The Hindu Business Line : Tarapore Report II — Little light on deficit, gold

The Tarapore Committee II could have emphasised fiscal deficit reduction, suggested ways to bring idle gold stocks into the system and touched on modernising and strengthening the banking system.

The Tarapore panel report on Fuller Capital Account Convertibility has been extensively discussed. But three areas — reduction of fiscal deficit, the role of gold in the country's reserves and banking sector reforms — deserve a closer look.

Reduction of Fiscal Deficit

This is a critical element of any economic reforms programme. This issue assumes greater significance in any move towards convertibility of currency, in general, and capital account, in particular. Opening a country's capital account when it has an unsustainably high fiscal deficit can be likened to administering polio drops to a child suffering from high fever; it can prove fatal.

One of the major drawbacks of the first Tarapore Committee report was that it had confined itself to the Central Government deficit, while it is essential to look at the combined fiscal deficits of the Centre and the States in a federal economy like India. The combined fiscal deficit of the Centre and the States has been hovering above 8 per cent for quite some time. Though the Revised Estimate for 2005-06 is 7.7 per cent, it is more attributable to the Finance Ministry putting on hold Plan loans under the Gadgil formula to the States under the pretext of the Twelfth Finance Commission's re commendation that the Central Government should not act as an intermediary for future lending and allow the States to approach the market directly.

Though the Tarapore panel has emphasised reducing fiscal deficit as a percentage of GDP as a necessary condition for fuller convertibility, it has not set a clear timetable.. The Committee should have paid attention to the observations of the Twelfth Finance Commission (TFC) on the States' debt position.

According to a study commissioned by the TFC, the aggregate debt-GSDP ratio for all States worked out to 34.21 per cent. At the end of 2002-03, all States, except Maharashtra and Jharkand, had debt-GSDP ratios exceeding 25 per cent. The paper on debt relief outsourced by the TFC had suggested a fiscal deficit target of 3 per cent of GSDP for every State and a targeted debt ratio of 25 per cent of GSDP.

If these were to be translated into reality, it would be necessary to take certain concrete measures by the Government and the RBI. First, it would be desirable for the Planning Commission to stop approving State Plans in excess of their resources as most States rarely keep up their assurances made to the Planning Commission on additional resource mobilisation efforts.

Second, the Planning Commission should also fix an overall ceiling for market borrowings and a sub-ceiling up to which approval for market borrowings through the RBI would be given and for the balance amount the States may have to fend for themselves from the market. In the light of the observations of the Twelfth Finance Commission on the States' indebtedness, it would be desirable if those States whose interest payments as a percentage of revenue receipts are more than 25 per cent are not permitted to contract any fresh loans, both domestic and external sources, till such time this parentage comes down to around 20 per cent.

The Tarapore panel should have also considered the possible impact of the implementation of the Sixth Pay Commission on the fiscal health of both the Centre and the States. Omission to recommend concrete measures to contain and reduce the fiscal deficit as a percentage of GDP during the next five years is a major drawback of the Tarapore panel report.

The Role of Gold

One would have expected the panel to have gone into the growing importance of gold in the foreign exchange reserves. Gold prices have on a high the last eight to ten months. There is a school of thought that once the reserves exceed external debt, 10-25 per cent of the reserves should be invested in refined gold, as a buffer against any exogenous shocks to the currency. China has been buying gold in the region of 4000 tonnes the last four years. India has the largest hoard of private gold; gold holdings are almost a third of its GDP and 10 per cent of the worldwide stock. It would not be exaggerating to claim that gold holdings in India are comparable to oil reserves of, say, the US, if only they could be brought into the banking system instead of lying idle in bank lockers. The panel should have come up with some measures to bring the hoarded gold into the banking system.

Banking Sector Reforms

The report is more in the nature of reforms of the banking sector rather than on currency convertibility. For example, the recommendation to permit industrial houses to start banks to capital account convertibility. The recommendation of banning Participatory Notes not only attracted a dissent note from one of its members but it is highly unlikely to be accepted by the Government as this issue has already been gone into in depth by the Ashok Lahiri Committee.

Even on banking reforms, the panel has not touched on the aspect of modernisation or strengthening the corporate governance of the system. If the public sector dominance of the banking sector is to remain, it is imperative to lay out a roadmap for autonomous management of the banks. As things stand today bank autonomy leaves much to be desired.

In the final analysis, it is rather doubtful if the recommendations of the Tarapore panel report alone would facilitate opening the country's capital account at the end of the five-year period without reducing the nation's fiscal deficit to at least 3.5 per cent of GDP, which will be feasible only if both the States and the Centre work together towards this target.

(These are the personal views of the author and in no way represent those of the Government where he works. E-mail: sitharamgurumurthi@yahoo.com)

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