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February 22, 1999
Business Commentary/ R C Murthy
Time for tough measures to tackle fiscal travails
The focus now is on the Vajpayee government's Budget and the Bharatiya Janata Party's ability to turn round the Indian economy through conventional means. Or does it need a stronger medicine -- rupee devaluation?
Pessimism is widespread that Finance Minister Yashwant Sinha is not capable of taking hard decisions and is unable to stand firm on whatever tough measures he proposes, earning him the dubious distinction of "roll back" finance minister.
Obviously, to lend credibility and authority, the Prime Minister is actively getting involved in decision-making. The coming Budget will not be crafted by the Finance Minister and his secretary Vijay Kelkar; it will be done by the foursome that includes Vajpayee and N K Singh, the high-profile secretary in the Prime Minister's Office.
Earlier, as revenue secretary in the finance ministry, Singh was the chief architect of radical direct and indirect tax policies, including what is known as "VDIS," or the Voluntary Disclosure of Income Scheme.
In the PMO, Singh has a free hand in total Budget-making, or at least to suggest to his boss, unlike the narrow scope he had as a finance ministry operative. His theory of lower direct tax rates leading to more revenue did not work then. But the VDIS, which was a spectacular success, bailed him out.
Apparently, Singh has built bridges with Sinha now, judged by the camaraderie between them seen at Davos, Switzerland, early February.
As colleagues of the Bihar cadre of the Indian Administrative Service, the two were not on the best of terms, to say the least. But Sinha resigned his job, took to politics and became his boss.
Will the government squander the foreign exchange reserves and precipitate a crisis a la 1991? Foreign exchange reserves at around $ 29 billion, are at a reasonable level. But other external fundamentals are far from comfort.
Exports have dropped dangerously in recent months, widening the current account deficit. Capital inflows, institutional and private, have not been sustained, bedevilled as they were first by nuclear tests and then by political instability.
The strategic mileage the Vajpayee administration got out of the May nuclear tests is debatable. But it is still grappling with the mess in their aftermath. The psychological setback to foreign investment is damaging indeed.
The delay in kickstarting infrastructure financing upset the official calculations of achieving a soft landing for the Indian economy. Recession is a reality now.
A few days back, the group of top eight industrial nations asked the World Bank and the Asian Development Bank to reopen their lending windows to India but with a rider: Don't make up for the shortfall arising out of aid suspension nine months ago.
Aware how costly it is to clear the political mess, Sonia Gandhi's Congress refused to vote the BJP out of power. In the process, it did not fall in the Left's trap. But the agony for the Indian economy springing from the political instability continues.
Experts fear the present fiscal mess is not amenable to conventional solutions and can only lend itself to strong remedies like rupee devaluation.
But in the international context, rupee devaluation now will send wrong signals and may unleash another wave of competitive devaluation in this part of the world.
The world economy is already groaning under the south-east Asian currency crisis, followed by the Russian rouble trouble, and more recently by the Brazilian currency Real devaluation. Now there is speculation over China's currency Renminbi's devaluation.
If that happens, the entire world economic scenario changes. The issue of rupee devaluation may have to be looked at afresh. As of now, the rupee devaluation is not the panacea for our current ills. While it can be a remedy at the appropriate time, the crying need now is a sincere effort at fiscal correction.
No doubt, a cheaper rupee would obviate the need for introducing complex export incentives. Devaluation would probably send the right signals to international investors. Provided of course there is a chance for devaluation to succeed. It calls for greater political will.
How can the state welfare packages demanded by coalition partners at the Centre and the states and rising uncovered Budget deficits be in tune with tight fiscal policy? Can the BJP resist them?
Mamata Banerjee and Jayalalitha want the cake as well as to eat it too. And, Haryana satrap Om Prakash Chautala withdrew support to the BJP when it refused to roll back fertiliser prices and restore the subsidy.
An administration that is squabbling over small issues like fertiliser subsidy cannot muster courage to tackle tougher issues like rupee devaluation. Tighter monetary and fiscal policies will have to be in place to keep domestic prices on the leash. Otherwise, the price spiral would neutralise whatever advantage gained by the devaluation.
A mistimed rupee devaluation will have disastrous consequences. Its adverse impact would be perceptible on India's external debt, which was $94.4 billion in 1997-98.
Imports would become costlier. Higher petroleum product prices would bloat transport costs and fuel inflation. So too the import component of industrial production. Unless exports, especially of manufactures, rise sharply, the devaluation gamble would not pay off.
The Prime Minister has made the right beginning by emphasising on reduced subsidies. If he makes some progress on this front and tightens the belt, the Budget would be on the right track.
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