The Hindu Business Line : Economic agenda for new government

The current disconnect in policy-making will be broken in the coming days with a new government in office. As the first government to take office in the 21st century, it is important that it sets its sights beyond short-term considerations. A simple but credible medium-term path of macroeconomic policies is the need of the hour, says A. Vasudevan, emphasising attention to the real sectors.

DECISION-MAKING during periods of elections often receives a jolt because of the uncertainties about the continuance of the policies that have been followed hitherto. The hesitation to take policy initiatives is understandable: The policy-maker is dammed if he does not take policies, and equally dammed if his initiative is perceived to be non-partisan or not in line with the conduct rules of the Election Commission.

It is no wonder, therefore, that in the past two months there had been no major economic policy initiatives. What is more interesting is that the elections themselves have not thrown up any sharp differences in the perceptions of the political parties on what the future development strategies should be. One would, therefore, expect that the strategy that has been hitherto followed would be largely pursued with some nuanced changes depending on the party (or coalition of parties) in power.

Since the newly-elected government would be the first of the 21st century to take office, it is important that it sets its sights beyond the short-term considerations. It is important for the sake of India's development, to lay down a simple but credible medium-term path of macroeconomic policies with 2003-04 as the year for referencing. Since we live in a world of uncertainty, it is necessary to have a mid-course review at the end of two years/three years in order to bring about necessary changes to the policy-set.

Credibility of such an exercise, however, would be realised and, in fact, enhanced if in the first instance the policies of the year ahead (that is, 2004-05) are drawn out of the exercise itself.

The first point of focus would obviously be the fiscal position of the governments at the Centre and in the States. The overall public sector deficit, not the deficit of the Central government alone, should be made sustainable.

The public sector deficit is currently estimated at double-digit figure — around 11 per cent of GDP — and it is clearly in the interest of long-term sustainability that it is reduced to not more than 3 per cent of GDP by 2008-09 with a margin of tolerance of 100 basis points.

For this to occur, the growth rate would have to be considerably higher than the average of 5.5 per cent of the last five years. In other words, the actual annual growth rate would need to be in the vicinity of 8 per cent on the average over the next five years.

One may not agree with the above numbers but there can be no quarrel over the direction to which the economy would have to move. There is, however, no definiteness that the logic of this argument would be pursued in the Budget for 2004-05. The size of the fiscal deficit would depend on who is in power at the Centre and by what margin.

One should not rule out the possibility of the fiscal deficit going up with expenditures especially in social sectors and on agriculture and some infrastructure projects including the famous bijli (power), sadak (roads) and pani (drinking water), pitched at high unsustainable levels and taxation strategies largely undisturbed. One hopes that expenditures on education and health do not fall in percentage terms.

The idea of improving receipts through disinvestment would be pursued depending again on the ideology of the party in power. One hopes that the temptation to be populist and to consider the main budget as a preliminary one to be followed by a supplementary budget in about six months from now would be resisted.

The medium term path for the Monetary Policy cannot be easily laid down because it is guided more by market expectations than that of fiscal policy. Facilitating an average annual growth rate of 8 per cent through adequate credit resources would have to be the first priority. Given the continued inflows of capital, the monetary authorities should not find it difficult to persuade commercial banks to extend larger amounts of credit to viable schemes without sacrificing the lending norms. But a strong medium-term economic recovery would also mean some hardening of interest rates from the present levels — a point where the governments' interests would collide since their interest-servicing costs would go up.

The best balancing act lies in smoothening interest rate increases over the medium term and to manage liquidity through active open market operations including the one associated with the issuance of market stabilisation bonds/bills. Apart from undertaking fiscal and monetary policies, the new government would need to undertake some major forward-looking policies. Support for such policies would materialise if they were clearly stated preferably along with a schedule of intended actions.

Three issues relating to the real sector need to be addressed with a sense of purpose and urgency. They are: The continued dependence of agriculture on weather conditions and other exogenous factors; the absence of fair competition in the industrial sector; and the inadequate development of infrastructure including power, roads and drinking water.

It is not that there are no solutions to these problems: There have, in fact, been a large number of suggestions of expert committees and views of specialists in these areas. It would be a pity if the new government wastes time by instituting committees after committees on these problem areas because there are no serious objections to most of the well-known solutions and because the government cannot afford to be casual about the aim of attaining an average rate of growth of 8 per cent on a sustained basis.

In the area of finance, the institutional and market development and regulation, corporate governance, and pension reforms (which also falls in fiscal area) are the critical ones to be addressed.

Market developments are constantly monitored and regulations are set in place. But this is an area where the exogenous factors play a major role now that the economy is gradually moving towards global financial integration. It is difficult to lay down a medium term path in this area but the message to the market participants would have to be clear assuring them of stability in the frame of policies. The record in this regard has so far been good but as financial integration processes get further strengthened, transparency and communication policies would have to be given emphasis.

In the medium term, corporate governance needs to be improved in line with the prevailing thoughts on the subject. But the relationships between the board composition and the performance of firms are not as yet clear and need to be researched into.

With the ageing of the population, and medical costs going up, the question of how to ensure that the returns on savings are sufficient to take care of real income needs to be seen not only from the prism of pension reforms under a regulatory set up but also from the viewpoint of how asset price profiles would evolve.

If equity returns were to be the main source of such earnings (for say the elderly), there is no knowing how the transmission channels of monetary policy would evolve in the medium term but that could perhaps be addressed through transparent policies and practices.

(The author, former Executive Director of the Reserve Bank of India, can reached at asurivasudevan@hotmail.com)