Poor Mr Sinha. with the economy settling down to a 5 per cent hindutva rate of growth, India's finance minister can prevent a fiscal crisis only by backing, through budget 99, what the BJP doesn't really believe in: liberalisation.

By Swati Kamal, Rukmini Parthasarathy, & Abheek Barman

SEPTEMBER 30, 1999. The Mid-Year Review Of The Economy reveals that Budget 99 has not succeeded in reviving the economy yet. Gross Domestic Product (GDP) growth is unlikely to cross 4 per cent this year provided the agricultural sector grows by the projected 4.80 per cent. Corporate sales have grown by less than 1 per cent in the first two quarters of the year while net profits fell by 4 per cent. The Centre's borrowings are likely to climb to Rs 110,000 crore as it seeks to finance a fiscal deficit that has shot up from 5 per cent of GDP in 1997-98 to 6.10 per cent in 1998-99, and is likely to touch 7.50 per cent in 1999-2000. Bankers forecast a Prime Lending Rate of 18 per cent by March 31, 2000. According to stockmarket experts, the Bombay Stock Exchange Sensitivity Index, which has already dropped to a low of 2,700, will fall below the 2,500-mark. Portfolio investors have pulled out more than $2 billion--Rs 9,600 crore at the current exchange rate of Rs 48 to the US dollar--from the stockmarkets in the past 3 months. Foreign exchange reserves have fallen to $8 billion, and are shrinking at the rate of $30 million a day, fuelled by a trade deficit of $10.40 billion, which is 3 per cent of GDP. The Union Government will shortly seek a standby loan of $5 billion (Rs 24,000 crore) from the International Monetary Fund.

The countdown to the Crash Of The Century has begun. No one--not even the only man who has risen in the Central Hall of Parliament to present a budget on February 27--seems to be aware of the real calamity that stares India Inc. in the face.

While growth has all but vanished, Union Finance Minister Yashwant Sinha is fashioning economic policy under the misguided notion that his enemy is the fiscal deficit. What is speeding the Indian economy to self-destruction, however, is not just the growing gap between the Exchequer's revenues and its expenses. It is the growing gap between the growth that India needs--and the growth that India is getting.

In a sense, growth in fiscal 1998 will ride on a recovery in agricultural production. Since it shrank by 1 per cent in 1997-98, the rate of growth of 5.30 per cent that the Central Statistical Organisation (CSO) has projected for this year may be feasible. However, for the prophesy of 5.80 per cent GDP growth--versus 5 per cent in 1997-98--to come true, the industrial sector must grow by 4.60 per cent. Since it grew by only 3.50 per cent in the first 9 months of the year, that seems utterly fanciful.

Worse, the slowdown-turned-recession may not, as Sinha may have hoped, be part of its progress through the classic business cycle of bust-boom-bust. Had that been the case, reveals an analysis of industrial growth-rates since 1993-94, the 4-year gap between any 2 crests--and any 2 troughs--should have resulted in a bottoming-out in 1997-98, followed by an upswing in 1998-99. Unfortunately, the rates of 5.60, 6.60, and (a projected) 4.60 per cent, respectively, in the 3 years upto 1998-99 indicate that this is no cycle, but a long-term secular decline.

Blame it on drooping demand growth, both domestic and global. With the implosion in Asia shrinking global trade, India's exports have collapsed, shrinking by 2.9 per cent in the first 9 months of 1998-99 over last year. However, the deceleration in domestic demand is more difficult to explain. Money supply growth continues to run at over 20 per cent per annum, which suggests that nominal incomes are growing. Inflation rates are heading downward, which indicates that real incomes are also rising. Higher agricultural growth should translate into increased spending by farmers. And yet, private final consumption will grow by just 3.92 per cent in 1998-99.

That is not enough to propel a recovery. Sure, the changing structure of demand will lead to pockets of growth: infotech, pharmaceuticals, and, more recently, fast moving consumer goods. But then, these are businesses that, typically, do not have strong linkages with other sectors. As for the industrial core of the economy, it continues to shrivel. Between April and November, 1998, the basic goods industries grew by just 1.4 per cent--down from 6.8 per cent in 1997.

Obviously, the growth impulses generated by the first wave of the reforms have ebbed. And the economy is settling down to a new trajectory: the Hindutva rate of growth of under 5 per cent per annum. A reincarnation of the Hindu rate of growth that acted as unwelcome ballast through the 1970s, this is what Sinha must attack--first. Unfortunately, Budget 99 threatens to be devoid of an understanding of the bad karma that stalks the economy. And will, mistakenly, focus only on controlling the deficit, not on igniting growth. Forgetting, of course, that growth is the most powerful deficit-decimator there can be.

