No gains by repeating targets that are not credible

Exclusive Interview/ Montek Singh Ahluwalia, economist

Montek Singh Ahluwalia | Sanjay Ahlawat Montek Singh Ahluwalia | Sanjay Ahlawat

There have been mixed reactions to the Union budget presented by Finance Minister Nirmala Sitharaman on February 1. Economic experts, market analysts and the people have all spoken about both hits and misses.

While the budget gave a boost to the infrastructure and the agrarian sectors, and gave due attention to the technology sector and startups, little was done to boost the real estate segment and the bleeding automotive sector. Reforms around income tax aim to improve the spending capacity of individuals in order to boost consumption.

Eminent economist and former deputy chairman of the Planning Commission Montek Singh Ahluwalia said that the budget is a “business-as-usual budget”. In an exclusive interview, he told THE WEEK that the budget does not present a clear strategy to address constraints that are hampering the growth of the economy. Excerpts:

Does the budget come up to your expectations? Will it help to achieve the government’s aim of making India a $5 trillion economy?

It is essentially a business-as-usual budget and not one which is designed to address the serious challenges facing the economy. Growth has collapsed, and this in turn is reflected in the very poor employment performance. The important point is that the slowdown is not just a cyclical phenomenon from which a rebound can be expected with a business-as-usual budget. Growth in the current year is likely to end below 5 per cent. A purely cyclical reversal could bring growth back to 6 per cent although it will take longer to achieve this than this budget projects. However, we grew at an average of 8 per cent in the first seven years of the UPA government. The fall from 8 per cent to 6 per cent reflects structural constraints. The budget does not present a clear strategy to address these constraints. The collapse of private investment and the poor performance of exports are the major problems. I do not think the budget offers any credible solution to these problems. Reducing the corporate rate of tax moves us to a better tax structure, but reviving confidence among domestic private investors requires a much larger effort that is missing.

Reaching a $5 trillion economy by 2024 requires a growth rate of close to 9 per cent between 2019-2020 and 2024-2025. Since we are likely to get only 5 per cent growth in 2019-2020 and recovery next year will be slow, the $5 trillion dollar economy target cannot be reached by 2024.

Reaching a $5 trillion economy by 2024 requires a growth rate of close to 9 per cent between 2019-2020 and 2024-2025. Since we are likely to get only 5 per cent growth in 2019-2020 and recovery next year will be slow, the $5 trillion dollar economy target cannot be reached by 2024. Of course, as along as the economy grows, we will reach $5 trillion dollars some years later, but that is not what the original target implied. Finance Minister Nirmala Sitharaman would have gained points for credibility if she had said as much. We do not gain anything by continuing to repeat targets that are not credible. The budget also repeats the target of doubling farm income by 2022. That is simply not on the cards given what is happening in agriculture.

What were the plus points of the budget?

A plus point is that the budget does not take any large fiscal risk. There was much talk about the need to expand expenditure to give the economy a stimulus but this ignored the fact that the budget is already quite expansionary. The finance minister was right in my view not to try and achieve the earlier fiscal deficit target by contracting expenditure. That would have been quite wrong given the lack of demand in the system. Ideally, the finance minister should have come clean on the size of the fiscal deficit and abandoned the off budget borrowings to finance the food subsidy which end up understating the deficit. I give her credit for coming half way by making the extent of these borrowings explicit. But continuing with them makes discussion about fiscal deficit targets and their trajectory meaningless. For example, reducing the measured deficit over time is of little relevance if these borrowings are allowed to increase. We should now talk of the fiscal deficit plus the off budget borrowings and fix a medium-term target for the two together.

A credible plan for reducing the combined deficit of the Centre and the states in the medium term is absolutely essential because at present a realistic assessment of the combined deficit including postponement of expenditures takes it close to 9 per cent of the GDP. Since net financial savings by households is only 10 or 11 per cent of the GDP, it means the government sector absorbs almost all the savings leaving very little for the private sector. The burden of this scarcity falls on small and medium enterprises since the big ones resort to funding from abroad.

And, the negative features.

