The Hindu Business Line : A review of reforms

THE RBI's latest Report on Currency and Finance 2001-02 is marked by an interesting and 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 central bank. The need for such a disclaimer is not clear.

The distinction drawn between the views of one of its wings and itself can be a distinction without a difference. What comes out of the portals of the central bank has necessarily to be assigned the respect and regard due to it as having the imprimatur of the issuing authority. A disclaimer cannot reduce its importance.

The RBI is much more than a centre of research. It uses research as a tool for making policy. Staff reports issued by the RBI cannot be viewed in isolation from the central bank. The analogy with the World Development Report issued by the World Bank is far-fetched. The subject matter in this case is vital to the RBI's role.

Subject to this reservation, the report lives up to the reputation of its predecessors. It is marked by professional excellence and attempts a comprehensive review not only of currency and finance in the previous year, but also over the decade of reforms as a whole. Intellectually, the report is quite stimulating.

It brings together varying shades of opinions and research on this complex subject. Understandably, it is biased in favour of reforms. But it gives space to dissent as well.

I propose to devote this piece not to a review of the report in its entirety, but to cull out certain aspects of its excellent summary of the data relating to the last decade.

The report notes the recent deterioration on the fiscal front with the gross fiscal deficit at 5.9 per cent of GDP in the Revised Estimates (RE) 2002-03. The report, however, notes that monetary conditions remained stable with ample liquidity creating a favourable interest rate environment conducive for investment. The Centre's market borrowing programme went on smoothly. Large and persistent capital inflows from abroad were sterilised by timely open market operations led to a moderate expansion in base money.

M-3 growth, net of merger effects, was below the projections made by the RBI's Monetary and Credit Policy for 2002-03. Bank credit to the commercial sector, however, increased by 11.3 per cent, a marginal rise over 9.2 per cent shown during the corresponding period of the previous year. The revival in non-food bank credit reflects improvement in the industrial climate. Inflation has remained moderate, notwithstanding the shortfall in agricultural production and volatility in oil prices.

Headline inflation, measured by point-to-point annual changes in WPI, edged up to 4.7 per cent on March 01, 2003 due to a hardening of international oil prices and base effects.

On an annual average basis, however, the inflation rate decelerated to 3 per cent as on March 01, 2003 compared to 3.9 per cent in the preceding year. The prospects of further inflation in the light of West Asian developments, however, remain to be seen.

Referring to the external front, the report notes that the current account balance recorded larger surplus than in the previous year despite a reasonably well-distributed pick-up in imports. Capital flows remained stable both on account of FDI and non-resident deposits. This salutary development resulted in a record accretion of around $20 billion to foreign exchange reserves during the year. The report records with some degree of gratification that today India stands seventh in terms of the size of its reserves. However, it notes that these accretions resulted in a modest appreciation of the rupee with implications for export competitiveness.

What is particularly relevant to the reader is the attempted analysis of the economic developments in the decade preceding reforms. The report notes that in the decade preceding reforms India had a growth rate of GDP of 5.6 per cent while the period from 1992-93 to 2002-03 showed a marginally higher rate of growth of 6.1 per cent.

The report suggests that the higher rate of growth of 5.6 per cent in the 1980s compared to 6.1 per cent of the 199os was achieved at a cost of unsustainable fiscal performance. Note, however, that the fiscal deficit was 8.03 per cent of GDP for the period 1981-82 to 1989-90 against 9.13 per cent for the period 1997-98 to 2001-02. The fiscal performance was not too bad in the pre-reform period.

The pre-reform decade had witnessed a substantial increase in public investment in infrastructure, particularly on power, transport and rural development, which was reduced in the 1990s. The fiscal reform of the 1990s was essentially achieved by a contraction in investment. Again, the revenue deficit in the pre-reform decade was only 1.65 per cent of GDP against 6.07 per cent for the reform period 1997-98 to 2001-02 (see Table 1). The quality of fiscal reforms definitely leaves much to be desired.

One aspect of economic development post-reforms is the decline in momentum in manufacturing growth. The fall in the share of industry in GDP is perhaps an unintended consequence of the reform process and calls for rectification. Many of our peers in the developing world have shown a higher share of industry in GDP (see Table 2).

Policy innovations, which will increase the proportion of industry's share in GDP, seem necessary.

One of the many reasons for the slowdown in manufacturing, as stated in the report, is the credit crunch initiated as part of the reform. The report suggests that the unexpected, albeit temporary, tightening of liquidity in the money market in 1995-96 may have been one of the factors responsible for the decline in manufacture. The depressed stock market conditions in 1995-96 inhibited the redemption of financial investments of corporates and reduced their free resources.

Rising real interest rates during the earlier part of the reform period also led to entrepreneurs shying away from investment. Further, the industrial slowdown mirrored the fall in Government capital investment, especially investment in infrastructure, which reduction had adverse implications on the growth of manufacturing. Another contributory factor may have been the lagged effect of the negative agricultural growth in 1995-96.

Industrial performance still continues to be hampered by physical infrastructural bottlenecks. The report, therefore, stresses the need for power sector reforms and correction of the cross-subsidies in the tariff structure, which leads to power being supplied at a very high cost to manufacturing. The report is right in its emphasis on the need for extra investments in the power sector, be it in the public sector or the private, both to be supported by adequate tariff reforms.

The report rightly stresses the role of credit in the growth of industry. It notes the slowing down of credit to small- and medium-scale industries. There is need for greater concentration on cleaning up the institutions, including the State Finance Corporations. Credit flow is an essential precondition for economic growth. This is recognised by the report.

The observations of the report on the increasing role of services in the Indian economy are interesting.

The Indian experience is somewhat unique, in the sense that sectoral shift in favour of services accompanied an almost stagnant share of industry and agriculture. The growth performance of the services sector has provided a modicum of resilience to the overall growth of the economy.

The reform process, which involved liberalisation of the financial sector, also provided an environment for faster growth of financial services. As a result, the share of services touched a high 50 per cent of GDP.

A substantial fillip to the services sector also came from exports, such as software and call centres.

True, the growth in services may be attributed, in part, due to growth of expenditure on public administration and defence, particularly in the backdrop of the Pay Commission's recommendations. In the view of the report, the exclusion of the public administration and defence sectors affect only marginally the contribution of service sector in India's economy. The latest Report on Currency and Finance forms a useful input for policy-makers of India and for students of economic development around the world. Biased though it is in favour of reforms, it is balanced in its presentation. The authors of the report deserve our thanks and compliments.

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