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G. Srinivasan

The RBI's Currency and Finance Report addresses the unfinished agenda on the reforms front. The areas of weakness in the economy need to be pondered over by policy-makers instead of their merely being conscious about them, says G. Srinivasa n.

The RBI's recent Currency and Finance Report stresses that improved savings, higher investment and better credit delivery are critical to reaching the high economic growth targets.

THE Mint Street in Mumbai where the country's apex bank, the Reserve Bank of India, is located, is always looked upon with due reverence, particularly when the central bank sets forth its well-researched points on the state of the economy, the distance it has traversed and the trajectory it has set itself to overcome structural rigidities and policy follies that otherwise plague the economy. In this regard, the Currency and Finance Report (2001-02), released recently, has not belied expectations, as the subject it addresses is the unfinished agenda of India's economic reforms and a genuine assessment of achievements made on the reforms front, warts and all.

Although the RBI authorities hasten to insert an unwonted 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 (DEPA) and should not necessarily be interpreted as the official views of the RBI", this in no way detracts the underlying message and conclusions so convincingly and eloquently made throughout the tome to the delight of discerning readers and to the dismay of policy-makers and ruling classes alike.

The nub of the report is the candid admission at the outset that the potential of the economy to sustain the targeted high growth exists "but hinges critically on improvement of the domestic saving rate, increased public investment supported by marked improvement in public saving rate, higher inflow of foreign capital as well as net terms and better credit delivery mechanisms". Considering that the Budget's broad proposals were able to address only some of the justifiable concerns spelt out by the central bank, it is important that the "emerging weaknesses" highlighted in the ongoing reform must perforce be corrected "so that the real sector reforms gather further momentum".

As the report itself admits, the touchstone of any reform process is the impact it has on the real economy. It is but natural to look at the economic growth rate after a decade of the reform process was set in motion. The real GDP for 2002-03, the inaugural year of the Tenth Plan (2002-07), is likely to grow by 4.4 per cent. This is in contrast to the 8 per cent average annual GDP target for the quinquennium projected by the Planning Commission.

The RBI report highlights the improved economic growth performance during the first flush of reform span — 1992-93 to 1996-97. The overall growth in this period was led by a marked acceleration in the industrial growth, though the growth momentum flagged in the latter phase of reforms, that is, 1997-98 to 2002-03, with the slowdown exacerbated by global deceleration.

This was also responsible for pulling down the trend rate of growth for the reform period (1992-93 to 2002-03) to 6.1 per cent, which was moderately higher than the trend rate of growth of 5.6 per cent logged during the pre-reform decade (1981-82 to 1990-91).

The report frankly concedes that, unlike India, the growth momentum in most other emerging market economies was led by the industrial sector rather than the services sector, which has provided some resilience to the overall growth process.

Yet, the pronounced deceleration in manufacturing activities during the second phase of the reform period poses "a major challenge for sustaining the growth momentum". The apex bank blamed a medley of structural and cyclical factors for the deceleration in growth during the second phase of reforms.

Structural factors include, inter alia, the lack of appropriate reforms in the agricultural sector, infrastructure gaps, labour market rigidities, weak bankruptcy and exit procedures, while the cyclical factors basically encompass decline in aggregate demand.

The slowing down of the structural reforms along with declining domestic saving rate and cyclical influences transmitted through global business cycles attenuated the investment demand during the second phase of reforms. Declining public sector investment was reflective of the spillover effects of rising revenue deficits on capital budgets of the Governments of both Centre and States, the report said.

The RBI report contends that the slowdown in the domestic saving rate in the second half of the 1990s, mainly caused by public sector dis-saving, has constrained investment levels in the economy. However, a crucial feature of household saving during the reform period was the increasing importance of saving held in insurance funds and provident and pension funds in what is called contractual saving. Rightly has the report observed that the saving comport of the household sector reveals that despite financial innovations, there is continued preference for relatively risk-free assets such as bank deposits and contractual saving. But in the case of private corporate sector, a decelerating trend in investment was noticeable during the latter half of the 1990s, which could not maintain the momentum it witnessed in the initial years of the 1990s.

The RBI report attributes the constraints in private corporate sector investment to reduced saving from this sector, lack of adequate regulatory reforms in core and infrastructure sectors and lack of public investment in infrastructure. Moreover, increased uncertainties in the domestic investment climate created by factors such as poor progress and lack of clarity on the directions of disinvestments and privatisation programme and the continued slowdown in the global economy, might have dampened private investment. A matter of major concern, according to the RBI report, was the steep fall in public sector investment rate during the 1990s, which was caused by deterioration in public sector saving rate. The escalating interest payments and rigidity in subsidies and wages pre-empted a larger part of the revenues and borrowed funds of the Government, leaving reduced resources for investment. The declining tax-GDP ratio and lower user charges on public infrastructure service reduced the ability of the Government to undertake investment in basic infrastructure.

This is compounded by the fact that the process of fiscal adjustment led to direct cutbacks on the capital expenditure of both the Central and State Governments. This approach to fiscal correction was not sustainable, the report said adding, and "while reduction in investment spending affected future growth prospects with consequent slowdown in revenue receipts, the interest payments and public debt continued to grow, resulting in reversal of fiscal consolidation process in the latter half of the 1990s".

Against this bleak backdrop, the apex bank notes with concern that the growth target of 8 per cent for the Tenth Plan would require an investment rate of about 32 per cent, whereas, over the years, the investment rate has stagnated at 24-25 per cent of GDP. Acceleration of saving and investment rate would critically depend on the efforts to restore balance on the revenue account, the report said adding that restoration of revenue balance both at the Central and the State level would require a few desiderata.

These include that user charges are adequately raised, the tax collection machinery is overhauled to achieve better tax compliance, returns on government investment in public sector undertakings (PSUs) are raised through appropriate pricing policies, eliminating implicit subsidies and the burden on the fisc is lowered through phasing out of unviable PSUs.

The introduction of value-added tax (VAT) should do away with the practice of competitive tax concessions, which has seriously dampened tax buoyancies. But the apex bank's expectation of the April 1, 2003 deadline for ushering in VAT has gone with State governments not yet coming forward to sink their differences. The bank pertinently and persuasively pinpointed that the sizeable outstanding liabilities contracted at higher rates during the late 1980s and the early 1990s and the resultant huge interest payments have led to the widening fiscal gap.

The scheme of swapping States' high-cost debt to the Central Government on account of small savings could make a major dent in the growth of interest payments. For the Centre, aggressive restructuring and disinvestment in unviable public sector units could bring in sizeable resources to redeem a part of outstanding liabilities and consequent reduction in interest payments. In all, what the RBI has cogently summed up as the areas of weaknesses in the economy down the decade of economic reform the country had traversed need to be pondered over by policy-makers instead of merely being conscious about them.

It is easier to tag disclaimer and ignore even the familiar suggestions made by authoritative agencies that are charged with the conduct of the country's monetary policy, the principal pillar on which the mandarins in the Mint Street are crafting a non-inflationary growth strategy with meticulous care.

There is no harm in listening to the litany of woes articulated in the latest RBI report so that "policy reforms would need to focus more sharply on the gaps mentioned in it, specially in the areas of real and fiscal sectors".

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