The Budget proposals for fiscal 2011-12 to be announced later today may throw some light on the policy-level thinking about the eternal debate on the relative emphasis between growth and social spending, between the politics of production and the politics of distribution. Jagdish Bhagwati in his Hiren Mukherjee Memorial Parliamentary Lecture in December 2010 emphasised economic growth as the principal means to reduce poverty. On the other hand, Amartya Sen has characterised as “stupid” the aspiration “to double-digit economic growth without addressing the chronic undernourishment of tens of millions of Indians” (Financial Times, December 22, 2010). The prime minister has added his own weighty voice to the debate by saying that, while inflation needs to be curbed, this should not be at the cost of affecting growth. He, along with the Cabinet, has also opposed several proposals from the National Advisory Council for an extension of food security and the National Rural Employment Guarantee Act. Though one is in full sympathy with the idealism of the proponents of distributive justice, they need to take into account two points.
One, the resources for increased outlays on social programmes can come only through rapid economic growth (while on the point, it seems the prime minister has succeeded in curbing the licence permit raj, re-birthed under the environment ministry).
Two, and even more crucial, the administrative/managerial resources of the government are nowhere near what are needed to deliver even the existing programmes with a minimum acceptable degree of efficiency and honesty. Larger outlays are unlikely to yield any better outcomes. In fact, reports suggest that in several segments, even the existing allocations in the Budget are not being used.
Last Monday, I had listed a large number of factors that can lead to major social unrest, as several countries in West Asia have witnessed in recent weeks, and which are equally present in India. Is there any specific factor in the Indian macro economy that could trigger a major problem? To my mind, there is — and it is not minor either. It is the external account of the economy, a point on which I have commented on in my previous columns. In recent weeks, concerns on the subject are being voiced by several weighty policy makers.
In its report on the economy released last Monday, the Prime Minister’s Economic Advisory Council emphasised the need to stabilise the current account deficit “at a lower level of around 2 to 2.5 per cent of GDP”.
In a speech at the Special Governor’s Meet in Japan (Business Standard, February 1), the Reserve Bank of India (RBI) Governor said, “Our reserves comprise essentially borrowed resources, and we are, therefore, more vulnerable to sudden stops and reversals as compared with countries with current account surpluses.”
The RBI’s Financial Stability Report (December 2010) cautioned that, “A potentially worrying feature of capital flows to India has been the dominance of portfolio flows and debt flows as compared to the more stable investment flows on a gross basis. Such flows require watchful management as they are prone to sudden stops and reversals ... the ratio of short-term external debt to foreign exchange reserves and of total external debt to foreign exchange reserves having risen to their highest level since the foreign exchange crisis during the early 1990s.”
One is apprehensive that the “potentially worrying feature” may become an actuality in 2011-12, particularly if the crisis in West Asia extends to more oil-producing countries, and the price shoots up. Even otherwise, the merchandise trade deficit is unlikely to be less than 7 to 8 per cent of GDP (it was less than 1 per cent in 2004-05). Remittances could also be adversely affected by the situation in the Gulf countries, and net invisibles actually fell in the first half of the current fiscal year as compared to the corresponding period last year. (In this connection, the export jump in December and January has puzzled me and I am still pondering on the implications.)
On the capital account, the position is far from reassuring. Foreign direct investment is falling, and the propensity to unilaterally alter or re-interpret contracts invoking “sovereign rights” will not improve the position. A recent JP Morgan research report suggests that the prospects of emerging markets getting larger portfolio inflows in the current year are not very good. And, a Bank of America-Merrill Lynch survey of global investors has found India as the least favoured economy in the Asia-Pacific region.
It is high time Delhi gave up its complacency on the external front, looking merely at the level of reserves. Financial markets are prone to function in “feedback loops” which tend to exaggerate price movements in either direction. Policy makers also need to be reminded that like the current account, savings and investment in an economy are not independent of the exchange rate; that the deficit also implies loss of huge potential output and jobs. I expect to revert to the issue in the context of the strange pronouncement on exchange rates at the recent G20 Finance Ministers’ meeting in Paris.