A preview of Sinha's strategy can be derived from what S.L. Shetty, 69, Director, EPW Research Foundation says: "The grave was dug by earlier budgets. Lowering the marginal tax-rate was a suicidal step since it has led to a considerable reduction in government revenues." So, Sinha will take the easy way out, and hike some Excise and Customs duties. This will be a dampener to growth, and distort the markets although it will keep uncompetitive business groups masquerading as swadeshi groupies at bay.

His myopia is predictable. In the first 7 months of 1998-99, the Central government's spending rose by 28.50 per cent--the highest in the last 5 years. However, between itself and Indian Railways, the government consumed 91.40 per cent of this amount, leaving less than 10 per cent for investment. Moreover, the additional revenues that were expected to pay for all this haven't come, mainly because the Bharatiya Janata Party-led coalition forced Sinha to reverse many of Budget 98's sop-cutting and tax-raising decisions.

By January 31, 1999, with 2 months to go before the books close, tax-revenues have grown by only 7 per cent. What else could Sinha have expected with industry responding to the last budget with a growth-rate of 3.70 per cent in the first 9 months of this year, and services with a rate of between 6 and 7.50 per cent? Even in 1997-98--no boom year--they grew by 6.60 per cent and 8.20 per cent, respectively.

With the annual projections for these sectors--accounting for 76 per cent of India's gdp--at 4.60 and 6.70 per cent, respectively, it is certain that Budget 98's forecast of a 19 per cent jump in revenues will fall flat on its face. While direct tax collections may manage to meet their targets, indirect tax collections have grown by just 2 per cent (target: 19 per cent). As a result, despite the CSO's superbly-timed recalculation of the GDP, the fiscal deficit will still overshoot Sinha's optimistic 5.60 per cent of GDP forecast in Budget 98--and touch 6.10 per cent.

Deja vu. In 1990-91, when the economy tanked, the fiscal deficit stood at 8.30 per cent of India's GDP. Believes Sunil Bhandare, 57, Advisor, Tata Economic Services: "The fiscal deficit is worse than (it was) in 1991. Although it was over 8 per cent then, it at least had some elements of capital expenditure. This year, it will be close to 7 per cent after knocking off capital expenditure. We are worse off."

He is not the only one worried about a replay of 1990. Economist Bibek Debroy, 43, Director, Rajiv Gandhi Foundation, says: "Virtually everything that happened in the late 1980s is doing so again, primarily on the fiscal deficit front. It is not back to the 1980s level, but it is inching up. All it will take is a crisis of confidence of some kind--and everything will be gone."

Sure, the A.B. Vajpayee Administration has been pointing sanguinely to India's foreign exchange reserves of $30.50 billion as reassurance. This, alas, is a fig-leaf. For the record, Thailand, South Korea, and Malaysia had swanky reserves of $38.90 billion, $33 billion, and $27 billion, respectively, in January, 1997. But they collapsed nevertheless. In any case, the trade deficit of $5.80 billion--compared to $2.70 billion in 1997-98--augurs ill for India's reserves.

While exports declined by 5.10 per cent in the first 7 months of the year over the corresponding period of 1997-98, imports grew by 9.40 per cent. As for the capital account, inflows are dropping: foreign institutional investors sucked out $661.20 million between April and November, 1998, while foreign direct investment is sliding. From $862 million in the first quarter of 1998-99, it fell to $388 million in the second quarter.

Meanwhile, the exchequer has only saved itself some small change. While the food- and cooking-gas subsidy cuts announced in February, 1999, will shave off Rs 2,800 crore from the subsidy bill of Rs 1,40,000 crore, disinvestment in the Gas Authority of India will bring in Rs 180 crore--3.60 per cent of the target for the year. Of course, North Block also wants a clutch of Public Sector Undertakings (PSUs) to buy their own, or each others' shares, which could transfer Rs 5,000 crore from the public sector's reserves to the Exchequer--and make a mockery of disinvestment.

None--or even all--of this will be enough. In the first 9 months of 1998-99, the government's market borrowings, net of repayments, were Rs 61,356 crore--4 per cent of India's GDP. This has hardened real interest rates, crowded out private investment, and squeezed industrial growth. Worries B.B. Bhattacharya, 52, Head, Development Planning Centre, Institute of Economic Growth: "I'm not hopeful that industry will recover quickly now that the infrastructure has crumbled. High real interest rates will deter investment."