The decision to raise import duties on consumer goods is a big mistake. Reducing import duties was a key part of the economic reforms of 1991, aimed at making the Indian industry more competitive. The process was continued by the subsequent governments including the Vajpayee government. It yielded very good results in the sense that Indian industry became much more competitive and India’s share in world exports increased over the years. I personally think we could have reduced duties faster, offsetting it by a more aggressive policy of weakening the exchange rate, but the gradualism at least brought us continuity. That continuity has been consciously reversed. I worry about the danger of slipping into the same protectionist trap which produced poor growth in the prereform years.

The finance minister has invited suggestions on what more needs to be done by September. I am sure she will be flooded by demands for more protection. I hope there is enough debate on this issue to persuade her to change course. We should also have a clear articulation of a principle. How high an import duty is acceptable? Industry organisations should speak on this issue because, if I am right, it is the industry that will suffer. Unfortunately, industry typically does not oppose protectionist demands from some of their own brethren.

What could have been done in the budget to spur growth?

Much of what needs to be done by way of structural reform is in areas outside the finance ministry. However, I would flag three issues which could have been in the budget. First I wish we had got a clearer game plan on how we are going to raise more revenues in the years ahead. Reform of the Goods and Services Tax is critical in this context. Everyone agrees that the GST is a major reform but it has performed poorly mainly because of poor design with too many rates and also too much lowering of rates. Admittedly, much of this is because of demands made in the GST Council. The finance ministry could have given a lead by indicating that the government would go to the GST Council with a proposal for a two-rate structure, with a separate tax on luxury goods. Unless a major GST reform of this type is implemented, there is little hope of raising the revenues we need to pay for the ambitious schemes that are being announced.

Second, the continued proliferation of cesses which are not shared by the states should have been abolished or at least proposed to be phased out in three years starting this year. If necessary, the underlying rates could be increased; but cesses should go.

Finally, I wish we had got a clearer statement on banking reforms. There has been talk of reforming the public sector banking system since 2015 but there has been very little action. Public sector banks will never have the flexibility they need to act commercially unless we get the finance ministry out of controlling the banks. Their privatisation is politically unacceptable—and that seems to be the case across the political spectrum. The P.J. Nayak Committee recommendations provide a via media to reduce the intrusive control of the finance ministry. All we have had so far is the proposal to merge 10 public sector banks into four. Merging 10 unreformed public sector banks into four unreformed public sector banks is not reform. It will only dissipate managerial energy on the problems of merger of the staff, which will only distract attention from the challenge of bringing about credit expansion.

You mentioned that the collapse in growth has reflected on the employment performance. Your comments on the employment scenario in India?

It is deeply worrying. Employment has not grown as much as we needed and much of the growth that has occurred is in low quality, informal jobs, which are unlikely to satisfy the young and increasingly aspirational entrants to the labour force. This is reflected in the fact that the rate of unemployment has increased and it has increased much more among the young and especially the educated youth. This is a recipe for social disaster. Part of the problem is the collapse in growth. An economy growing at 5 per cent will obviously generate far fewer jobs than an economy growing at 8 per cent. So reviving growth must be a top priority. If we want to create more jobs, we must bite the bullet on all the reforms needed to get faster growth.

There is also another aspect and that is the nature of technological change which is making many existing jobs redundant. We cannot hold back this change especially if we want to integrate with global supply chains. However, while new technology will displace existing jobs, it will also create new jobs in the process. The question is whether we can position ourselves to benefit from these new opportunities. To do this, our economic policy must be sufficiently flexible. This calls for reforms that will make it easy for new businesses to be set up and also to wind up. It also calls for flexible labour markets. Unfortunately, our labour market is regarded as one of the least flexible. In some ways, this inflexibility prevents expansion of regular employment and encourages informal job contracts. Labour does not benefit from this situation. We also need to do a much better job of imparting employable skills.

How do you think the Indian economy will shape up in near future?

Indian economy grew at an average rate of over 8 per cent in the first seven years of the UPA government. We should at least try to get back to that rate. This will not be easy. We can probably get back to 6 per cent as purely cyclical recovery but going beyond 6 per cent requires deeper structural reforms. The agenda for such reforms includes completing the unfinished first generation reforms and undertaking second generation reforms. I have talked about this agenda at some length in my book 'Backstage The story behind India's High Growth years' which will be published in mid-February this year.

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