The Telegraph
Since 1st March, 1999
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- India’s forex reserves must be turned into a tool to spur growth

A mid-year review of the Indian economy was recently presented by the government of India. It added to the feel-good factor in the economy by improving on earlier predictions of the rate of growth of gross domestic product this year, pitching it at above 7 per cent, thanks especially to the turnaround expected in agriculture, due to the better than expected monsoons, as also the industrial sector.

It is not yet time for celebration. The rise in growth estimates of India has been against the perspective of rising rates of growth elsewhere. The global economy as a whole is growing again, with indications of growth pick-up in the United States of America. So too, the figures of growth in China and other east Asian countries should serve to remind us of the distance yet untravelled. China, according to estimates published by J. P. Mortan-Chase clocked an annualized rate of growth of 18 per cent in the first quarter of the year. So too, Taiwan and Singapore registered rates of growth of 15 per cent. Now that other countries are doing better, we should not rest on our oars.

The survey being one of a series mandated by the Fiscal Responsibility and Budget Management Act, its focus is rightly on the fiscal situation. The outcome of fiscal deficit to GDP in 2002-03 was worse at 5.9 per cent than what was expected earlier (5.5 per cent). Part of the reason was the decline in revenues consequent on the drought and increase in drought-related expenditure.

The first half of the current year shows an optimistic outlook in respect of the growth of revenues. Gross tax revenues have shown a spurt in the second quarter, growing by nearly 70 per cent from Rs 34,000 crore in the first quarter to Rs 60,000 crore in the next. Direct taxes also registered a sharp jump by 22 per cent over the same period of last year. Corporate taxes have shown an increase of 30 per cent. Equally impressive is the record of collections of service tax, growing by nearly 50 per cent over the same period last year. Non-tax revenues have shown a lower rate of growth, due to a lower Reserve Bank of India contribution.

On the side of expenditure, there is a continuing trend of increase. One, however, misses a detailed analysis of the contributory factors to this increase, although the review touches on the growth of subsidies. What measures are under contemplation to bring this under check is not discussed. One looks in vain for any discussion of this potential problem, apart from broad suggestions that measures are under way or under discussion. Following the experience in previous years, the turnout of fiscal numbers may be more adverse than the budget had estimated. While revenues go up by the stairs, expenditures go up by the elevator — given the pre-poll pressures.

Turning to the external account, the review notes that the current account has shown a reversal of the positive trend it has shown for six consecutive quarters. The outcome in the first quarter of 2003-04 saw a deficit. But capital flows are continuing to grow apace, partly due to the attractiveness of India and stock markets. The reserves are therefore growing fast. The government of India could meet the burden of repayment of the $5.18 billion Resurgent India Bonds, without the reserves going down even a bit.

The embarrassing affluence on the foreign exchange front has led to an appreciation of the rupee, which in turn has had an impact on exports. Exports grew only by 10 per cent in the first half of this year compared to 18 per cent in the corresponding period of last year. Appreciation of the rupee has also contributed to the increasing attractiveness of imports, particularly of gold and silver. But the economic experts in charge of the review tend to dispute the attribution of the worsening trends to appreciation of the rupee. Their argument is rather convoluted as it emphasizes the existence of other hurdles faced by the exporters. I quote from the review: “Simply trying to relate the export growth deceleration to the real effective appreciation of the rupee misses out on the important issues of productivity growth and the benefits of a market-determined floating exchange rate regime.”

With all due respect to the experts, this is too simplistic an approach. At the best of times, exports present a challenge. The importing country does not give much regard to the efforts we take to reduce these hurdles in the path of the exporter. They go by the price they have to pay in their currency. Appreciation of the rupee means our exports become costlier to the importing country. To deny that this affects our exports adversely is flying in the face of logic. Economists have tried to pooh-pooh the anti-appreciation lobby as protectionism of a different kind. But, other countries have shown that in their early stages of growth, appreciation of the currency is a handicap. We should learn from their experience.

One misses in the review an analysis of the trends in unemployment and poverty alleviation. I do hope that the coming economic survey, which the finance minister will lay on the table of the house before the budget is presented, will address these deficiencies. An economic survey should go beyond estimates of the rates of growth and fiscal deficit and should touch on important structural issues, such as unemployment and poverty.

The recent developments in Europe are a pointer to the risks that arise from a ritualistic adherence to fiscal standards. Both Germany and France are struggling to get out of the Procrustean bed that the growth and stability pact has imposed on them by restricting their fiscal deficit to 3 per cent and debt to GDP ratio correspondingly. True, Germany was once keen on such an act. But, by a strange turn of events, recessionary conditions in the euro zone have led to Germany and France breaching the standards of fiscal deficits laid down by the act and inviting punitive sanctions.

There is danger in such “medicine” being imposed irrespective of the health of the economy. We should learn from their experience. Fiscal standards should be tailored to fit in with the larger goals of growth and poverty alleviation. If fiscal rigidity stands in the way of growth, we have to consider twice before abandoning the latter goal, especially when the threat of inflation is not too great, given the abundant foreign exchange reserves and global trends.

The review touches briefly on the linkage between the expected spurt in economic growth and increase in public investment. But, it is guarded in drawing conclusions. Given the surfeit of forex resources, many economic experts are coming round to the view that increased public investment, with accommodating monetary and fiscal policy, is the best way we can use our current conjuncture of circumstances to prop up growth in the Indian economy. Otherwise, we will only be supporting the spendthrift habits of the developed world, such as the US, which sends us its IOUs in the form of its securities.

Our policymakers need to put on their thinking cap and evolve measures to transform an embarrassment of riches — our forex reserves — to a tool to spur growth. The political leadership should not fight shy of radical solutions to the problem of slackness in the economy in the midst of surpluses.

An investment upsurge, which will enable the country to reach higher rates of growth, with growth of jobs, is urgently called for. The coming budget will show whether the mandarins in charge of the ministry of finance and the finance minister are equal to the challenge posed by this happy convergence of forex reserves and unutilized capacity in the economy. Depending merely on export demand is not advisable.

Growth has to be provided by domestic sources. Public investment in infrastructure is, perhaps, the only answer as it will also help crowd in the private investment and thus increase the availability of jobs across a wide range of industries. Appropriate credit and monetary policies should also be encouraged. India is straining at the leash. Growth has to be spurred by a combination of public investment and accommodative monetary policies. Here is to hoping that the coming budget will unveil radical measures that break the “bottleneck” posed by forex flows and turn the challenge into an opportunity.

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