End Of Economy Blues

THERE is considerable reason to be optimistic about the future of the Indian economy. Several factors lead one to conclude that the economy has likely bottomed out, and that one can look forward to close to 7 per cent growth in the gross domestic product (gdp) in 1999-2000. Despite the best efforts of some, India is integrating into the world economy; the successful listing of Infosys on Nasdaq is the latest example of this trend. While international organisations like the World Bank are sceptical of a recovery in world gdp in 1999, others (for instance, we at Oxus Fund Management) believe that 1999 gdp growth will be close to 2.7 per cent, or a reasonably sharp recovery from the round 2 per cent that was posted for 1998. This should mean that the Indian economy can obtain a stimulus from external demand and that Indian exports can (again) grow at close to double-digit rates.

On the domestic side, Yashwant Sinha's budget has been a breakthrough in one important respect-it is the first budget to (almost) explicitly integrate fiscal policy (that is, what the budget does) with monetary policy. Tax surcharges and efforts to raise tax revenue are signs of a contractionary fiscal policy, that is, such policies decrease the growth rate. An expansionary monetary policy is what is needed to counteract the contraction. In 1998-99, money supply expanded at close to 20 per cent; some analysts argued that the rbi should think about raising interest rates, from already record high levels! What is encouraging is that the rbi eschewed such crude unthinking monetarism in favour of the modern era approach of interest rate targeting, which means real interest rates for depositors should be close to 2 per cent (in a growth recession economy like India) and borrowing rates close to 5 per cent. With inflation around 5, this means that lending rates should be close to 10. Thus, the recent interest rate cuts announced by rbi are hugely welcome; it is hoped that another cut will arrive soon. This additional reduction in the cost of capital should be the final impetus for the Indian economy to revive. When it does, the economy will truly be set on achieving its destiny.

Additional reasons why now might be the turning point are the significant reforms in taxation introduced by Sinha. As was obvious to everybody, the plethora of excise tax rates was meant for only one purpose-to line the pockets of political parties, politicians and bureaucrats. The importance of Mr Sinha has to be understood by one simple fact-policy-oriented bureaucrats and economists have been consistently advocating such reforms for the last 20 years. Yet, no ruling party-Congress for 16 years in three avatars (Indira Gandhi, Rajiv Gandhi, Narasimha Rao), and the Janata-United Front in three avatars (V.P. Singh, Deve Gowda, I.K. Gujral)-was willing to cut off its nose to help the country.

In this regard, Sinha's actions are more commendable than even Chidambaram's ground-breaking tax reforms. In the latter, there were few interest groups that were hurt; it was a clean win-win situation. In the excise tax case, the ruling political party is the biggest loser: it has lost a major "traditional" funding source-corporates willing to buy excise tax concessions.

The implication of excise tax reform for the economy should not be underestimated. When economists talk about "animal spirits", they are talking about releasing the energy of entrepreneurs for productive, profitable goals, rather than the highly unprofitable activities of increasing economic rents for oneself.Corporates can now assign monies for research and training rather than seek appointments with politicians before the budget. Thus, tax reform will not only help growth in 1999, but also increase the future growth rate.

Lest it be misunderstood that I believe that Budget 99 was nirvana, let me emphasise that there were drawbacks as well. For example, the policy on investments in equity funds was heavily flawed. It is understandable that tax benefits be given to equity investments. But why reserve this privilege for mutual funds, and especially those that have not performed well over the last few years? Why assume that the Indian investor is stupid and should be taxed if she uses her mind, and that mutual fund fatcats, who charge about 6 per cent for their "smart" services, should be subsidised? And subsidised at the rate of 30 per cent (tax paid on short-term capital gains)! Why hide behind a uti-leaf-why not extend tax benefits to all investors, and investments, in equity?

Some research outfits, both domestic and those belonging to foreign institutional investors, have come out with gloomy forecasts for 1999-2000. Some even suggest that the economy will have difficulty topping 4 per cent. These Cassandras were wrong in 1998-99; they are likely to be wrong next year as well. Why? For two reasons-first, because a more "correct" economic policy is now in place in India than has been the case for a long time. Second, in the last 20 years, only in three years (3.8 per cent in 1981-83, 3.7 per cent in 1983-84 and 0.4 per cent in 1990-91) has the economy has grown at below 4.8 per cent. Look for gdp to top 7 per cent in 1999-2000, and for India to grow at a sustained 6.5 rate over the next decade.

( The author is director, Oxus Fund Management, a New Delhi-based emerging markets advisory and asset management company.)