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IMPROVING THE ECONOMY
- Politicians must observe how subsidies affect deficit

The years 2009 to 2011 saw India register a growth of gross domestic product by 8.4 per cent. This year it may be 4.8 per cent and the government talks of it climbing to 5 per cent next year. This may be better than most other countries. However, the comparison must be with our past record, not with others and those, too, developed economies. Since 2008 the powerful economies of Europe and the United States of America have been caught in major failures in their financial markets. Their growth is only now appearing to recover.

The Congress has run the Central government for 10 years and the Bharatiya Janata Party before that for almost six. Could either have done better today? Coalition governments and a weak global economy imposed some constraints. But all politicians are reluctant to raise administered prices (petroleum products, foodgrains, and health and education services). Poorly identified beneficiaries in social schemes (education, employment, food security, livelihoods, health) have led to rising social expenditures. They have further added to deficits. No politician will happily reduce or withdraw them. Economic growth, with better tax revenues, had kept deficits, owing to rising expenditures, low. The economic slowdown without cutting expenditures has led to higher deficits. These have led to inflation, declining savings and investment, poor industrial and employment growth.

India had an unannounced ‘stimulus’ through public investment during 2007-08 to 2009-10 (per cent to GDP 8.9, 9.4, and 9.2), falling thereafter. But in the same period, private investment was in decline. The public investment was in infrastructure, but implementation has been tardy because of slow government clearances. Consumption expenditures also rose as government added heavy expenditures on social schemes. Inflation rose, hence interest rates, further slowing the economy.

The global economy did have adverse effects as fund inflows and exports slowed. Oil prices remained high. With oil and gas imports making up almost 80 per cent of our imports, the balance of payments deficit rose and the external value of the rupee fell. However, the important reasons for the economy declining were our domestic policies, not declining global economy. In contrast, China did not have such a decline as we did.

Over the last three years, we have had record fiscal deficits, declining tax revenues as percentage of GDP, high balance of payments deficits, declining savings and investments, erratic overseas fund flows, poor industrial growth, enormous delays especially in infrastructure projects, and consequent pressure on bank finances and performances. High non-performing borrowers, high interest rates, and persistent high inflation, especially in food products, characterize the economy. Urban households have suffered because of poor employment growth and the rising costs of housing, transportation and food. Urban consumption expenditures have fallen, adversely affecting industry.

Rural incomes have been rising owing to rising crop support prices, good rains, write-offs of bank loans to farmers, substantial handouts under the employment guarantee and other schemes. Apparent rural prosperity has made industry try to develop rural sales. Rural prosperity is based on misguided policies (of subsidies — electricity, water, fertilizers and loan write-offs) and may be unsustainable.

The combined fiscal deficit of Central and state governments which was 4.04 per cent in 2007-08 went up in subsequent years to 8.44 per cent, 9.39 and 7.72 per cent. The finance minister is targeting 4.8 per cent, expected to be much exceeded even with postponing payments of bills due this year to next year. The deficits primarily owed to subsidies (mainly on petrol, diesel, kerosene and gas), and unbridled growth in social welfare expenditures. The highest deficit was in the same year as the start of the global economic crisis when India showed a GDP growth of 8.4 per cent. ‘Stimulus’ added to incomes, expenditures and inflation. It did not add much to outputs. The deficits on the current account in the balance of payments also spurted from 2.6 per cent of GDP to between 3 and 4 per cent each year. The rupee to dollar declined in 10 months from Rs 43 to Rs 67.

Over half of the revenue receipts of the Central government are spent on subsidies (around 5 per cent of GDP), in which fuel subsidies are estimated at 2.9 per cent. Then there are social schemes like the national employment guarantee programme, food security, national rural and urban health mission and so on. The Mahatma Gandhi National Rural Employment Guarantee Act alone had spent Rs 38,034 crore in 2011-12 and in 2012-13 Rs 29,433 crore. Repeated studies in different parts of the country have shown that a large part of these expenditures are diverted to the undeserving. So it is with subsidies. For example, 40 per cent of subsidized kerosene is estimated to go for the adulteration of diesel. Similarly, much food for the poor ends up in the markets.

The BoP deficit is caused by the global economic decline and high crude oil prices. But our policies are also responsible. Thus, we surrendered garments to Sri Lanka and Bangladesh. Our labour laws do not encourage factories to have 20,000 or so workers as those countries do. Our labour laws make labour intensive product exports uncompetitive. Iron ore exports are down due to bans caused by scams. The rupee decline led to massive gold imports.

Investment in infrastructure as a percentage of the GDP has been rising, and rose sharply from 2008. It was 5.71 per cent in 2006-7, 7.18 per cent in 2008-09, 7.51 per cent in 2010-11 and 8.37 per cent in 2011-12. But implementation has lagged because of the slow government, coal supply setbacks, the rise in imported coal prices, and unavailable gas. With around 80 per cent as bank financing, banks are now sitting on over Rs 7 lakh crore of loans to projects the implementation of which is stuck. Banks are in poor financial shape as a result. Now the prime minister’s office has taken charge of expediting clearances and is said to have cleared over half already.

Tax revenues to GDP, already low with comparable countries, showed a decline from 18.79 per cent in 2009-10, and 17.52 and 18.01 per cent in the next two years. Non-tax revenues are also not growing as expected. The fiscal deficit went up and has triggered high inflation, especially in food products, for the last two years. Subsidies have been considerably reduced in the last year, with government at last moving to market-based pricing for oil products. Petrol prices are now linked to imported crude prices. Diesel prices are being raised gradually.

However, fertilizer subsidies are rising. Social scheme expenditures are also being tightened. It does not appear that there is adequate reduction in these expenditures to truly reduce the deficit. The usual subterfuges like postponing to next year the payment of substantial bills of the current year may show a lower actual deficit figure this year.

How should a prudent Indian political party, the BJP or the Congress, manage the economy? All Indian politicians are populists. They rightly spend on the poor through subsidies and supports. However, they must always keep a close watch on revenues and the effect of the expenditures on the deficit. Growth is a valuable accompaniment to populism since tax revenues go up with growth. All import costs of products with high import content (petroleum and other oil products, fertilizers and so on), should be covered in their prices. Bureaucratic and administrative implementation procedures should be tightened. The individual accountability of all bureaucrats must be ensured. Penalties for stealing from such schemes must be severe. Targeting of beneficiaries and identifying them, with a direct benefit transfer, must be ensured.

Thousands of micro bank branches must be opened. Government accounting must shift from cash to accrual to prevent budget subterfuges. The government must get out of managing public sector enterprises, including electricity, and make them independent. The goods and services tax must be expedited to make India a single market. Incentives for savings and investment would help. Most of these are not political decisions but good governance. Both the BJP and the Congress must take and implement them.