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Issues and Priorities


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Issues and Priorities

The most intractable and long-standing issue confronting us is that of the fiscal prudence. The various aspects of the fiscal problem, namely the fiscal deficit, the revenue deficit, unproductive expenditures and unsustainable subsidies are now fairly well known. With the exception of the initial success achieved in 1991-92 under the pressure of the balance of payments crisis, subsequent improvements have alternated with set backs and reversal. As a result, the position today is not significantly better than in 1991-92. There is therefore a clear need for building a political consensus on this issue in terms of both constitutional and administrative measures that need to be taken.
The fiscal deficit is the key parameter of macroeconomic policy, which has profound implications for inflation, interest rates, investment, growth, the financial system, balance of payments and last, but by no means least, overall credibility of Government’s macroeconomic policy. For the Central Government the fiscal deficit simply reflects the net borrowing requirement of the Government. A high fiscal deficits leads to excess borrowing from either the RBI or the market for loanable funds. Excessive borrowing from the RBI leads to high monetary growth, which fuels inflation and puts pressure on the exchange rate. When considering Government borrowing from the market, the fiscal deficits of Centre and State Governments need to be aggregated (in 1997-98 (RE) this was 7.4 per cent of GDP). Such a high level of Government borrowing pre-empts funds which could otherwise have been used productively in industry, agriculture and services. High deficits also keep interest rates high and investment and growth low. Excess Government borrowing also places undue pressure on the domestic financial system and capital markets. There is also the long-term issue of sustainability of fiscal deficit.
Long term fiscal sustainability generally requires bringing down the Primary deficit (gross fiscal deficit minus interest payments) to below zero. For the Centre and States together, the primary deficit is estimated at 2.4 per cent of GDP in 1997-98 (RE), with little prospect of improvement in 1998-99. A reduction in the primary deficit to zero would, therefore, require at least a 2.4 per cent of GDP reduction in the fiscal deficit. If the entire adjustment falls on the Central government, this would require a reduction of the Central fiscal deficit to about 3.3 per cent of GDP. This target assumes that the real interest rate in the economy is lower than the growth rate. If this condition does not hold for any reason, a primary surplus and consequently a greater reduction in the fiscal deficit would be required.
Quite clearly, fiscal consolidation is absolutely necessary for containing inflation, reducing interest rates, promoting investment and growth, and fostering reasonable stability in the financial system and the foreign exchange market. Experience from the rest of the world underlines the importance of fiscal deficit reduction in regard to reducing interest rates and inflation. It is therefore essential to put the fiscal deficit on an irreversible and unambiguously declining trend.
In a broader qualitative sense, sustainability also depends on the quality of the government expenditure and the nature of the tax system underpinning the fiscal system. Concern about the revenue deficit stems from the legitimate concern that a significant part of revenue expenditures are of low priority. These low priority expenditures and non-targeted subsidies need to be identified and eliminated. This is also essential for freeing up funds for completing the unfinished tasks of universal primary education, effective public health systems and modern water and sewage systems for the entire population. The impact of the Fifth Pay Commission and its aftermath on revenue deficits of Centre, States and local bodies lends urgency to the need to downsize government. The time has perhaps come to reconsider the issue of constitutional limits on the deficit as well as to take up the challenge of reengineering government.
The task of reforming the tax system must also be carried forward and completed. But such reforms must be accompanied by determined efforts to augument revenue mobilization through base broadening, improved administration and other means. The decline in the tax to GDP ratio of recent years must be reversed. 
The commendable but gargantuan task of decontrol and de-bureaucratisation which every government in the nineties has set for itself remains unfinished. The extent and depth of the economic distortions such controls have created are perhaps still not fully appreciated by all, even though the negative effect on the public is known to all who interact with the government. The remaining price and distribution controls must be eliminated. At the State level this must be preceded by a major effort to identify such controls. Investment controls are the second most pernicious legacy of the control era and remain in several infrastructure service sectors. SSI reservation is another form of investment control. The need to replace all quantitative restrictions by fiscal measures was recognised even in the eighties, yet import and export controls remain widespread in certain sectors like agriculture. Though reform of the foreign exchange system has been one of the prominent areas of reform, the operation of exchange controls still requires improvement, particularly for exporters and knowledge-based industries. Similarly, though some of the well-known financial sector controls have been removed, many controls remain embedded in the laws, rules, regulations, norms and procedures.