Caught between a rock--the looming fiscal fiasco--and a hard place--the long-term threat of a low-growth economy--what can Sinha do? As with the crisis, so too can the solution be a re-run of 1991. Eight years ago, the Narasimha Rao Administration dealt with the situation by unleashing the reforms, and putting India on a new growth-path. Sinha must do the same. He must:

Remove Roadblocks To Foreign Investment. One reason why direct investment has shrunk to less than half its size is the mounting distaste for the way India continues to welcomes capital: by throwing masses of red tape at it. So, Sinha must introduce measures that will allow projects to be cleared within a week. For instance, he could dismantle the Foreign Investment Promotion Board, and announce the formation of an Investment Promotion Council, which will act as a unified approvals agency.

To ensure that the Council speeds up the process, it should be armed with a statutory status, and be staffed by both Central and state government officials. "The government is caught up in all kinds of non-issues such as a level playing field, competition, tax reforms, buyback, and so on, when we should have focused on facilitation, expediting clearances, quick financing of infrastructure, and delicensing at a deeper level," says T.K. Bhaumik, 48, Senior Advisor (Policy), Confederation of Indian Industry.

Cut Spending. Sinha must forget about the pump; let alone pump-priming. Budget 98 has proved that spending more does not kickstart growth. Instead of announcing hikes in Plan outlays--which are routinely missed--he should put into place a more effective monitoring system, making loans to states conditional on project performance. And the allocations to infrastucture ministries could be based on their ability to carry out pricing reforms.

In fact, getting infrastructure prices right would be the most effective form of priming the pump as that would unclog investment flows to a sector with the maximum pull on the rest of the economy. Of course, the transition to a pricing regime based on principles of cost, rather than cross-subsidisation, cannot be accomplished overnight, but a time-table can be announced right away for all sectors, the implementation of which must be monitored by autonomous regulatory authorities.

Anything Sinha can afford to spend must go in investments that private players can't, or won't, finance. That includes sectors like roads, which are difficult to price for users, but are vital to create markets. Sinha must also steer clear of the temptation, which many of his predecessors succumbed to, of using investment as an excuse to pump money into the government's pet charities: badly-run PSUs.

Privatise. Cross-country experience has, repeatedly, demonstrated that privatisation succeeds when the process is transparent. If the objective is to build public support for the programme, the shares of profitable PSUs should be sold to the public--not to the public sector financial institutions. Loss-makers, on the other hand, are candidates for strategic sale rather than for phased disinvestment to the general public.

However, no one will be willing to buy such undertakings unless they are restructured. Since the Disinvestment Commission has already mapped out the blueprints for 41 public sector enterprises, all Sinha has to do is to announce his acceptance of these recommendations and a time-table for their implementation.

Revitalise The Capital Markets. In 1998, the primary markets saw 19 public issues--that raised Rs 365 crore--compared to 125 (Rs 2,182 crore) in 1997 and 1,444 (Rs 13,887 crore) in 1995. Claims Prithvi Haldea, 48, Managing Director, Prime Database, which tracks the primary markets: "If the primary market revives, industry will revive, and vice-versa. It is a circle." Yes, but to revive the markets, Sinha must focus on reducing transaction costs instead of doling out fiscal sops.

For starters, the Securities Contract Regulation Act, 1956, must be amended to allow for derivatives trading. Trading would be further facilitated with the implementation of a uniform rolling settlement-procedure for all stock exchanges, and the compulsory dematerialisation of securities. Fundamentally, Sinha must yank the government out of the financial markets, ending, for instance, its stranglehold over the pension and provident funds business.

Boost Farm Markets To Modern Times. Last year's vegetable price-hikes punished the government for neglecting rural markets. Organisations that let people trade the risks of price-volatility cushion farmers and buyers against fluctuations, allow production-plans to be rationalised, and slash storage and wastage costs. Such commodity exchanges will provide the farmer with a more efficient alternative to the public distribution system, and will go a long way in reducing the upward pressures on procurement prices and, hence, the food subsidy bill. Therefore, Sinha should use farm futures as the most important part of his rural reforms, and create guidelines to facilitate their operations.

Sinha must also prevail on his government to delicense and dereserve all those industries that remain closed to the private sector, and accelerate the privatisation process wherever it is stuck--as in telecom services and insurance, for instance. Sadly, everyone is talking about only incremental change, a cautious Budget 99, and the lack of options. Even if he can look into the future, the finance minister of a wobbly 13-party coalition will always be under pressure to present a budget for the polls--not for the economy.

Clearly, there is one unwelcome truth that business is beginning to believe: that the Vajpayee Administration, given its centrifugal and centripetal forces, is in no position to take the bold decisions that can grow the economy. As Sinha gazes blearily ahead, the lack of ammunition in his armoury becomes clear. Only if corporate India gets a government that is committed to liberalisation, no matter what the price, can it dream of revival, revitalisation, and renewal. Sadly, Budget 99 isn't being presented by a government that believes.

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