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A few right steps

What we should do to retrieve the India story

Written by Nilesh Shah |
December 26, 2011 3:58:30 am

Rising deficit,falling rupee,stubborn inflation,stagnant investments,a dropping Sensex and policy paralysis have cast a dark shadow over the Indian economy. Has the macro-economy deteriorated as much as it is perceived to be? Is the situation beyond retrieval?

The Sensex has fallen in price as well as valuation terms for the whole of 2011. However,it is still trading at a premium to its peer group. The Foreign Institutional Investors’ confidence is visible in terms of marginal outflows this year (as compared to large outflows in 2008). Notwithstanding the gloom around,that is reassuring.

India has many problems. The good news is that some of them are self-inflicted and can be solved with relative ease.

The free fall of the rupee has created a fear of adequate reserves for the world’s seventh largest holder of foreign-exchange reserves. This year’s trade deficit of $117 billion is one culprit. We need to reduce the import of gold,lower the trade deficit with China and limit remittances abroad to make deficit a non-issue. India is expected to import 850-1,000 tonnes of gold in 2011-12,aggregating to $52-62 billion. As the world’s largest holder of gold,this is avoidable. We need to find ways to monetise gold or re-circulate the gold we hold within the country. We don’t have to go to extremes,like the US,which nationalised gold in the early 1930s. The trade deficit with China is expected to cross $25 billion in 2011-12. We need to send a strong message to narrow the gap or create barriers which will narrow the gap. The remittance sent by Indians,primarily on travel and education,is expected to cross $5 billion in 2011-12. We need to develop quality educational institutions in India to manage that outflow. As a bonus we may end up attracting students from abroad,creating inward dollar flow.

The fiscal deficit (Central,state and off-budget liabilities) is likely to cross 10 per cent of the GDP in 2011-12. India is spending more than what it earns at an alarming rate,especially on revenue expenses. Our tax to GDP ratio,at under 10 per cent,is the lowest in the peer group. India forgoes about 6.5 per cent of the GDP as tax concessions. Only 20,336 returns have been filed declaring income in excess of Rs 1 crore for 2009-10. There is a huge scope for improvement in tax collection except from the salaried class. We need to enforce tax rules through better administration. We also need to fast-track laws like DTC and GST to improve tax compliance. On the expenditure side,subsidy is a big spend. Undeserving subsidies like diesel for automobiles and cooking gas for APL families can be removed gradually,if not at one-go. The payment of subsidies through bank channels,market pricing of petrol and linking of payment to identity cards like the UID will help in curtailing subsidies. Better tax administration and reducing the leakage in subsidy payment can bring the deficit to manageable levels. In the intervening time,divestment of the Government of India’s assets across PSU equities,land and spectrum can keep the deficit within reasonable limits.

Inflation has been stubbornly high this year. While the RBI is keeping liquidity tight and rates high on a nominal basis,its impact is felt more on growth than on inflation. An increase in the Minimum Support Prices,a sharp increase in M3-GDP ratio from 53 per cent in 2001 to 80 per cent in 2010 and the recent depreciation of the rupee are keeping inflation sticky. It is impressive to note that consumer durables like TV,refrigerators,air conditioners and computers,or services like telecom are today available at prices lower than what they were even in 2000. Economies of scale,appropriate technology,open-market competition and facilitation by government have tamed inflation in these sectors. We need to apply the same lessons to other sectors,especially in agriculture,to manage inflation on a long-term basis. We need to improve the yield in agriculture sector rather than compensate farmers through higher MSPs.

While there are concerns about growth slowing down to below 7 per cent in 2011-12,this should be seen against the backdrop of a tight monetary policy. On a base of 2008,India has matched China in terms of growth over the past three years and is way ahead of many of its peers. While India has a higher savings ratio,the bulk of its savings is in physical assets like gold and real estate,leaving little financial savings for investments. In the residual financial savings,the private sector has to compete with the government’s funding of the fiscal deficit. We need to monetise gold to increase financial savings and make enough available for investments to support growth. Growth will move to higher levels if it can be complemented by a transparent approval process and support at the ground level for the speedier execution of projects like the Delhi Metro.

India has an unfunded and growing pension liability. Pension payments are likely to exceed Rs 55,500 crore in 2011-12. Future pension liability is capped under the New Pension Scheme as it is on a defined contribution basis. Past pension liability is a cause for concern as it is on a defined benefit basis. We can consider launching a sovereign bond issue (which will not be an easy task but is doable with a little hard work and planning) at near-zero level of interest rates. We can use this money to commute pension liability,that is,pay pensioners a lump sum amount today against monthly pension through their lifetime. The difference between the rate at which dollar borrowings are made (can be as less as 0-2 per cent) and the rupee discount rate for calculating the net present value of future pension liabilities itself will mean huge savings. The dollar inflow through the sovereign bond issue will comfort the rupee and prompt pensioners to save too. It can spur consumption as well as investment to support growth. The appreciation of the rupee through corrective action over the tenure of bond can reduce the interest burden. It may look unconventional,perhaps could be inflationary,but can be managed and bring in significant rewards.

India’s macro-economic environment has deteriorated more in terms of perception than in reality. A few right steps and the perceptions can change quickly,making India an oasis of growth amid a global desert.

The writer is director,Axis Direct,an online portal for investors

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