In a way, every finance minister stores some problems for his successor. Mr Chidambaram has also been storing some problems. It is not certain whether he will be there to face the music in future. The Gujral government is so fragile that any small accident could bring it down. However, whether Mr Chidambaram will be there or not is immaterial. The country will have to bear the cost of the problems that he has been storing.
The first job of a finance minister is to ensure macroeconomic stability. It is only in an environment of macroeconomic stability that the market can deliver positive results. Manmohan Singh also had left the task of fiscal consolidation half-done as he was in a hurry to "produce" growth. Growth' he did produce. But it was short-lived. Also, whatever little Dr Singh achieved in the area of bringing down fiscal deficit was at the cost of slashing capital expenditure on infrastructure, particularly power. Moreover, to show better results on the inflation front, Dr Singh resorted to heavy government borrowing which resulted in crowding out private sector investment.
Thus, Mr Chidambaram inherited an economy which had the potential of industrial slowdown inherent in it. It was his bad luck that the impact of Dr Singhs slowdown policies was felt most severely during Mr Chidambaram tenure. However, Dr Singh's policies achieved the objective of bringing about a deceleration in the inflation rate but this was accompanied by an industrial slowdown.
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Mr Chidambarams response to what he inherited from Dr Singh was to stimulate consumer demand without reducing fiscal deficit. Like his predecessor, Dr Singh, Mr Chidambaram has no control over the governments consumption expenditure. Dr Singh didn't pursue the Biju Patnaik Committee report on freezing the wages of government employees. Mr Chidambaram didn't resist further improvement of the Pay Commission recommendations. State governments, local bodies, quasi-government organisations and the education sector too may follow suit. Thus, there is sure to be a big jump in the governments consumption expenditure.
Also, like his predecessor, increasing public expenditure either on infrastructure or on social consumption is not on Mr Chidambaram's priority list. Continued neglect of infrastructure will only increase the potential slowdown. Primarily because of infrastructure constraints, the industry ministry feels that industrial growth during the current year may be only around 4 per cent.
On other hand, heavy inflows in portfolio investment are continuing. The Reserve Bank does not seem keen to sterilise money expansion created by inflows as its brief is to reduce interest rates. Already, in the first quarter of the current year, M3 has increased by 16.6 per cent. This is clearly on the high side. But despite the massive increase in liquidity, non-food, non-oil credit has not increased. Increased money supply is being used to meet the fiscal deficit and the oil pool deficit.
Thus, money supply is increasing but is not going to the productive sector. Simultaneously, infrastructure constraints are aggravating by the day. Economic common-sense says that this a first rate situation for stagflation. When the first signs of stagflation will appear would depend on many factors. If these signs have not appeared till now it is only because of good agricultural crop. But as there are no signs of moderation in the expansion of money supply, even a good agricultural crop for the second successive year may not fully neutralise the inflationary impact of the high expansion rate of money supply.
An easy way out of the vicious circle of dysfunctional rising reserves and increasing liquidity is to liberalise import and export of capital. However, further liberalising imports would not add to the growth potential of the economy. Similarly, whereas some selective export of capital may be desirable "as a medium of learning by companies, export of capital cannot be adopted as a policy objective at this stage of economic growth.
The vicious circle of rising foreign exchange reserves and increasing money supply should be broken in a manner which will subserve the growth objectives. From the medium-term point of view, the best option is to boost investment -- both public and private -- in infrastructure, particularly power. Since the power sector is import-intensive, increased investment in the power structure would increase imports in a big way. Even if Mr Chidambaram has to print money for this, he should go ahead and do so. Short-term pains will be compensated by enduring gains later. Increased public investment in power will, instead of crowding out, crowd in private investment.