The Government has little room for manoeuvre in Budget '96. Almost whatever it does, it appears, will raise inflation.
A functional anarchy, commentators felt. Political pundits harked back to history and gave the government at best six months more. Realpoliticos gravely shook their heads and pointed to the inevitability of the situation. Chambers of commerce warned of serious economic distortions. And the middle class votary, organised labour and farm lobbies descended on the streets with extremely vocal protests.
Rarely has so much heartburn been caused so widely by a government move as the recent petroproduct price hike, which has let loose visions of high and higher-cost days to come. Says RPG Foundation director-general D.H. Pai Panandiker: "The fuel price rise marks the beginning of a new inflationary phase." Echoes M.G. Damani, president, Bombay Stock Exchange: "The hike will have a domino effect on most commodities." With the National Council of Applied Economic Research (NCAER) predicting a direct impact of 0.92 percentage points and a cascading effect of 1.4 percentage points in the inflation rate over the shortto medium term, and the Union Budget looming threateningly ahead, it seems the economy is back on the brink of a double-digit inflation and soaring prices.
Is it really? Says B. Bhattacharya, dean, research, Indian Institute of Foreign Trade: "A budget is one of the many instruments that trigger inflation, which is generally expectation-induced." For instance, vegetable prices went up in the capital a few hours after the petrol and diesel prices were raised, primarily on the expectation of higher costs. Explains Rakesh Mohan, director-general, NCAER: "A lot of money will go to feed the new prices, leading to a fall in demand for other commodities.
This results in net contractionary conditions." The economic tasks ahead of the Deve Gowda Government are multifarious and massive. It has to reduce the fiscal deficit from 5.9 per cent of GDP to at least 5 per cent. It has to electrify export growth, check fast-rising interest payments, halt the drain of resources through inefficient public sector units, and reduce the revenue deficit (the difference between the Government's current expenditure and revenues), hovering at 3.7 per cent of GDP. The Finance Minister's seat has never been hotter. And in an effort to achieve three basic goals of increasing revenues, cutting expenditure, and promoting investment, it seems the Government must let the inflation cat, long buried in electoral exigencies, out of the bag.
High time too. Says S.P. Gupta, director and chief executive, Indian Council for Research on International Economic Relations (ICRIER): "The Government can afford to have some inflation as the Wholesale Price Index (WPI) is very low now." Over the last financial year, the Rao government kept inflation down to an average of 7 per cent (current inflation is 4.5 per cent), by putting off unpalatable decisions like raising prices of administered items and essentials as also by starving industry of credit by squeezing money supply (see box 'Peddling a Wholesale Myth' ). As economist Abhijit Sen of Jawaharlal Nehru University puts it, "it was accepted that the new Government would have to go in for adjustment of prices to put things straight. Petroleum was one area where the lack of price revision in the last couple of years was most glaring."
Both the stops—on moneysupply and government-controlled prices—have been pulled out now to some extent. The fuel price revision should check subsidy growth, while the slack season credit policy and the cut in cash reserve ratio for banks—which can now lend more money—has released much-needed funds into the system. Minister of State for Planning and Programme Implementation Y.K. Alagh has indicated a hike in prices of essentials and axe on farm subsidies. But, confusing declarations of intent being the hallmark of this Government, the Prime Minister announced a few days later that fertiliser subsidies will be hiked. Then, a rise in crude oil, coal and power prices is also long overdue: the Government may not have too many options here. Pai Panandiker expects a hike in railway revenues too, more through freight than passenger fare.
BUT raising administered prices, a very convenient revenue-raising tool for the Government, is also the most unpopular one, as the anti-petroproduct price rise demonstrations across the country have shown. But why have these government-controlled prices at all in so many sectors? And there may anyway be an inherent flaw in the Government's formula of basing these prices on the costs of producing and distributing these items. For, as S. Gangopadhyay, professor, Indian Statistical Institute, points out, these costs may themselves hide several inefficiencies. To take a random example, if the cost of an LPG cylinder is actually Rs 180 in the public sector, some 20 per cent of it may be due to hidden sectoral inefficiencies. On the other hand, if the private sector is already importing LPG and selling it at Rs 180 and the Government is supplying a cylinder at 35 per cent less, this is an obviously unnecessary subsidisation. Secondly, and more importantly, such a regime goes against the grain of liberalisation, by disallowing competition.
What options does the Government have? Shrinking the fiscal deficit, for one. According to Raja J. Chelliah, chairman, National Institute of Public Finance and Policy (NIPFP), as much as Rs 12,000 crore has to be shorn off the deficit to bring it to 4.5 per cent of GDP. The middle course that the Government could think of pursuing—a strategy that will not hamper the economy's growth—may be to split this Rs 12,000 crore evenly between revenue and expenditure. But can the Government cut expenses by even Rs 6,000 crore?
