The Hindu Business Line : Reviving and completing the reform agenda

The global environment has been remarkably benign since 1980 and output growth has not only been sustained but is also less volatile. Should this change, the adverse consequences of India's high fiscal deficits would come into the open and could precipitate a crisis. This is a major concern, but several other issues need to be addressed urgently if the reform objectives are to be achieved, says T.N. SRINIVASAN.

Several objectives of the reform agenda are yet to be achieved, the most urgent being fiscal consolidation. With conservative fiscal policies there were no revenue deficits at the Centre or the States during 1950-80 except for negligible amounts in three years. Conservatism gave way to profligacy after 1980.

The gross fiscal deficit (GFD) rose from 5.9 per cent of GDP in 1982-83 to a peak of 9.9 per cent in 1986-87 and to 9.4 per cent in 1990-91. Fiscal consolidation was a major item of the reform agenda of 1991. After initially declining to 6.4 per cent of GDP in1996-97, the GFD began to rise, reaching a peak of 9.9 per cent in 2001-02, although it came down to 7.5 per cent in 2005-06 and is budgeted at a high 6.5 per cent for 2006-07. The debt of the Central and State governments stood at 88 per cent of GDP at the end of March 2006, with its ratio to current government revenues at an extremely high 440 per cent. Fiscal Reform and Budget Management (FRBM) legislation at the Centre and States were meant to bring down the deficits in a phased manner.

Unfortunately, the credibility of the Central FRBM Act of 2003 was eroded early on by the Finance Minister's pushing the "pause button" on its targets in 2004-05. The Planning Commission has proposed yet another pause in the Draft Approach Paper for the Eleventh Plan.

High growth and low interest rates will not by themselves take care of the problem of long run sustainability of the debt, nor the risks of a macroeconomic crisis. Some immediate action is called for by way of further tax and expenditure reforms given the possibility that the benign external economic environment that has muted the adverse impact could change for the worse.

Economy still protected

India, though far more open now, is still one of the most protected economies among developing countries. In 2005, India's share of world merchandise exports was only 0.9 per cent, compared to China's 7.5 per cent, though in exports of commercial services India did somewhat better with a 2.9 per cent share against China's 3.1 per cent.

India has the second lowest debt among the top 15 debtor countries and its debt largely domestic, so that the risk to its balance-sheet from mismatch of currency denomination of debt and assets is minimal. India has not relied excessively on debt-creating capital inflows to finance current account deficits. Yet, the risks from high fiscal deficits, high debt/GDP and government debt/revenue ratios and from possible rise in global interest rates are cause for concern.

Kenneth Rogoff, the former Chief Economist of the IMF, recently pointed out that despite several shocks to it, the global environment has been remarkably benign since 1980 and output growth has not only been sustained but is also less volatile. An adverse change in this environment could raise interest rates and thereby erode the value of government securities held by the banks and thus their capital adequacy. The adverse consequences of the high fiscal deficits, masked in the benign environment, would come into the open and could precipitate a crisis.

Change in RBI approach

Some serious challenges remain in the financial sector. The RBI is apparently moving away in its supervision from a purely procedural approach of ensuring that commercial banks faithfully follow specified procedures, towards an outcome-based approach, in which the central bank specifies the desired outcomes in very broad terms. Banks are free to design their own procedures to achieve the outcomes, which will be evaluated by the RBI and made public regularly.

The outcome-based approach presumes that the banks have the capacity to monitor and deliver specific outcomes, which in turn requires an ability to assess the return and risk of each activity and price it right. To do so, banks should use analytical models that yield robust assessments of risks.

The efficacy of the outcome-based approach also depends on competition-driven market discipline being brought to bear on banks. On the one hand, with public sector banks holding more than three quarters of the assets of the banking system, and an implicit `bail-out' guarantee by the government in place that it would recapitalise banks if they run out of capital, it is unlikely that public sector banks will be disciplined by competition.

On the other, managers of public sector banks are inhibited from taking even commercially appropriate risk, because, if they fail, as deemed civil servants, their commercial decisions and conduct can be investigated by the Comptroller and Auditor General and the Central Vigilance Commission.

A significant reduction in public ownership of commercial banks from its very high current level, and further entry of private and foreign banks are essential if market discipline and outcomes-based supervision by RBI are to succeed.

Infrastructure reforms

Turning to infrastructure, the reforms envisaged in the Electricity Act of 2003 are yet to be fully implemented and the political problem of properly pricing electricity is yet to be tackled.

The losses of the State electricity boards account for a significant share of the States' fiscal deficits. Power subsidies contribute to wasteful use of scarce water resources.

