The brochure of an upcoming documentary titled “Return of the Tiger” – which focuses on efforts to save India’s tigers from extinction – says that “the return of the tiger is possible if we make a collective effort.” This aptly describes the need of the hour to revive another ‘tiger’: the Indian economy. Coordinated action between the fiscal and monetary policymakers can revive India’s economy sooner rather than later.
Humbled by the adverse global and domestic economic scenario, the beleaguered ‘tiger’ will not able to conquer the 6 per cent growth hurdle in 2012-13. However, better coordination among policymakers would create a more conducive environment for raising India’s medium-term growth potential once again to 7-8 per cent.
As we enter 2013, collective action and co-operation should become increasingly visible between monetary and fiscal policies. Inflation, in particular, core inflation, which indicates demand side pressures in the economy, now appears to be on a downward trajectory. As a result, the focus of Reserve Bank (RBI) would shift more towards supportive growth.
FISCAL INITIATIVES
In addition, fiscal policy support in terms of recent reforms momentum by the government on issues such as foreign direct investment in retail, the land acquisition Bill, a national investment board and the banking Bill have paved way for monetary policy easing. In the absence of improvement in the investment climate and implementation of reforms, a large dose of the monetary pill could result in an undesirable side-effect such as rising inflation, as it can simply raise consumption rather than investment.
How can the framework for co-operation and collective action between fiscal and monetary policies be improved? The primary objective of monetary policy is to maintain low and stable inflation.
The RBI, therefore, needs to respond to any developments in the economy that have significant implications for inflation.
This includes changes in the fiscal policy that influence demand pressure via both direct government expenditure and via polices aimed at changing household incomes. Transparency about the fiscal policy’s short- and medium-term intentions will therefore, help inflation management. If, for example, major changes in tax and expenditure policies such as the goods and services tax, the direct tax code, expansion of social sector schemes, are announced well in advance before the implementation begins, the RBI will have enough time to factor them into its monetary policy decisions. How to operationalise an early commitment to changes to fiscal policies would need to be worked out.
During the high growth, ‘roaring tiger’ phase of the mid-2000s, India’s public finances improved considerably.
A sharp reduction in the fiscal deficit, which was partly responsible for low inflation, created a favourable environment for private corporate investment to soar. Private corporate investment in 2007-08 was 2.4 times the investment rate in 2003-04.
However, private investment as a share of GDP declined by over 5 percentage points in three years between 2008-09 and 2010-11.
FALLING PRIVATE INVESTMENT
A CRISIL research survey carried out around the middle of 2012 suggests that investments by the private corporate sector are likely to fall at current prices by 35 per cent on a year-on-year basis in 2012-13.
The government’s recent announcement of the roadmap to fiscal consolidation is a step in the right direction. It is also critical for inflation management to know how the reduction in fiscal deficit to GDP ratio is to be achieved without compromising the government’s investment expenditure.
Inflation control would be more effective if fiscal consolidation does not compromise investments in agriculture and education/skill development sectors.
Raising agriculture productivity is crucial to lower food inflation, while increasing the supply of skilled labour is necessary to keep in check salary growth in key sectors.
With fiscal policy now beginning to demonstrate the will to create a conducive environment for economic recovery, especially on the investment front, coordinated action from the monetary policymakers in terms of lowering the repo rate is likely to follow soon.
The makers of the tiger documentary call for a nationwide movement to save the tigers with action at the legislative level in terms of more stringent policies and norms, increased education and awareness backed by an action plan.
In order to save our economic tiger, the recipe is no different. The tiger’s roar will then be heard again soon.
Mahambare and Agarwal are Principal Economist and Economic Analyst, respectively, at CRISIL.