacity building assets including human capital.

If these conditions do not hold good either in full or in part, the fiscal and revenue deficit targets, as laid down in the Fiscal Responsibility and Budget Management (FRBM) Act, would be breached, according to the Planning Commission. As the model-scenarios showed that at least in the first two years of the Eleventh Plan (2007-12) the breach would be evident, the Planning Commission advocated deferring the FRBM Act by two years. While the Finance Ministry rejected this view, obviously to be politically correct, and being bound by the enacted legislation, the Reserve Bank of India (RBI) acted as the defender of price stability.

Revenue versus primary deficits

The Planning Commission also questioned the sanctity of the revenue deficit and pleaded for the internationally accepted primary deficit. On the revenue deficit, neither the Finance Ministry nor the RBI has reacted. On the primary deficit, however, there has been a long-standing difference of view between the Finance Ministry and the RBI on the latter's use of the concepts of gross and net primary deficit, even though the net primary deficit concept does not figure in the general literature on fiscal policy.

More recently, the Tarapore Committee II on Fuller Capital Account Convertibility advocated the public sector borrowing requirement (PSBR) as the appropriate concept for measuring fiscal performance. It is not clear whether either the RBI or the Ministry has accepted this particular recommendation, but given the overarching aim of reducing the role of the public sector over time, there may not be any takers for it.

Participatory Notes

On FII flows, the RBI favours a ban on participatory notes (PNs), further reinforced by the Tarapore Committee II report; it is for phasing out the existing ones within a year because of the lack of identity of the beneficial ownership. Moreover, large flows via the PN route have implications for asset prices. There were two minutes of dissent in the Committee on the issue. The Finance Ministry and the financial services industry, too, do not accept it. While the Securities and Exchange Board of India (SEBI) is with the Finance Ministry on this, not all political parties are.

Infrastructure development

The large accumulation of foreign exchange has encouraged the Planning Commission to suggest use of the reserves for infrastructure development by creating a special purpose vehicle (SPV). The Finance Ministry's view on this matter is not unequivocal. The RBI feels that the hard earned reserves would be dissipated quickly, lowering, in the process, the confidence of foreign investors in the economy. Moreover, the scheme would give incentives for undertaking infrastructure projects that are not worthwhile. Good projects through public-private partnerships (PPPs) would not, according to this view, face problems of funding. Nor would they face high interest-servicing costs.

Special Economic Zones

SEZs, promoted by the Commerce Ministry, faced a roadblock when the RBI found the loans for the development of these enclaves to be akin to real-estate credit that attract high margins and interest rates and provisioning by banks. The issues relating to development of SEZs, however, have now become more complex, going beyond effective interest costs, with opposition coming from political parties and a number of other official organs, in the absence of PPPs and a regulatory framework.

The issue of interest rate positioning has been on the table at both the RBI and the Finance Ministry, with the latter opting for a soft loan regime and the former preferring to use the interest rate for effective monetary policy that is obliged to realise the dual objectives of price stability and growth. With the Planning Commission assuming 7 per cent interest rate in its scenarios on fiscal outcomes for the Eleventh Plan, can these views be reconciled?

Is there a need to air diverse views in public by the official machinery? Is the motive really to encourage healthy debate or exercise the prerogative to be autonomous? Would the ends, on which there is no disagreement, justify the means?

Eliminating uncertainty

Reconciliation of views is needed to eliminate uncertainty about the dynamics of growth and stability. For instance, all official players would do well to recognise that revenue deficit is a mere accounting concept and has to yield to gross primary deficit. Also, one needs to check the degree of commitment to inclusive and faster growth and to the promised setting up of the Sixth Pay Commission before deciding on the fiscal deficit target. If by end-December 2006 the fiscal outcomes are likely to breach the fiscal target, it is best to place before Parliament necessary amendments to the FRBM Act in the last quarter of 2006-07.

Take the case of large FII flows through PNs. The logic of the RBI is infallible. It is not enough to reduce the transaction costs of firms that operate in the stock market to address the RBI's concerns. It would be useful if the Finance Ministry issues White Paper addressing the concerns so that the markets would be certain of the stability of the policy on PNs.

The issue of utilisation of reserves for eliminating bottlenecks to achieve faster growth without losing sight of the balance between returns on and safety of international reserves requires a revisit by technical experts at the Planning Commission, the Finance Ministry and the RBI. One need not necessarily follow the Singapore or the China models — PPPs are more imaginative and credible.

Communication policies

To wit, the official agencies should not communicate in the name of autonomy, transparency or legal requirement. There should be a constitutionally constituted coordination committee (CC), not merely a high-level committee, to ensure that the communication policies of the agencies are harmonious and committed to concerted action when warranted; preferably the Economic Advisor to the Prime Minister should be the body's chairperson.

Where the views continue to remain unresolved, the matter can be referred to the Prime Minister. The proceedings of the CC should be fully recorded so that the public, under the Right to Information Act, can exercise the right to know the views of the different official organs.

(The author is a former Executive Director of the RBI. He can be contacted at: asurivasudevan@hotmail.com)

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