The verdict and the way ahead

Published : Jun 18, 2004 00:00 IST

From the economic point of view, Verdict 2004 was a vote against neo-liberal economic reforms. To respect this verdict and to make democracy meaningful, the new government should formulate a socially beneficial growth strategy.

THERE are many meanings that could be read into the defeat of the Bharatiya Janata Party-led National Democratic Alliance (NDA). It was, in the first instance, a rejection of the pursuit, through state-mediated and independent channels, of a divisive social and communal agenda. But, one must remember, the BJP had sensed the danger of using, for electoral purposes, the blatantly communal platform that had in the past helped it rise rather rapidly from near obscurity to national prominence. It had, therefore, made its self-perceived success in governing the economy the focus of its election propaganda. Hyped by its media managers, this took the form of the now-ridiculed "India Shining" campaign.

However, in reality, notwithstanding the buoyant stock market, the large foreign reserves, the Information Technology-enabled boom and the rebound from drought year 2002-03, economic performance during the NDA rule was poor. An agrarian crisis, decelerating employment growth, higher morbidity and mortality in the small business economy and the wearing down of a social sector starved of funds had all meant that much of India was waning not shining. Not surprisingly, as revealed by a post-poll survey of the Centre for the Study of Developing Societies and Lokniti (The Hindu, May 20, 2004), economic performance during NDA rule was perceived as poor, with some variation depending on the class position of the respondents. While just 20 per cent of the poor felt that there was any improvement in their economic condition under the previous government, even among the upper middle class only 41 per cent perceived an improvement.

In addition, there are signs that there is some resentment over the unequal distribution of the benefits of whatever growth did occur. The perception that government should reduce inequalities in land ownership through ceilings on land holdings and intervene to redress income inequalities that seemed to predominate among those surveyed. Verdict 2004, therefore, can also be seen as an expression of anger at the adoption of a strategy and of success indicators that meant little for most Indians, especially the poorer among them.

Significantly, the dissatisfaction with their economic condition, which was "high" among about a third of the poor, seems to have translated itself into a rejection of the economic policies that constitute the neo-liberal reform programme embraced by the NDA. Disinvestment found favour with just 20 per cent of those polled and downsizing of government found just 29 per cent in favour. Responses such as these do suggest that the lack of improvement in or even worsening of their economic condition was seen by those affected as being related in some sense to the acceleration of the "reform" programme by the NDA government. That is, from the economic point of view, Verdict 2004 was a vote against neo-liberal economic reform as well.

It is not surprising, therefore, that commentators of widely varying persuasions sense in the verdict a disillusionment with reform, even, if not always, a complete rejection. What is surprising, however, is the response of much of the media and large sections of the urban elite to this feature of the verdict. The concern is not with the ways in which the reform can be stalled, modified and even reversed where necessary in order to respect the popular mandate. Rather, the sections of the media and market analysts seem to be gripped by the fear that the new government would actually respect the verdict and resort to such measures. Every indication of caution or a rethink on reform is treated as a recipe for disaster. And every statement from Ministers in the new Cabinet is searched through for signs of reassurance that the reforms would continue.

This campaign for "continuity" is backed of course with a suitable reading of movements of the Sensex. Any decline is presented as evidence that an irresponsible statement or act has frightened the markets; any rise is seen as evidence that normalcy is being restored and continuity assured. The message is clear: the role of the government is to calm the market. And the index of a calm market is asymmetric: the Sensex cannot decline, but it can rise without fear.

It should be obvious that when the new government formulates and then fleshes out its economic programme it must dismiss this market-linked rhetoric that reforms must continue whatever the verdict. But it cannot ignore these manoeuvres. It is not just that the media and the markets can be used to create panic of a kind that browbeats the government into holding back on what the mandate requires it to do. Inasmuch as the principal movers in today's markets are foreign institutional investors and the notorious hedge funds, their exit on being dissatisfied with any effort by the government to respect the popular mandate, will involve the outflow of foreign exchange that can impact on the currency market and lead to a run on the rupee. Even if the Reserve Bank of India today has large foreign currency reserves that it can put to use to defend the rupee, every such action can be read as a signal that the rupee is weakening, accelerating the outflow and threatening a currency crisis.

If such a crisis ensues, the experience of a large number of similarly placed developing countries indicates, the room for manoeuvre for the new government will be severely restricted. It would be confronted with deflation but would be under pressure not to reflate the economy by increasing its expenditure. To prevent itself from being straitjacketed by those financial profiteers who have thrived on the outcomes of "economic reform" under the BJP and by sections of the media which too have benefited from the easy liquidity conditions and the credit-financed boom in urban enclaves that capital inflows had generated, some action to curb volatile capital flows, both in and out of the stock market, is necessary. Thus, the first step on the way ahead must be a minimal set of measures of capital control that helps the government retain and even expand its room for manoeuvre. This is not blasphemy: it is what all developed countries did when they were at and beyond a stage of development similar to India's, and this is what some other developing countries, such as Chile and Malaysia, did at different points in time with positive effect.

