Montek Singh Ahluwalia discusses the scale and nature of the economic downturn facing India. He also explains the scope of, and rationale behind, the government’s stimulus efforts.
ESSENCE OF FISCAL DISCIPLINE: You’ve got to be extra good when things are good so that you can be a little bit bad when things are bad, says Montek Singh Ahluwalia, Deputy Chairman, Planning Commission.
“Is this just a this-year problem? And the answer is ‘no.’ This is actually a two-year problem at least, so I expect that in 2009-2010, since the world demand conditions for exports will be poor, there will be some need for stimulus there also,” says Planning Commission Deputy Chairman Montek Singh Ahluwalia, speaking about the economic situation and the ongoing efforts to face up to it. And he adds: “The essence of fiscal discipline is that you’ve got to be extra good when things are good, so that you can be a little bit bad when things are bad… you’re borrowing future fiscal deficits for the current year.” Explaining that the widening of the deficit over the next two years would cause investment to be pumped into the infrastructure, automobile, export and real estate sectors, he urges the States, and job-seekers, to use the expected two-year period of the downturn to make themselves more competitive. He spoke to The Hindu on January 9, while in Chennai for the Pravasi Bharatiya Divas event, days after presenting the Union government’s second fiscal stimulus package. Excerpts from the interview:
How do you expect the stimulus to have an impact, to work in reviving the economy? And what kind of timelines are we looking at?
If the fiscal deficit increases, but if there’s a lot of other demand in the system, it will lead to a very high interest rate. But the Reserve Bank of India is, hopefully, targeting a sensible interest rate, which actually means that the combination of the high fiscal deficit plus an accommodating monetary policy will lead to a net injection of demand into the system.
Everybody knows that both the fiscal and monetary action have lags. Frankly, exact estimates of these lags are not known. But in general, if there has been a fiscal deficit in the current year and if the monetary policy is preventing an excessive rise in interest rates, then you can say that the demand impact is already there in the current year. Which really means that the GDP [growth rate] that we hope to get out of the year — the 7 per cent that we’re talking about — reflects the impact of the stimulus.
So it’s already having an impact…
Yes, in the second half, and [it] will continue to have that impact.
The real question that is very difficult to answer is: in the absence of the stimulus what would the GDP [growth rate] have been? If you want to be very technical about it, you should simulate that. None of the models are precise enough to get that right, but I have a feeling that when many people say that GDP growth in the current year will be much lower — some people have said that, some have evensaid it could be as low as 5 per cent — that does not take into account the fact that there is a stimulus at work. So I’m assuming that instead of going down to 5 per cent, it might be 7 per cent — and that’s the effect of the stimulus.
Now what happens if interest rates do fall and you end up with the danger of inflation?
Well, that’s the key issue. My judgment — and I think that’s the government’s judgment too — is that for a variety of reasons, right now, inflation is not going to be a problem. We have very good agricultural production, stocks are building up, so there’s going to be no shortage of food and essential commodities. Plus the international price environment is very benign, so globally there’s a recession. I don’t expect to see, in the next year or so, any kind of inflationary pressure. Normally that would be a problem.Let me step back a little… A mere fiscal stimulus by itself does not necessarily lead to an actual stimulus if it just crowds out private demand. But to do that, the fiscal stimulus would have to be combined with a relatively tight monetary policy, in which case interest rates rise.And of course, the alternative is to allow monetary policy to be accommodating, to accommodate the fiscal stimulus. Interest rates do not rise that much, but then you have inflationary pressures. In my view, you won’t have inflationary pressures currently because the overall price situation is benign. Therefore a monetary policy that is accommodating the stimulus will have a stimulus effect, and will not lead to excessive inflation, at least for the next year or so. And this is a short-term management problem that we face.
So you’re expecting an accommodating monetary policy for this year, but you expect the deficit and the stimulus to go on next year as well?
Yes, that’s the second point that you could ask: is this just a this-year problem? And the answer is ’no.’ This is actually a two-year problem at least, so I expect that in 2009-2010, since the world demand conditions for exports will be poor, there will be some need for stimulus there also.
