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No quick fixes for the economy

LiveMint logoLiveMint 25-05-2014 Himanshu

This government’s primary priority will be to set right the economy. It requires a clear understanding of what went wrong with an economy which was doing so well only a few years ago.

It should also be kept in mind that there are no quick fixes. The solution will not be limited to urgently needed executive decisions, but also include the budget which is likely to be presented sometime in July. While the government may earn political brownie points by dealing with so-called low-hanging fruits, the real challenge will be to address structural challenges facing the economy that require a medium- to long-term perspective.

Part of the reason for the economic slowdown was the policy paralysis of the Congress-led United Progressive Alliance (UPA). This can be easily corrected.

Still, while this may shore up investor sentiments and kickstart the recovery, the real challenge, even in the short-term, will be to contain inflation, especially because the monsoon is supposed to be below par this year.

Unlike investor sentiments, inflation management may require a mix of short-term and long-term measures, particularly on the supply side.

Running down government food-grain stocks would certainly help the government mitigate any supply shocks arising from a poor monsoon on the food-grains front, but food inflation has largely been caused by a spurt in prices of fruits and vegetables and containing these would require coordinated steps to ease supply bottlenecks. Given that reforms in agricultural marketing such as amending Agricultural Produce Marketing Committee (APMC) rules may not be easy in the short run, better coordination with states to monitor inflation is a viable option. Last but not the least, employing monetary policy to contain structural inflation not only hurts the economy but also does not help in reducing inflation.

The real challenge has to do with reviving economic growth. Unfortunately, things are far more complicated here. The budget will be the real test not only of what the government thinks to be the problem with the economy but also of what it intends to do about it. Both are linked but the room for manoeuvre may be limited given the concern on fiscal and current account deficits, both of which seem to have eased a little.

Unlike what many commentators claim, the problem with the economy may not be the excessive spending by the UPA government in the past few years. If at all, it is likely a result of a cut back in public investment. Public investment, which was rising till 2008, reduced drastically in subsequent years.

An economic revival requires not only a boost to public spending with the aim of capital formation, but also restoring cuts on programmes, such as the rural job guarantee scheme, that have a multiplier effect necessary to keep up rural demand.

Some cushion on the expenditure side has been created by the previous government, particularly on petroleum subsidies, but there may not be enough room to cut food subsidy. Regardless, most projections suggest that the food subsidy bill may not be higher than what it was last year, even after the national food security law kicks in this year.

Still, managing expenditure is only part of the fiscal story. With little room to manoeuvre on expenditure, the priority of the government should be to raise revenues. This may be the difficult option with the economy not doing well. The budget will be the opportunity for the government to signal its intent on raising revenues. India is still among the countries with lowest tax to GDP (gross domestic product) ratio.

Once again, the ability of the government to manage states will be tested if the goods and services tax has to become a reality. But some of the easy choices are enacting and implementing the direct tax code, reducing revenue foregone by eliminating discretionary concessions to big industry. The ultimate impact of the coming budget on the economy will depend on whether the government decides to cut expenditure or raise revenues to balance its books.

The real question is: what kind of economic model does this government envisage for the country?

Given that the government has been elected in the backdrop of an economy that did reasonably well on growth (at least till the turn of the decade) but failed miserably on jobs, there is certainly the need to revisit the objective of economic policy.

Any strategy of reviving the economy has to put growth, with jobs, as the cornerstone of economic policy. That can happen only by sustaining demand in rural areas, reviving small and medium enterprises, and making manufacturing the centre of growth. This will not only require large-scale infrastructure investment in the large metros but also in small and medium towns, which continue to be the incubators for most small and medium enterprises.

The economy will not only have to create jobs for the new entrants in the labour market but also for those who are moving out of agriculture. This can happen only if the government spends more, on infrastructure, education, health and skill enhancement. The state will also have to help small and medium enterprises by providing them access to markets, easy and cheap credit, and technological know-how.

I am not sure this can happen with the slogan of minimum government, maximum governance championed by Prime Minister-designate Narendra Modi.

What is needed is a larger and more efficient government..

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