The very uncertain global environment during 1998 has brought external issues back into focus during 1998-99. As downside risk remains prominent in all the forecasts of the world economy for 1999, the prominence of external issues in our own policy making is likely to continue in the coming year. The deceleration in the growth of exports over the last three years has mirrored to some extent the deceleration in growth of exports from developing countries. It is somewhat disturbing that the deceleration in the dollar value of our exports has been greater than that of ‘developing countries’ during 1997 and 1998. Though real exchange appreciation since 1996 has contributed to this decline, we have to now go beyond such macroeconomic variables to address the more long-standing and intractable structural disadvantages faced by our exporters (relative to those of exporters in China, Malaysia, and Thailand).
During the last two to three decades, the fastest growing economies of the world have also had fast growth of (manufactured) exports and employment. Most of these countries have built a much more positive environment for exports (and investment), than we have been able to do. This has two aspects: a liberal and flexible policy regime for export production and marketing and simplified rules and procedures for exporters. The increased opportunity in the area of software and other service exports and knowledge-based industries has thrown up additional areas for policy reform and procedural simplification.
In terms of routine interaction between exporters and the organs of the state, such as customs, exchange control, tax authorities and licensing authorities (DGFT), a sea change in approach is required to bring it on par with successful exporters of East Asia. Even a neighbouring country such as Sri Lanka reportedly has a much friendlier operational environment for exporters than India.
The policies applicable to export production need to be transformed to remove the controls and constraints facing exporters. This requires a comprehensive re-examination of labour laws and SSI reservation as applicable to exporters, with a view to bring them on par with successful, exporting countries, like China. Warehousing and cargo handling of imports and exports at airports and ports remains a monopoly of the state, with the consequent deleterious effect on service. The supply of infrastructure services like electricity, telephones and rail transport to exporters, remain of as poor quality as for the general economy. If these policy and procedural steps (along with fiscal correction) are not taken, the balance of payments could again come under pressure. Better export promotion policies also require a clear recognition that high import tariffs discourage exports, while lower tariffs enhance the relative profitability of exports. Greater liberalization of trade in agriculture is also desirable for promoting exports.
Radical reforms in the areas of infrastructure services, agriculture and factor markets are necessary to initiate a virtuous cycle of export growth, employment generation and economic growth. With only a year left before the start of the 21st century it is perhaps an appropriate time to start preparing for a second generation of economic reforms. Such a reform agenda must include reform of factor markets, public sector, government and other public institutions, legal systems, State level policies and procedures and reform of critical sectors such as infrastructure, agriculture, education, R&D and agricultural/rural extension.
Within factor markets, capital markets and the financial sector have also seen considerable reforms. The financial collapse in East Asia and other countries has, however, emphasized the fact that we still have some way to go in bringing the financial sector (including banking) to international standards. Completion of insurance and pension fund reforms is merely the first step in creating strong and vibrant long-term debt market. Other factor markets areas such as labour, land, natural resources and corporate management have not been tackled seriously by reforms so far.
The fact that primary responsibility for social sectors, agriculture and rural development is generally assigned to the States under the Constitution, underlines the importance of state level reforms. These include fiscal reforms, decontrol and de-licensing particularly with respect to transport, storage and processing of agricultural goods, reform of infrastructure sectors like electricity, canals and road transport and decentralisation and involvement of local bodies, including NGOs. Institutional reforms such as those related to size and quality of government, freedom of information, economic laws and the legal system require involvement of the Central and State Governments as well as the judiciary.
These reforms have to be designed to set in motion a process of self-sustained, employment promoting growth. Democratic participation and empowerment of the people through education, public health improvement and information/knowledge is an essential element of such growth. Once policy distortions that promote capital intensity or discourage hiring of labour are identified and removed, investment can create more new productive jobs. Government administration and Public institutions will need to be transformed to recognise and appreciate the centrality of efficient investment (physical, human or knowledge capital) in any self-sustaining development process.
The award of the Nobel Prize in Economics to Prof. Amartya Sen has again brought home to us (if such a reminder was needed) that growth and development are ultimately about the entitlements of people. Universal literacy and compulsory primary education are necessary not only for sustaining productive employment and economic growth, but also for making every individual a full participant in the democratic life of the nation. The provision of public goods and basic amenities like water, sewage and sanitation must extend not just to the middle class but also to the poorest of the poor. Research & monitoring and control of contagious diseases and epidemics may not be glamourous activities but often have far reaching effect on the poor. Similarly, strengthening of the norms of civil society and elimination of violence and corruption will bring substantial benefits for the poor. It is critically important to refocus government priorities to those areas which are the basic responsibility of government and to withdraw from areas where private initiatives can often achieve the goals more efficiently.
 

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