I have often been criticised for being critical of the present regime, even by people near and dear to me. One argument, which has often being flung in my face, is that I am being critical without being constructive. Though that is not correct, perhaps there is no harm in making those suggestions once again in a concise form here.
What is the root cause of the present malaise in our economy? At the risk of differing slightly with a learned economist like Manmohan Singh, who in a recent article said that the root cause was lack of investment, I would assert that the root cause is the “death of demand”. I am not an economist but according to me, growth in any economy depends on the growth in demand, both for investment as well as consumer goods. If that demand slackens, then the installed capacity will not be fully utilised, fresh investment will not take place, employment will slacken and the economy will get caught in a vicious cycle, as we are experiencing today.
The basic challenge, therefore, is to revive demand in the economy in a sequence where the revival takes place first in the investment goods sector, automatically followed by boost in demand for consumer goods through enhanced employment opportunities. This is the prescription we had followed in the Atal Bihari Vajpayee government when we were faced with the East Asian crisis and the post-Pokhran global economic sanctions soon after the government assumed office in March 1998.
In a developing country like India, there is no dearth of “good” demand. We still have to provide so many goods and services to our people in order to improve their “quality of life”. Simultaneously, we have to create new infrastructure and improve the existing ones to reduce the transaction cost in our economy and make it more competitive. There is so much to be done really. The emphasis on construction of roads of all kinds — rural, state and national highways, the new telecom policy, the investment in railways, the emphasis on housing construction and development of real estate, the improvement in rural infrastructure and reform in the agricultural sector were all meant to lead to creation of demand in the economy. But we also sequenced the creation of demand in such a way that the demand for investment goods picked up first and faster, which created the virtuous cycle of full capacity utilisation, followed by fresh investment for new capacity creation, larger employment opportunities of various kinds — unskilled, skilled and highly skilled — which reached money into the pockets of people leading to a surge in demand for consumer goods. In fact, my quarrel with the policy that the UPA government adopted in the wake of the global financial crisis of 2008 was precisely on this count. The UPA government reversed the sequence, went for strengthening consumer demand first, which in the absence of sufficient supply side measures, led to inflation which in turn forced the RBI to raise interest rates 13 times, making money unaffordable and leading to a collapse of fresh investment. The fiscal deficit, especially revenue deficit, went up steeply.
This government is also barking up the wrong tree. First of all, it is solely responsible for the present slowdown. Second, it has no understanding of what has caused the problem. Third, therefore, it is flailing its arms in all directions except the right one and causing more pain. All commentators are agreed now that instead of tackling the demand side it is dealing with the supply side, which is tantamount to a doctor prescribing medicine for TB instead of dealing with the coronavirus. For instance, if, instead of wasting a precious amount of Rs 1,45,000 crore on tax relief to a limited number of corporates the government had spent that money on rural infrastructure and agriculture and a part of it on railways and highways, it would have led to the creation of demand both for investment goods as well as consumer goods. Alas, the money has been wasted, certainly in the short term. And who has seen the long term?
There is also the issue of resources. Where is the money for my prescription? Here, therefore, let me deal briefly with the issue of fiscal deficit. The government claims that it has stuck to the fiscal deficit targets despite all the pressures on the fisc. This claim of the government must be the subject matter of another discussion. But, as the author of the Fiscal Responsibility and Budget Management (FRBM) Act, I must express my great disappointment at the cavalier manner in which the provisions of this Act have been treated by all subsequent governments.
The basic purpose of the act was to eliminate the revenue deficit completely within a short period of time and live with a limited fiscal deficit. The reasons for this were simple. Revenue expenditure of the government is generally considered to be unproductive expenditure like the huge amount we pay by way of interest on past loans. Therefore, if you borrow money from the market to pay for revenue expenditure you will be hard put to repay that loan because that expenditure does not produce any returns. On the other hand, if you invest the money you have borrowed gainfully, debt servicing will not pose a problem.
In other words, borrowed money should be spent as capital and not as revenue expenditure. The original FRBM Act, therefore, mandated that revenue deficit should be eliminated completely and rest of fiscal deficit should be limited to one per cent of GDP. I shall have no quarrel if, in special circumstances like today, the fiscal deficit is allowed to go up to even two per cent of the GDP, which will mean an amount of Rs four lakh crore. Can you imagine the multiplier effect on the economy if the government were to spend this amount on infrastructure?
But let us look at the latest figures. The government has taken credit in the Budget for the fact that it has successfully restricted total fiscal deficit for this fiscal to 3.8 per cent and for next fiscal at 3.5 per cent of the GDP. What the finance minister has failed to point out is that the revenue deficit for the current fiscal is 2.4 per cent of the GDP and for the next fiscal it is 2.7 per cent. In other words, minus the revenue deficit the fiscal deficit is only 1.4 per cent of GDP for this year and for the next year, it is 1.7 per se. So, the real villain of the piece is revenue deficit and not fiscal deficit per se. It is clearly the government’s responsibility to manage its expenditure and carry out reforms in it, including austerity in expenditure. I see no signs of that. Controlled fiscal deficit will make more money available in the market for private sector investment and help RBI in reducing interest rates — things which will have an overall benign influence on the economy.
A lot of other things will have to be done, no doubt, like preventing companies, specially banks from failing, to further strengthen the growth impulses but in the present situation, the key is government spending and in the desired sequence. Is any body listening?
This article first appeared in the print edition on March 10, 2020 under the title ‘A prescription for revival’. The writer is a former finance minister.
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