However, what I don’t know at the moment is whether next year, that’s 2009-2010, let’s say by August-September, if all the financial kind of choking of the system stops and there’s the beginning of a real turnaround, if that leads to a big change in investor sentiment, then of course you have to balance how much fiscal stimulus you need. And that’s a judgment that the government will have to make when they present the budget.I guess what I’m saying therefore is that because of the possibility that although exports may be low next year, the investment, the depressed condition of investment, that may not be as bad as people fear at present. If it is not as bad as people fear at present, then the crowding out aspect of the fiscal deficit does become important.
So I would hope that next year we certainly can’t have an FRBM [fiscal responsibility and budget management] type of deficit — 3 per cent is out of the question.
But I think we should show a distinct improvement of the deficit compared to the current year and I think the logic of going for a fiscal stimulus over a two-year period is that we will then be back on to a corrective track.
If you’re concerned about the fiscal deficit…Normally you have two concerns about the fiscal deficit. One is the current demand condition, and the other is the build-up of debt. As far as the build-up of debt is concerned, we should be quite clear that while for the next two years the build-up of debt will be more than we had expected, within the next two years we’ll correct that.
How do you correct that?
Well, for example, if in the Plan period you were expecting a 3 per cent fiscal deficit uniformly, but you decide that this year you’re going to have 6.5 per cent and next year you decide to have, let’s say, 5.5, you’re above your normal target… The essence of fiscal discipline is that you got to be extra good when things are good, so that you can be a little bit bad when things are bad.
But it’s absolutely correct that if you want to get back to square one, then you have to do better than you expected. So you’re borrowing future fiscal deficits for the current year – that’s what you’re doing.
Where exactly is this money coming from? You had earlier broached the idea of accessing forex reserves. Is that where you’re looking for some of this money?
No, that can be done, but I don’t think the government will do it that way.
Basically, the government borrows. And there are two ways of addressing this issue: one is that the government just borrows and the Reserve Bank watches what’s happening. If nobody else is borrowing, then fine, the interest rates remain the same, and the government borrows and the private sector doesn’t borrow.
If, on the other hand, the private sector is borrowing something and the government is also borrowing, then there will be some need for an accommodating monetary policy. There aretwo ways: either the Reserve Bank directly picks up the government bonds, which means it creates money. Or it allows the government bond operation to go on in the normal way, but as monetary conditions tighten, they relax the monetary restraint.
So one way or the other, what it means is, more aggressive fiscal policies can be followed without pressure on interest rates, if (a) nobody else wants to borrow, or (b) people do want to borrow but you’re willing to have an accommodating monetary policy. If you do the accommodating monetary policy, the advantage is that the interest rates don’t go up so much, the danger is inflationary pressure.
What I’m saying is that right now, that’s not a serious problem. That doesn’t mean that if you keep on doing that, there won’t be a problem. That’s why I’m saying that this is spinning in the short run.
Monetary policy is virtually continuous. Leave it to the Reserve Bank to watch. The stimulus is now known. Next year’s stimulus…Well, I think there would be an understanding on most people’s part that next year also there would be a stimulus. The debate would be ’how much,’ then. I don’t think anyone would be happy if we had a current account deficit the same as this year, given that this year’s deficit is going to be high. Some people would say instead of 3 per cent you can be 4 per cent, and others will say ’no, no, no, why can’t it be 5.5 per cent?’ and that’s a debate which we can argue.
In the stimulus package, are you looking at industry-specific stimuli as well for sectors that have been badly affected?
Spending is one thing, tax reduction is another. Tax reduction linked to bond issues by the IIFCL (the India Infrastructure Finance Company Limited), which actually leverages bank lending, is a third thing. And all of them are in one way or another part of the stimulus package.
To the extent to which we’re giving tax-free bonds to the IIFCL, the tax-free part of it is a part of the stimulus, but that stimulus is linked to money going to infrastructure, so in that sense there’s an indirect link. On the spending side, most of the money, the additional money, is going to rural infrastructure, some additional money is going into the RLEG (the Rural Landless Employment Guarantee programme), which is supporting income at the rock bottom.
