The Hindu Business Line : IMF's study on Budget

HAVING crossed the first stage of general discussion on the 2004-05 Budget in Parliament, the Finance Minister, Mr P. Chidambaram, has the unenviable task of taking on board the concerns of members, in general, and the Left parties, in particular, to some of his controversial proposals such as hike in the sectoral cap for foreign direct investment (FDI) in telecommunications, insurance and civil aviation and addressing them head-on.

`Idea of India'

But Mr Chidarmbaram need not get unduly upset over convincing his own allies, leave aside the Opposition parties, particularly the Bharatiya Janata Party (BJP), which had its own reservations on the hike in the sectoral cap in insurance, as also the validity or otherwise of his salutary intentions in this regard. No less a body than the International Monetary Fund (IMF) has in its latest working paper praised "the habitual pragmatism and gradualism of Indian policy-making dictated by the need to manage pluralism and diversity", which it described as the organising principle of the "idea of India," more of an asset than a liability.

In a monograph, Why India can grow at 7 per cent a year or more: Pragmatism and Reflections, the Fund's Research Department Senior Economist, Mr Arvind Subramanian, and Prof Dani Rodrik, at Harvard University, state that India should eschew the mistake Latin America made in the 1990s by hastily embarking on an overly ambitious agenda of economic liberalisation and privatisation that ran ahead of the supporting institutions or the productive abilities of their economies. They say that economic growth is best sustained by keeping the private sector excited about investing in the local economy. "This requires a pragmatic set of policies toward the private sector that combine carrots with sticks, incentives for dynamic efficiency with market disciplines".

The authors rightly say that the knee-jerk reaction of many economists to move as quickly and as broadly as possible in areas such as privatisation (in infrastructure sectors), labour market reform and capital account liberalisation has to be tempered with serious empirical analysis and an appropriate concern for social and distributional impacts. Does not the National Common Minimum Programme (NCMP) postulate the constituents to move ahead on the reform path with a human face? Probably, the Left parties, which opposed Dr Montek Singh Ahulwalia, who landed from the Fund's first Independent Evaluation Office (IEO) to the Planning Commission, should derive comfort from the metamorphosis the IMF had made over the years to prescribe reform, tempered with concern, for its social and distributional impact.

Delineating developments in India's economic performance over the last two decades, the authors said India experienced very high growth of output per capita at 3.8 per cent per year, surpassed only by China and the East Asian countries. Second, Indian growth was the most stable, surpassing even China and the East Asian countries with the standard deviation of output per worker being the smallest for India. Third, the contribution of growth of total factor productivity (TFP) to overall labour productivity growth was the highest in India — about 60 per cent — a feat that was only surpassed by China. India's per capita income growth has, therefore, been extensive — motored by productivity — and, hence, sustainable in the future, rather than anchored in deferred gratification, which runs into the limits imposed by diminishing returns to capital.

Step-by-step approach

As the TFP growth of 2.5 per cent per year has been achieved with relatively modest reforms, especially in the 1980s, there is still unexploited potential. With reforms proceeding apace, the level and pace of improvements in TFP would be enhanced, they said. On the need for going apace with reforms, they said while reforms were crisis-driven in the early 1990s and, for that reason, stalled in the mid-1990s, there has however been, over the last few years, a distinct pickup in the pace of reforms — in telecommunications, electricity, transport and privatisation. Now that reforms are going from being crisis-driven to success-driven, wisdom lay in persuading allies, both willing and unwilling, on the importance of going ahead on this path measure by measure, instead of wallowing in helplessness. Mr Chidambaram has packaged in his Budget a step-by-step approach to reforms to earn the plaudits of a larger constituency in no unmistakable manner.

There can be no two opinions on the soundness of setting apart higher allocation for education and health sectors in the Budget with even the 2 per cent cess designed to mop up resources to redirect in these two important segments of the populace being ungrudgingly underpinned by all sections except exporting community which appears to be seeking exemption even from this well-meaning cess.

Reputed economists have always laid due emphasis on high levels of human capital as a vital precondition for a developing country to exploit the benefits of technological progress. The Fund study said India's stellar productivity growth in the last two decades and not just in the information technology (IT) sector has benefited from its stock of highly educated human capital. The study reckons that the growth in the skilled labour force in the future available for domestic activity would be greater than in the past because of less emigration and, possibly, the return of previously emigrated Indians.

Stress on education

But the other side to this positive trend is the contribution of less-skilled labour to growth. The future evolution in participation rates and basic educational attainments remain two key unknowns, as the IMF study has diagnosed, implying that the time to bestow attention on basic education in India has come. From this perspective, the Budget stress on higher provision for basic education and enrolment assume added importance. As participation rates in schooling in India have been stubbornly dismal despite rising levels of education, the Fund study expects that if this changes in the future, the impetus to growth could be substantial. For instance, a 10 percentage point spurt in the participation rate over the next two decades would add another 0.3-0.4 percentage points to growth rates.

Disparity between States

The study also highlighted the disturbing trend in the last two decades of rapid growth was the growing disparity in economic performance between two groups of States. Instead of convergence among the States, the Fund study detects big-time divergence, with peninsular India growing more rapidly than the hinterland BIMARU (Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh) States. The disparity between States is both a cause for concern but also the consequence of a very powerful positive dynamic in India, namely the competition among States to improve institutions and policies — a sort of "race to the top"— as a means of attracting increased amounts of foreign and domestic capital.

For these reasons, the IMF study reckons that the divergence is self-limiting — States left behind would be under pressure to follow the demonstration effect of the more successful States or else face the consequences. Lest this should sound too harsh, the Budget has proposed Backward States Development Fund that might help alleviate the crushing burden of disabilities plaguing these States.

Economic goals

The United Progressive Alliance Government, led by the reputed economist, Dr Manmohan Singh, has, in the NCMP, spelt out seven clear economic goals, encompassing a growth rate of 7-8 per cent per year for a sustained period, universal access to quality basic education and health, generating gainful employment in agriculture, manufacturing and services and promoting investment, accelerating fiscal consolidation and reform and ensuring higher and more efficient fiscal devolution, besides assuring 100 days of employment to the bread-winner in each family at the minimum wage and focussing on agriculture and infrastructure.

The Budget 2004-05 is naturally premised on these goals and the few reformist signals it flashes are only to sustain investor interests, both domestic and international. It is also a testament to the success of India's gradualist reform process as no less an institution than the IMF, to which India leaned for tiding over its worst balance of payments (BOP) crisis in the early 1990s, is now acknowledging the self-styled approach India has crafted to lift itself out of the woods.

It is also not off the mark to recall that before demitting office at the IMF, Dr Ahulwalia, told IMF Survey in an interview that the new Government has announced a CMP with a target growth rate of 7-8 per cent combined with economic reforms that have a human face. He said that this means, "We have to address very large deficiencies in the social sectors, particularly in health and education." Will the Left now focus its attention on beefing up social sector outlays instead of expressing its resentment over declared policies of the ruling Government, even as the latter has committed it to undertake "reforms with a human face"? If policy space for carrying out even incremental reforms is restricted, the UPA Government would fast lose its credibility even with indigenous investors and crumble under pressure, leaving the potentials of the economy unrealised and unrealisable. Hence, the Left parties supporting from outside would have to be a bit circumspect in not rocking the boat.

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