The recent spate of suicides of farmers in some parts of the country has drawn attention to the problems facing agriculture. Contrary to simplistic assertions that the burden of debt and trade liberalisation are the main causes of suicides, a recent analysis shows that no more than 20 per cent of households were indebted, even in the States where the number of suicides was high, and that dependence on high-cost, non-institutional sources such as moneylenders is declining progressively.

Import liberalisation

Also, the import liberalisation that occurred was not because of India's implementing its commitments under the WTO Agreement on Agriculture, as it did not require India to reduce its subsidies. Moreover, India's commitment to reduce its high bounds on tariffs had no effect on actual tariffs, leaving India, in effect, free to change them at will. India changed applied tariffs and the restrictions on private trade in response to domestic circumstances.

For example, private traders were allowed to export foodgrains to reduce excessive stocks with the FCI. And cotton (or onion!) exports are restricted whenever a rise in the domestic prices of either is a concern to the textile industry or to consumers.

Farm policy

The Government has intervened massively, but not cost-effectively, in the agricultural sector through public investment in irrigation and fertiliser production, procurement and distribution, subsidisation of credit, electricity, fertiliser and water, price supports, crop insurance and others. Subsidisation of power and water have led to excessive use of water, endangering the lives of people and the environment, with little to show in return.

In addition to improving the effectiveness of policy interventions the focus of agricultural policy has to shift from trying to keep unviable small and marginal farmers in agriculture, towards helping them to move out of agriculture into more productive off-farm activities.

An efficient and corruption-free system of recording ownership of land and efficient markets for the sale/purchase of land will enable non-viable farmers to sell their land to viable ones at a fair market value and exit from agriculture.

Industry, services

In the six decades since Independence the industrial structure of employment has changed only modestly. Nearly 60 per cent of the labour force is still engaged in primary activities. The share of industry in GDP increased from 20 per cent in 1960 to only 27 per cent in 2004. The only redeeming feature is a slow rising trend in the small share of the secondary sector in total employment for both males and females in rural areas.

The rapid growth of the service sector notwithstanding, India cannot leap-frog the stage of manufacturing growth in development and shift massive numbers of less educated unskilled workers to the high productivity end of service activities within a reasonable time.

Professor P.C. Mahalanobis had warned in 1961 that India's labour laws, which ignored any consideration of efficiency, would be an obstacle to growth and increase inequalities.

The slow change in employment and its structure have attenuated the poverty reduction impact of growth. Understandably, this has led to the introduction of an expanded Rural Employment Guarantee Programme.

The growth-enhancing and poverty reducing potential of a well-designed and well-executed rural work programme is high. However, such a programme can only be a palliative and will not eradicate poverty once and for all.

Health, education

The UPA government's common minimum programme envisages a significant increase in expenditure on health and education. However, the failure to improve the health and educational parameters is in large part due to the poor public delivery system, as Prof Amartya Sen has pointed out.

Three different deficiencies of the system act together to the detriment of the poor, according to Prof Sen. First, the low level of public expenditure. Second, the failure to ensure that doctors are present, and medicines available, in the public health centre.

Third, the failure to identify and weed out quacks from the medical services. Analogous deficiencies plague the public education delivery system. It is unlikely that dramatic improvements in health and education will come about just from increases in expenditures. Addressing the whole spectrum of diseases is a major challenge. Also, with the traditional joint family disappearing, caring for the elderly is becoming increasingly important.

The problem of financing health and old-age care and the sharing of it between public and private sectors is another challenge.

HIV Scourge

The most ominous and emerging challenge to the economy is from the spread of HIV/AIDS. According to UNAIDS, India had an estimated 5.7 million persons infected with AIDS in 2005.

Although India's overall infection rate — 0.9 per cent of the population in age group 15-49 — is low compared to the 30 per cent rate in Sub-Saharan Africa, this should not lead to complacency.

First, in South Africa, infection rates were comparable to the current Indian rates only a decade ago and grew very rapidly thereafter.

Second, India's estimated infection rate could be biased downward. And even if it is not, being a sample-based estimate, at the upper end of the confidence interval around the average of 0.9 per cent, the infection rate will be much higher.

Third, with a population of 1.1 billion, even a small increase in the infection rate would translate into millions of infected persons. Fourth, the epidemic is concentrated in just six States, including the rapidly growing Maharashtra and Tamil Nadu.

HIV/AIDS poses a difficult challenge, given its social stigma, the complexity of epidemiology with as yet no cure for the infection nor a vaccine for its prevention, and connection to sexual behaviour, lack of knowledge about the syndrome, and its very high cost of treatment.

A coordinated effort by the governments at various levels, the private sector, religious leaders and the media has to be mounted if the scourge of HIV/AIDS is not to doom the lives of millions of Indians.

(Concluded)

(The author is Samuel C. Park Jr. Professor of Economics at Yale University.)