As far as the rest is concerned, I think some of the tax deductions, the tax rebate, the 50 per cent accelerated depreciation, are specifically linked to commercial vehicles. Similarly, some of the tax, some of the duty drawbacks, etc., are aimed at the export sector, so that’s sector-specific. And I think the credit moves and the changes in debt restructuring norms are aimed at supporting the real estate sector. The loosening up of ECBs (external commercial borrowings), for example, is supporting real estate development. Earlier, they were not allowed, integrated townships couldn’t borrow, so that’s helping them.
So there is a sector thrust. I would say the sector thrusts are automotives, automotive components, exports in general, certain types of real estate development. Those are the sectors that we think are the most hit, and therefore some sectoral pressure is there.
Are the States looking at incentives to attract manufacturing industry to ensure a revival?
Well, that’s a very important issue. Any complacency that jobs are booming, investments are booming…There was perhaps, there always is, in an upswing, that sense of ultra-optimism. And sometimes it’s good. But when it goes too far it can result in complacency. So one of the things that happens in a downturn is the harsh realisation that there are tough times also.
And the States should also certainly, in my view, do whatever is necessary to make them competitive destinations. When investment programmes are slowed down, they will come back in again. And when they come back in again, they’ll be looking at the States that have used this period to prepare themselves to be more competitive.
For example, if we use the next two years to make a real breakthrough in the efficiency of the power sector, we can have a fantastic growth renewal two years down the road.
In the last few years, when we have been growing, the focus of this growth has been toward job creation, employment generation. How is that going to be affected and what are we doing about it?
I think it’s clear that when you move from a 9 per cent growth rate to 7 per cent, the system not only creates fewer jobs, but the system also suddenly gears itself up to uncertainty. People who were expecting sustained rapid growth very often recruit in advance because they’re training for a higher level workforce, so when you get a shift down, there’ll be an interruption in that process but that interruption may be unduly sharp in the short run.
But you know, a 7 per cent growth process is also going to generate jobs. It’s just that you see, in the very fast growing sectors, you see a sudden shock. Now, to the extent to which we are trying to minimise the growth reduction, that’s obviously job related, to the extent we’re helping particular sectors, that’s minimising disruption in those sectors.
But I think one has to accept the fact that if there is a major global shock, then the recovery of the economy to its full growth potential might take another two years or so. And during that period, we’ll be producing fewer jobs.
One important good development is that the shock is perhaps in the high income range of jobs, not in the rural sector. Agricultural growth is actually better than in the past. Some of the information I have from the retail people seems to bear this out. There’s a drop in the growth of retail in the metros, but not in the small towns — which would suggest that if you think of the economy in two parts, the rural-based part and the modern part, it’s the modern part that’s taking the brunt of this shock.
That still does cause uncertainty… For example, college graduates this year are suddenly finding that recruitment, campus recruitment, is literally frozen. In a State like Tamil Nadu, where engineering colleges are mushrooming, how do you deal with the social issues that come up with that?
This is a painful process. And the only thing one has to say is that, first of all, this is temporary and we hope that if the strategy of getting back to a high growth path works, then the jobs will get back into the market. So there’s no doubt that to the extent to which there is a slowdown, there will be some temporary pain and one of the groups that will experience it is this group, which was earlier having a huge excess demand.
Now let me say this. Earlier we were told that there is a shortage of engineers. So probably what is happening is that the prime jobs are not so readily available but there are other jobs in the system. I mean, the main thing I would say to younger people is that we know that it is difficult and it will be difficult for the next year at least.
But the only thing is that they shouldn’t view this as a permanent loss of opportunity because this is not a world in which the job you’re going to get now is the job you’re going to have for the next 30 years. They’re going to be changing jobs and so on. At least at the upper end, they all do. So they may not have got the jobs they want, but maybe next year or a year and a half down the road, those jobs will get back into the market.
Job entrants, new entrants, never have a social safety net, they rely on family income, they look at other opportunities, they wait a bit. Some of them might even, rather than look for high paid employment, look for self-employment and entrepreneurship. You never know, these are some of the brightest people and if some of them are pushed into entrepreneurship, five years later they may even feel that was a lucky break, because otherwise they would just get sucked into a high-paid job.