Once such room for manoeuvre has been garnered, there are two issues that the new government must squarely confront: First, if markets fail from the point of view of the vast majority, as they clearly have, they must be reined in. So the areas in which the state must restore and even expand its role need to be identified and the segments in which markets must be regulated and controlled and agents must be disciplined singled out. Second, if the state is to restore and expand its role in these and other areas, it needs the wherewithal to finance that role. This requirement is the greater because of evidence that the deceleration and even decline of public investment in areas such as agriculture, infrastructure and the social sectors, were crucial in delivering the outcomes that were rejected by Verdict 2004. The new government must, therefore, find ways of raising the rate of investment, despite the fact that under pressure from international finance and the international financial institutions, previous governments have internalised the logic that aggregate expenditure must be curtailed in order to keep the fiscal deficit under control. With revenue expenditures proving sticky and "reform" eroding the tax base, this has necessitated a cut in much-needed capital and social sector expenditures.

THE most damaging failure of the growth process since the early 1990s has been its inability to deliver adequate employment opportunities. Results from the quinquennial surveys of the National Sample Survey Organisation reveal a sharp, and even startling, decrease in the rate of employment generation across both rural and urban areas. Indeed, so dramatic is the slowdown in the rate of employment growth that it calls into serious question the pattern of growth over the last decade.

This deceleration in employment growth occurred despite the immense opportunity for expanding employment that arose in the late 1990s because of the accumulation of huge food stocks with the government. Using these stocks and combining it with some rupee expenditure, the government could have launched a massive food-for-work programme geared to improving and creating rural infrastructure of various kinds. Inasmuch as inadequate investment in such infrastructure was principally responsible for the slow growth of agricultural gross domestic product (GDP), such a programme would have helped stimulate agricultural growth as well and ensured second-order employment generation effects. The launch of such a programme, parallel to existing employment generation programmes that must be strengthened, must be a high priority for the government.

Overall, greater dynamism in agriculture and its concomitant effects on non-agricultural employment in rural areas are crucial for accelerating employment growth. This in turn requires reversing the decline in capital formation in agriculture. Given the evidence that private investment follows public investment in the agricultural sector, public capital formation needs to be stepped up substantially.

The other important means for increasing employment is a revival of the small business economy, damaged by the withdrawal of measures of protection, including protection from import competition. For example, reserving areas of production for the small-scale sector makes little sense if simultaneously imports of those products are not merely liberalised but duties on them reduced substantially. In addition, a major reason for the closure of small-scale units is inadequate access to credit of the right magnitude at the right time. Even prior to the reforms of the 1990s, small industry had complained about the lack of access to credit. Since financial liberalisation has diluted programmes aimed at directing credit to the priority sectors, undermined development banking institutions, and rendered the banks less willing to lend to small customers with limited collateral by making profitability the sole indicator of banking performance, this problem has increased substantially. Thus a rethink of the nature and direction of financial sector reform is called for when considering options for accelerating employment generation.

It is not just import liberalisation and deficient rural credit that affects employment. It is indeed true that foreign direct investment (FDI) is not as inimical to the economy as speculative financial capital. But FDI often displaces domestic production by acquiring local firms rather than creating greenfield projects, as has happened in several sectors such as the soft drinks industry. Since the import intensity of foreign firms is high, this amounts to a form of implicit de-industrialisation. So foreign investment should be encouraged only in areas where it expands domestic production, either by using India as a base to supply hitherto inaccessible export markets or by substituting for imports in essential high-technology areas. This would also ensure that foreign exchange needed to meet outflows from these firms is simultaneously earned or saved. That is, FDI should be encouraged in areas where it expands domestic economic activity without adverse balance of payments implications.

FINANCIAL reform must be reassessed also because of the second area of concern that the new government must tackle immediately: rural indebtedness. Reports of suicides by farmers routinely point to an unbearable debt burden as being the cause of their extreme action. While a range of factors such as the failure of high-cost cash crops into which farmers have diversified or an unexpected fall in prices of those crops account for the inability to repay debt, an important factor is the high interest rates paid on debt taken from informal sources. The evidence suggests that the dependence of rural producers on such debt has increased during the 1990s. With financial reform resulting in reduced access to debt from the formal sector and banks even closing down rural branches as part of a process of restructuring, this dependence has increased substantially. The shift to "universal banking" at the expense of development banking and directed credit programmes has far-reaching implications, necessitating a halt to, and even some reversal of, such policies.