The conflicting ideologies and demands of a many-hued coalition have left little room for manoeuvre on the expenditure side. Having positioned itself as the sarkar of the underprivileged and the peasantry, there is no way the Government can get away without raising farm subsidies. In the last five years, subsidies as a proportion of revenue expenditure have steadily declined, from 16.5 per cent in '91-92 to 9.1 per cent (projected) in '95-96, though in absolute terms, it's still quite high. Interest payments, on the other hand, eat up about half of the revenues, as Government dependence on market loans for bailout during short-term crises has zoomed in recent years. Even as industry was hobbled by high-cost funds, in '95-96, the Reserve Bank of India printed money worth Rs 19,855 crore to lend to the Government. This is 30 per cent more than in pre-reforms '90-91. Grumbles Pai Panandiker: "Now we have a situation where the Government is competing with industry for money."
Says Shyamal Roy, professor, IIM, Bangalore: "A revenue deficit to the tune of 54 per cent of fiscal deficit is akin to the Government borrowing money to that extent to finance a project bringing in zero returns." Unfortunately, any attempt to slash revenue expenditure has historically resulted in an axe on development expenses. Which this Government has committed not to do, having already promised to raise social sector expenditure by 15 per cent and increased investment in infrastructure. Agrees Charan Wadhwa, professor, Centre for Policy Research: "The budget will be populist on the expenditure side." The issue therefore is: can the Government make up for the rise in spending by other means, for instance, cutting its workforce and minimising wasteful expenditure? As Chelliah says disarmingly, "I feel guilty about suggesting more ways of raising public money for the Government when one considers the terrible leakage in development schemes, especially up to 30 per cent in construction projects."
The violent reaction within the Government to the austerity measures Chidambaram had proposed doesn't raise hopes on that score. Well, then it can make the public sector more efficient. But this opens up the hornet's nest of tack-ling organised labour, which also forms a very important constituency for the United Front-Left Front-Congress grouping. Suggests Wadhwa: "Loss-making PSUs should be sold off and there should be some divestment, at least in hotels and services." Adds Alok Vajpeyi, analyst, Barclays de Zoete Wedd (BZW): "For the long term, the Government needs to privatise the PSUs in practice and in precept."
Some experts also feel a high fiscal deficit is hardly the bogey it's made out to be as long as it remains manageable and aids growth, unaccompanied by a large revenue deficit, trade deficit or high inflation. The Government should instead focus on raising revenues, mainly taxes. According to NIPFP economist Amaresh Bagchi, the tax revenue-to-GDP ratio, already dropping from 10.9 per cent in '91-92 to 9.9 per cent in '95-96, can be safely increased by one percentage point to net about Rs 8,000 crore to the Centre alone. Most feel the Government has more than enough leverage to ignore political considerations and implement most of the Chelliah Committee recommendations on direct tax reforms promptly. That is, it can widen the tax base, shift towards a comprehensive value-added tax, cast the net wide on services, collect taxes more efficiently and minimise avoidance. Says Chelliah: "Revenues should be increased so as not to nullify reforms. Not, say, by introducing a tax that'll have a cascading effect on other areas. Import duty can be raised on high-tech consumer goods, those that are being smuggled into the country anyway."
Economists converge on the need to raise direct tax revenue, a tried and tested option in many developed countries. Especially in India, where its incidence is not particularly high, accounting for less than one-third of total tax revenue. Worse still is the amount of revenue that escapes the Government kitty every year, mostly due to loophole-riddled, cumbersome tax laws and faulty and antiquated administration. The recent furore over big corporations—public and private—getting away without having to pay any tax at all makes a mockery of the numerous incentives and concessions on offer (see box 'Zeroing In, Finally'). Ironically, experts feel, the suggested minimum tax on book profits—tried earlier through Section 115J and withdrawn after a few years—may, in the long run, go the way of its predecessor. A much better option may be to minimise all concessions and do away with the plethora of minor amendments.
Like the proverbial genie in the bottle, however, all grand plans threaten to come asunder when one considers the minority and fragile status of the Government, which may not finally manage to raise even Rs 2,000 crore—which economists agree is the bare minimum by which the Government should hike its revenues—without treading on its many already-hurt toes. Chidambaram has a truly unenviable task ahead. The fuel price hike, for instance, had to be done in one fell stroke, when it should have been staggered over the last three years. But the climbdown on the diesel price points to the Government's inability to stick by hard decisions. With this retreat, the Government has actually managed to maintain the status quo on the oil pool deficit, while its earlier move would have reduced it quite sharply. However, while LPG and petrol would not have contributed much to the price hike, diesel would have done that, and also put the states in a tight spot. But add to that some more instalments of hike in administered prices, and we're looking at serious cost-push inflation.
Though maybe not to the extent of double-digit inflation. Gangopadhyay clearly rules out high or even long-term inflation, while Sen feels the Government shouldlearn to live with inflation and go in for need-based contractionary policies, that is, ways to curb demand and consumption. Food-for-work programmes, a streamlined and well-directed public distribution system and other employment promotion programmes can also cushion the impact of high prices in the short term on the poor and marginalised. But can the Government deliver?
In the long run, taking the liberalisation process further in the right direction, a process which stopped three long years ago, as well as promoting high growth and investment can have a salutary effect on inflation. Says Gangopadhyay: "It is wiser to look at real income growth." Hopes are already high of incentives to boost savings and investment, both domestic and foreign, and increased deregulation and opening up of sectors.
Especially with an economy which has shown as much resilience during a structural adjustment as few developing economies have across the world, there's one thing that sure shows no sign of ebbing: optimism.