The Finance Minister's fallacy

Print edition : February 13, 1999

The Government's economic policy is anti-poor and fallacious. Squeezing the consumption of the poor by raising prices of foodgrains does not reduce the fiscal deficit significantly.

THE Bretton Woods institutions advance a particular argument in all seasons: that the fiscal deficit constitutes the "original sin" in any economy, whose reduction must be the overriding concern of policy, and that the best way of reducing it, if "investor confidence" is not to be jeopardised, is by cutting subsidies. Against all those who are squeamish enough to object to subsidy cuts on the grounds that they hurt the poor, a further argument is usually thrown in, to the effect that much of the subsidies intended for the poor do not reach them anyway. The Finance Ministry has imbibed this argument in toto, and the recent hikes in the prices of a whole range of essential goods are a reflection of it.

The prevalent official view is that the enlarged trade deficit India is witnessing is a result of excessive domestic absorption of goods and services, which in turn springs from the excess absorption of the government sector reflected in the large fiscal deficit. The causation according to this view runs from a large fiscal deficit to a large trade deficit: the fiscal deficit generates excess demand pressures which spill over into the trade deficit. Since the latter obviously has to be checked, for otherwise the country would have to borrow inordinately large sums from abroad to finance it (and the non-availability of such sums would push the economy into insolvency), it follows that the fiscal deficit has to be reined in; and if in the process some essential goods' prices rise owing to subsidy cuts, then so be it.

The unconcern for the poor which informs this argument is shocking, and has been widely and deservedly condemned: if the fiscal deficit is to be curtailed, there are surely other ways of going about it (for instance, taxing the rich) rather than squeezing the poor (and the partial rollback in PDS prices for the population below poverty line does not signify much). In addition, this entire argument on the basis of which the increase in prices has been announced is erroneous. The causation in the present context runs from the trade deficit to the fiscal deficit and not the other way round.

Yashwant Sinha meets a group of economists in North Block on January 12.-SHANKER CHAKRAVARTY

WHAT is noteworthy about the current increase in the trade deficit (which is estimated to reach $9.6 billion in 1998-99, compared to $6.8 billion for 1997-98 and $5.7 billion for 1996-97) is that it is occurring in the midst of an industrial recession in the country. Indeed the growth rate of industrial production is estimated to be only about 4 per cent in 1998-99, compared to 6.6 per cent in 1997-98. A situation of industrial recession should normally reduce the rate of growth of imports which enter to a significant extent as capital or current input into industry. Instead, what has happened is an increase in the rate of growth of imports in dollar terms, from 4.2 per cent in 1997-98 to an estimated 7 per cent in 1998-99 and, what is more, this has happened despite an absolute reduction in the oil import bill (from $8.2 billion in 1997-98 to an estimated $6.5 billion in 1998-99). In short, despite an industrial recession, the non-oil import bill has risen significantly. This phenomenon of rising imports despite subdued industrial growth is not specific to the current year; it happened last year as well. And what it clearly shows is that the enlarged trade deficit is not due to any general excess of demand over potential supply. What then is the cause of it?

This apparently abnormal increase in imports has occurred at precisely the same time when export growth has slowed down (from 21.1 per cent in 1995-96 to 5.2 per cent in 1996-97 to 1.6 per cent in 1997-98 and an estimated 0.2 per cent in 1998-99), and this has been the other major factor that has contributed to the expansion of the trade deficit. It is well known that the growth of world trade has slowed down significantly in the last couple of years, a symptom of the developing recession in the capitalist world. India's import splurge, export stagnation, as well as industrial recession, owe their origin to this developing recession in the capitalist world: the demand for Indian exports has stagnated because of it, while at the same time manufactured goods have been dumped on Indian market by foreign producers, eager to save their own skins in a situation of crisis, at the expense of India's domestic production, thus precipitating an industrial recession here.

This is a classic case of a "beggar-my-neighbour" policy being pursued by the advanced countries at the expense of the Indian economy, and the Indian Government is aiding and abetting them through its policy of "trade liberalisation". By pursuing a "liberal" trade policy at this juncture India is not only importing the crisis currently afflicting the capitalist world into its own economy, in the form of unleashing industrial recession and unemployment here, but is even financing the import of this crisis by running a larger trade and current account deficit on the balance of payments and increasing its external indebtedness to cover it. India would only be compounding this folly, and in addition worsening the plight of the poor, by trying to reduce the fiscal deficit in the manner it is being done.

THE enlarged fiscal deficit is to a large extent owing to industrial recession, which has reduced the Government's indirect tax collection. The indirect tax revenue for 1998-99 is estimated to be 6 per cent of the gross domestic product (GDP). It was 6.5 per cent in 1997-98 and 7.2 per cent in 1996-97, when the slowdown in industrial growth began. If this figure for 1998-99 had been in the neighbourhood of 7 per cent, where it was when the industrial slowdown began, then the gross fiscal deficit of the Central Government would have been 5.5 per cent or even less, which is about as low as it has been during the 1990s.

The Finance Minister with Finance Secretary Vijay Kelkar (centre) and Revenue Secretary Javed Choudhury.-

In short, the current increase in the fiscal deficit is a reflection not so much of government profligacy as of the impact of the crisis of the capitalist world. It is not government profligacy that - by causing an enlarged fiscal deficit - is creating excess demand pressures in the economy which are spilling over into an enlarged trade deficit. Rather, it is the crisis of the capitalist world which is being imported into the Indian economy under the "liberal" regime via a trade deficit and is causing industrial stagnation as well as an increase in the fiscal deficit. The causation in the present instance runs not from the fiscal to the trade deficit as the Finance Ministry believes, but the other way round - from the trade to the fiscal deficit.

THE way out of the present predicament of the Indian economy, therefore, lies in preventing dumping by foreign producers and, generally, in restraining imports. This would reduce both the trade deficit and the fiscal deficit, the latter by means of stimulating industrial growth and hence increasing excise duty collection. In addition, if the Government wished to make an impact on the trade deficit by using the fiscal deficit as an instrument, then it should reduce the latter in a manner which directly affects imports; for instance, by reducing import-intensive items of government expenditure, or by taxing the rich whose consumption has become highly import-intensive. But reducing the fiscal deficit by cutting down on subsidies to the poor, apart from being regressive, would not even have much effect on the trade deficit, since the reduced consumption of the poor hardly saves on imports or enlarges exports. (True, some primary commodity exports may rise but these may not fetch much additional foreign exchange owing to the adverse terms of trade effects they would generate.)

The Government's economic policy, in other words, is not only anti-poor but fallacious. But the fallacy is even greater than what appears at first sight. Squeezing the consumption of the poor not only does not reduce the trade deficit; it does not even reduce the fiscal deficit significantly. And it compounds the industrial recession. A squeeze on the consumption of the poor would reduce demand for certain essential industrial consumption goods and for foodgrains. Reduced demand for the former would worsen the industrial recession, while reduced demand for the latter would entail larger stock-holding by the government. And both these consequences would mean that the fiscal deficit would not have been lowered by as much as appeared at first sight.

A worsening of the recession would have further reduced excise duty collections; and larger stock-holding would have entailed larger expenditure by the Government for this purpose, which would have effectively nullified the impact of higher PDS issue prices on the food subsidy bill. In short, the thinking of the Finance Minister and his officials is not only morally objectionable but is based on a fallacious perception of the present state of the economy; and because of this it would not even achieve its own immediate objective.

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