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The arbitrary decision had wider repercussions. As the PM noted, the consequent impact on the sentiment of foreign investors led to the withdrawal of capital out of India. At a time when the country is running an enormous payments deficit, the capital flight can only lead to depreciation of the rupee. India's payments situation has never been so adverse since the crisis of 1991. Luckily, the Reserve Bank has some reserves and can ride out the storm for some time. But it is time for the government to take action. Domestically, the situation is not so desperate, but the economy is obviously not in good shape. The combination of falling growth and high inflation is one that would have worried any finance minister. The changeover in the finance ministry has not come a moment too soon.
However, the economic situation did not fall from heaven; the finance ministry's steering of the economy contributed to it. It was not just the last budget; throughout the tenure of the last two finance ministers, economic management has been poor. The reversal of retrospective taxation is urgent, but it is unlikely to be enough to turn around the economy. Policy-making has been as retrogressive in the past four years as it was in the years before the reforms; if the damage it did is to be repaired, it would require a close look at all that was done, and a reversal of many detailed measures. Although the steps announced by Manmohan Singh in his budget of 1991 made all the news, the process of reforms was a long-drawn one; it went on at least till the abolition of import licensing in 2001. The PM does not have so much time this time. His party is going to face a general election in two years; if recent election results are any guide, it faces a very difficult situation. He therefore needs to have a much greater sense of urgency this time. And he will have to concentrate on a handful of crucial actions that can turn the tide.
His policy options on the balance of payments are limited. The RBI has been depreciating the rupee anyway; faster depreciation would not help much. It has also done everything to attract foreign capital. But the finance minister's measures to scare it away were overwhelming.
Hence the best the PM can do is to concentrate on inflation. Here too, the RBI has tried all it can; monetary policy cannot achieve much more. That leaves a short-term and a long-term option. The short-term option is to bring down foodgrain prices. All that is required is that the government should start selling its indecently large stocks of wheat and rice. Their consumers, who are an overwhelming majority as against producers, would bless him if he brings down food prices. The question is whether he has the political courage. Surplus producers of wheat and rice, whom the present government policy of inexorably pushing up prices helps, are organised and concentrated in a few states; a government that has tried to please them for years is unlikely to be prepared to displease them now.
The long-term option is to use fiscal policy to reduce inflationary pressure. Both Chidambaram and Mukherjee ran recklessly large fiscal deficits; they were the prime movers of inflation. Now the PM has a chance to reverse their profligacy and present himself, as he did many years ago, as a responsible finance minister. He can do so by cutting government expenditure, or raising taxes, or both. There are good candidates for expenditure cutting. Foodgrain subsidies go, to a large extent, to finance bribes to politically influential intermediaries; the poor, in whose name they are given, hardly ever see them. And precisely for that reason, the PM may not see his way to cutting them.
Employment subsidies, which go under the grandiose name of the Mahatma Gandhi National Rural Employment Guarantee Scheme, also largely end up in the pockets of political intermediaries. The PM could save thousands of crores of rupees on subsidies. That is what the doctor would recommend; the question is whether he can persuade the political patient inside him to take the medicine.
(This story was published in Businessworld Issue Dated 16-07-2012)