In the long run, improving the lot of the agriculturists requires ensuring a reasonable return for them. This requires reining in their costs and guaranteeing them appropriate prices. On the cost front, the government must ensure that the prices of crucial inputs such as power and fertilizer are not allowed to escalate on the grounds that prices charged by those providing those inputs must include a healthy return over and above actual and not even normative prices. This requires the acceptance of two principles. The first is that the prices charged by public sector units should not be assessed in isolation but treated as one among the many instruments that constitute the government's tax-cum-subsidy regime. In the past, on the one hand, public sector prices have been raised to increase budgetary revenues or reduce budgetary expenditures and, on the other, large tax concessions have been handed out to those in the higher tax slabs, which has contributed to a decline in the tax-GDP ratio. This implicitly treats public sector prices as one element in a redistributive fiscal regime, even though this reality is shrouded in the rhetoric of efficiency. While continuing to use public sector prices as redistributive instruments, it is necessary to ensure that such redistribution favours the poor.

The second is that prices received by farmers must not be allowed to fall relative to costs as a result of the liberalisation of imports, reduction of import duties and the gradual dismantling of the minimum support price scheme. This has indeed been one consequence of the reform, which needs to be corrected.

WHILE these are policies directly aimed at alleviating some of the most adverse consequences of reform for the poor, corrective reform is required in other areas as well. One is the strengthening of the public distribution system (PDS). Experience under the NDA has made clear that efforts at targeting subsidies at the poor neither achieve their goal nor result in a reduction in the subsidy bill. Hence, as the high-powered committee set up by the NDA government itself had recommended, there is need for a universal PDS that makes no distinction between populations above and below the poverty line. The tendency to raise the prices of food issued through the PDS must be abjured since the expectation that this would reduce subsidies has been proved completely wrong. It only reduces offtake from the PDS resulting in an accumulation of stocks with the government. The consequent increase in the carrying costs of the Food Corporation of India (FCI) results in a large subsidy bill, which does not reach the poor. Moreover, embarrassed by the large stocks, the previous government callously chose to sell it to traders for export purposes at below poverty line (BPL) prices, ensuring that the subsidy ended up as trader's profits or benefited international consumers.

Another area that must be urgently tackled is the decline in social sector expenditures and the consequent shortfall in social sector provision. To make such expenditures effective, they must be linked to a set of specific objectives, among which must figure the provision of free and universal primary education of quality, and free and universal primary health care of quality, within a fairly short time horizon.

If employment programmes are appropriately designed, efforts at achieving better social sector provision can be supported with infrastructure created with such programmes. This would allow a given expenditure to realise more than one goal.

The real challenge before the new government when dealing with the above issues is that of breaking the barrier to increase public expenditure in the name of meeting fiscal deficit targets implicitly set by the International Monetary Fund (IMF) and the World Bank. To do so would require reversing the decline in the tax-GDP ratio. It has been estimated that, if the ratio of Central government tax revenue to GDP which prevailed in 1990-91, prior to the onset of the current reforms, were prevailing today, then the Central government would have got an additional amount in excess of Rs.30,000 crores per annum at current GDP. Since India's tax-GDP ratio is known to be lower than that of other similarly placed countries, there is an obvious need to raise tax revenues through appropriate measures of progressive taxation, including larger taxation of the service sector, wealth taxation, especially taxation of financial assets, and so on.

Besides taxation, expenditures can be increased by dropping the obsession with the fiscal deficit, even when comfortable levels of foodstocks and foreign exchange reserves are available and industrial capacity remains unutilised because of lack of demand.

The previous government, rather than exercising this option, sought to deal with the fiscal crunch through the soft option of "mobilising" resources for the budget with disinvestments. This must be stopped. Disinvestment of profit-making public sector units (PSU) at throwaway prices is obviously irrational. But even in some PSUs that are loss making their condition is explained by the level of prices they charge rather than inefficiency.

Finally, a truly socially beneficial growth strategy cannot be put in place without a major role for the States. But State governments have for some time now been trapped in a fiscal crunch, which has become unmanageable after the implementation of the Fifth Pay Commission's recommendations. An important cause for the fiscal crisis faced by the State governments is the extremely high interest rates on loan provided to them by the Centre. By resorting to a combination of debt write off and swaps of high interest debt for low interest debt, the financial position of the States should be improved immediately.

These are some of the measures that the new government must adopt, to respect Verdict 2004 and make Indian democracy meaningful.

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