Arvind Subramanian Chief Economic Advisor- GOI: Rising star and Rajan clone?
The Indian Economic Survey is an annual document that is wrongly titled. The data it reveals is overpowered by large dollops of economic wisdom, literature and policy analysis. Arvind Subramanian, India’s Chief Economic Advisor and the key author of this year’s Survey, has clearly burnt the midnight oil liberally in making the Survey a reader’s delight, even for one who has only a nodding acquaintance with economics, gleaned primarily by pursuing the pink papers.
Running hard to stand still
The key guidance the general public has been looking forward to, is the credibility of the near miraculous GDP growth rate of 7.6 % recorded this year and in that context, prospects for the next year. Unfortunately, clarity still eludes the average reader. Whilst generally optimistic about the government’s ability to improve on the performance this year, the survey is curiously negative on growth prospects for next year (7 to 7.75%), which it says would be strongly dependent on world growth reviving rather than domestic reform being implemented. Running hard to stand still is not a very good incentive for public sector reform. Consequently, India should brace for lower growth next year.
Better fiscal administration but significant legacy problems
The Survey makes the point that over the last year India has done more than most of its peer countries- those with an investment grade of BBB, including China, to retain macroeconomic stability per the index of macro-economic vulnerability developed in the Survey last year. But it simultaneously notes that the quality of assets in government-owned banks has been deteriorating since 2010. This is complemented by the overleveraged position of large business houses who are finding it difficult to service these loans because market conditions are adverse and both the top-line and their bottom-line have taken a hit. Exports have reduced by 18% last year and the competitiveness of domestic suppliers even to meet domestic demand is dodgy. The domestic steel industry being the most recent example.
The popular explanation for the logjam in corporate funds has been that the financial stress of big corporates has less to do with inefficiency or injudicious resource allocations by them. The blame is pinned on government projects not progressing smoothly over the last few years of the previous government resulting in corporate funds getting blocked unproductively.
Minister Nitin Gadkari doing the impossible- shaking the dust off moribund highway projects
But over the current year Minister Nitin Gadkari has revitalized the implementation of a large number of projects in the highways sector. Railways Minister Suresh Prabhu has similarly awarded more than double the level of contracts in railways than was the trend earlier.
Minister Suresh Prabhu -improving the plumbing of Indian Rail – a colonial legacy and democracy’s neglected child
State governments have also enhanced public investment per the Survey which states that the combined public investment increased by 0.8% of GDP over the first three quarters of the current year versus the previous year with state government contributing 46% of the investment.
Why then does corporate loan servicing remain a problem? Is it just a time lag issue before public expenditure decisions kick in and funds flow resumes to corporates? If this is the case the salutary effects should be visible next year. Or is it that the loan defaults have less to do with poor implementation of government contracts than with the “smart” arbitrage strategy of big corporates to borrow domestically in an unreasonably strong rupee, post 2013 and salt investments away safely overseas? Is it not necessary then to keep the rupee at aggressively competitive levels to avoid the incentive for “carry trade”, boost export competitiveness and price the fiscal impact of imports- particularly oil, realistically?
Does a high risk fiscal strategy make sense?
If the economy could chalk up a relatively high growth rate of 7.6% this year, despite the adverse conditions, why then is there a clamour for more liquidity and lower interest rates to kick start private investment and to fund higher levels of public investment in the coming year?
Would it not be sensible to stick to fiscal rectitude and keep the fiscal deficit target at 3.5% of GDP and hope for the same growth rates next year particularly if domestic actions will count less than world growth and demand?
Does it not make sense to guard against the risk of inflation- particularly drought induced food inflation? Our poorly integrated agricultural markets and inadequately prepared public management structures for managing food inflation by using market mechanisms are unlikely to be effective to deal with the risk of such inflation should the next year also be dry.
Oil prices remain volatile even though the survey is sanguine on the potential for an oil price increase. Whilst there is still no agreement amongst the top oil producers for limiting production, India is badly placed, being heavily (85%) import dependent, to bank on low oil prices continuing. Adequate fiscal space must be reserved for dealing with an oil price shock. These could be occasions when drawing down capital from a highly capitalized Reserve Bank of India (the survey labels it second only to Norway in being highly capitalized) can help without increasing the debt burden.
At least Mint Street is like Norway – we like that
Drawing down RBI reserves to fund dodgy capital investments in the public sector is a bad idea. It would be ok in Norway but not if accountability levels are low.Oddly, to an average India, the fact that we are close to being like Norway, as least with respect to the RBI is comforting and gives hopes. Indians are notoriously miserly and magnificent savers.
RBI Governor Raghram Rajan – firm as a Norwegian rock: photo credit: businessindia.com
Tax revenue complacency
The survey skirts around the advisability of increasing the ratio of tax to GDP above the 10% achieved last year. It appears complacent that tax buoyancy in the first three quarters of current year exceeds the average of the last three years- particularly for indirect taxes. The full year’s data would only be available with a lag but the budget documents would show if this happy trend has persisted in the last quarter also and whether the revenue deficit is indeed on track as a consequence.
Ignoring the impact of committed and contingent revenue expenditure
The significant burden (Rs 100,000 crore) imposed by the 7th Pay Commission has been dealt with lightly. Enhanced government salary and pension can increase expenditure by 0.6% of GDP for the Union government alone and threaten the revenue deficit target. The jury is still out on its possible beneficial impact on stimulating demand.
More importantly, the survey deals unduly summarily with the issue of enhancing rural income support and social protection as necessary adjuncts of macro- economic stability. Marco-economic stability can be the first victim if India’s political stability is compromised by concentrated high growth, which is not reflected in shared prosperity. The survey notes that 42% of Indian households are dependent on the rural economy. What it does not mention is the low ability of 60% of households to adapt to income shocks emanating from loss of insecure jobs, medical emergencies or other social obligations. Food for this segment accounts for approximately 40% of their expenditure. Rural wages are down 2.5% this year. Around 40,000 jobs have been lost per the Labour Bureau’s September 2015 report. Even the IT industry has reduced jobs and IT majors like INFOSYS -under a new leadership- are automating processes and putting employees out to pasture. These ground signals fit the survey’s assessment of India being in a hard place. But the survey is short on the best options for dealing with this economic shock.
The historical inadequacy in dealing with out-of-control and poorly targeted power, fertilizer, food, water, public transport subsidies hinges around the inability of elected governments to be seen to be heavy handed with income strapped households. These resultant fiscal pressures amounting to around 5% of GDP (all of government) can only escalate in the highly charged political environment during the next two years on account of state level elections.
A soft Railway Budget- harbinger of the main budget?
The Rail Budget 2016-17 could be a harbinger of such populism. Despite a large number of facilities and passenger amenities being announced there was no increase in the passenger fares which recover on average only around one half of the cost of services. Air India continues to be heavily subsidized. Loss making PSUs continue to sap public resources. How credible the fiscal consolidation plan can be in the face of these risks remains unclear.
Hopefully the Finance Minister will show the way on Monday in the Union Budget 2016-17. We await with bated breath.
Adapted from the authors article in The Wire February 26, 2015 http://thewire.in/2016/02/26/the-bewildering-optimism-of-the-economic-survey-22864/