The author is former governor, Reserve Bank of India
The Reserve Bank of India’s report on currency and finance 2001-02 released recently has an unusual disclaimer that the findings, views and conclusions expressed in the report are entirely those of the contributing staff of the department of economic analysis and policy and should not necessarily be interpreted as the official views of the RBI. The RBI normally owns the responsibility for the conclusions of reports which are issued from its portals. It is not, however, clear to me what the RBI gains by distancing itself from the conclusions of a painstaking effort by its experts, which are intended to set policy guidelines for the central bank of the country. Notwithstanding the disclaimer, commentators have proceeded to treat the report with respect that is due to whatever comes from Mint Street.
The report also tries to analyse the development of the reform decade as a whole. It presents a slew of facts and figures to help a debate on the content and direction of reform. While the report is understandably weighted in favour of the reform process, it has not shut out dissent. Discussion of the performance of the economy in the decade of reforms as well as in the previous decade is a feature of the report.
Turning to its review of 2002-03, the report notes that the fiscal deficit in the revised estimates for 2002-03 has a higher percentage of gross domestic product than visualized in the budget. There is, however, ample liquidity in the banking sector, and the interest rate environment continues to be soft. The Centre’s borrowing programme is going smoothly, helped by the large and continuing capital inflows from abroad, which are sterilized by the central bank. Sterilization involves the central bank buying dollars from the participants in the financial sector, such as banks, and exchanging them for government securities. The very large inflow of foreign exchange is, thus, indirectly contributing to the creation of demand for gifts.
The report notes with satisfaction that inflation has remained moderate notwithstanding the reduction in agricultural production and the global volatility in oil prices. Headline inflation measured by point-to-point changes in the wholesale price index edged up to 4.7 per cent on March 1, 2003, while the annual average inflation had decelerated to 3 per cent on the same date, compared to 3.9 per cent the year before. Whether as part of the after-effects of the Iraq war inflation will rise further remains to be seen.
The report has a good story to tell on the external front. The current account of the country recorded a larger surplus than in the previous year, despite a pick-up in imports. Capital flows, including non-resident Indian deposits, remain comfortable. As a result, there was an accretion of $ 20 billion to the country’s foreign exchange reserves during the period. India today ranks seventh in the world in the size of forex reserves. The report notes the modest appreciation of the rupee.
The report does not give details of the manner in which the reserves are deployed in various securities of the developed world. The RBI is a master of its own financial management. It, however, stands to reason that considering the large magnitude of reserves deployed and the potential loss of earnings in view of low interest earned by securities in the developed world, there should be an independent review of the reserve management policy of the central bank from time to time. The results of such a view should be periodically placed before Parliament.
The report has attempted an analysis of the changes in the macro-economic performance in the decade of reform as well as the previous one. In the pre-reform decade, India had a growth rate of 5.6 per cent of GDP. The period from 1992-93 to 2002-03 has shown only a marginally higher rate of growth of 6.1 per cent. The contribution of reforms to the rate of growth has not, therefore, been too significant.
The report, however, suggests that the rate of growth of 5.6 per cent in the Eighties was itself achieved at a cost of rather unsustainable fiscal performance. The report’s data, however, do not substantiate the argument fully. For the period 1981-82 to 1989-90, the fiscal deficit as a percentage of GDP was 8.03 per cent, while it rose to 9.13 per cent in the period of reforms from 1997-98 to 2001-02, which according to the report, slipped.
It is also significant that in the evil Eighties, the revenue deficit was only 1.65 per cent of the GDP as against 6.07 per cent in the reform period. The problems that confronted the economy in the beginning of Nineties cannot, therefore, be fully attributed to the fiscal deficit of the previous period.
The spill-over of the deficit of the Eighties into the external account was the prime reason for the problems that the economy confronted in 1991-92, because of short-term borrowing from the external market to meet the balance of payments needs. The jury is still out as to whether the country needed this borrowing to balance the fiscal account. If the first Iraq crisis of the Nineties had not occurred and the consequent withdrawal of the rating of India had resulted in an outflow of NRI deposits, the 1991 crisis would not have been so serious. Not that there was no flaw in the conduct of the macro-economic policy of the Eighties. But, by the standard dimension of fiscal performance, the Eighties were not as fiscally bad as the reform period.
On the plus side, in the pre-reform period the country had invested well in infrastructure. The fiscal deficit was on account of investment expenditure and not on revenue account. One of the consequences of slowdown in investment in infrastructure in the recent period has been the decrease in manufacturing as a percentage of the GDP.
The report highlights that India’s share of industry in GDP has remained relatively low at 25 per cent compared to China, which has raised its share from 42 to 51 per cent. Even Indonesia, which is comparatively backward, has a share of manufacturing in industry at 47 per cent, Malaysia at 45 per cent and Thailand at 40 per cent. We rank with the laggards, like Brazil, Argentina and Mexico, which have 28 to 29 per cent. The low share of manufacturing in GDP has important repercussions in the growth of blue-collar employment. Unemployment in rural areas cannot be handled unless manufacturing increases its share in GDP.
The report cites many reasons for the slowdown in manufacturing in the reform period. One is the credit crunch initiated as part of the reforms. Tightening of liquidity in the money markets in 1995-96 may have also contributed to the decline in funds available for manufacturing. The report cites rising interest rates during the earlier part of the reform period, which led to entrepreneurs being reluctant to make fresh investments.
The industrial slowdown also reflected the slowdown in the government’s capital investments, particularly in infrastructure. Industrial growth is handicapped by infrastructural bottlenecks and high rates for power for industries. They pay high tariffs to meet power utilities’ losses on account of subsidized power to agriculture. Unless these are changed, the growth of manufacturing will be slow.
As important as the infrastructural bottlenecks is the shortage of credit. The reform period saw a slowdown in credit to small and medium industries. The institutional mechanism for ensuring adequate flow of credit to small and medium industries needs to be revived. Focussed attention must be paid to cleaning up the mess created by the flawed functioning of state finance corporations, with their non-performing assets. State finance corporations, which provide term capital to small and medium industries, need to be revived. The state governments must attend to this.
A revealing part of the report is its section on the role of services in the Indian economy. The growth of public administration and defence, particularly in the context of the recommendations of the fifth pay commission, did contribute to the growth of the services sector. However, the report points out that the services sector as a whole has been growing more in other components, such as financial services, information technology and so on. The opening up of the economy as a result of reform also contributed to the growth of services. So did the role of exports. Services contribute 50 per cent to our GDP. It is quite likely that the share may grow even more.
The RBI report on currency and finance has provided useful insights into the working of the reform process and implicitly suggests a number of action points for policymakers. It has rendered a signal service by eliciting the relative performance of the pre-reform decade and the reform decade. It points out the loopholes in the process of reforms. The policy-makers in Delhi and Mumbai will hopefully take to heart the insightful contributions that have been made in the report.