FinMin Should Prepare An Investment Budget

Updated: Jan 23 2003, 05:30am hrs
After a period of strong economic growth in mid-1990s, the economy has slowed down in recent years. Apart from the vagaries of agricultural growth, there has been a steady decline in the growth rate of industrial production. It is only the strong growth in the service sector that has helped to offset this trend and keep the overall growth rate at a reasonable level.

The impact of this growth process on employment remains to be seen. Usually the employment elasticity of the service sector is high. However, the type of employment generated depends on the nature of services that grow. For example, the strong growth in IT can generate demand only for the highly skilled.

One must have some understanding of the causes of the decelerating trend in industrial production in the last four years, if measures to counter the trend are to be taken. The slow down in1997-98 and 1998-99 can to some extent be attributed to the substantial building up of capacities in the previous three years. In fact, the investment-GDP rate reached the peak of 26.53 per cent in 1995-96.

However, the continued weakness needs additional explanation. The familiar argument of imports being a cause of deceleration of domestic production is not substantiated because the import growth rate has also been weak. In fact, there is a positive correlation between growth rate in imports and industrial production. The external demand has an important impact in an increasingly open economy. The deceleration in world trade growth since 2001, must have had some effect on domestic industrial production even though export growth in goods and services has substantially picked up in the current year, despite global recession.

Another factor which may have contributed to the deceleration of industrial production, is the deceleration in agricultural growth rate. As mentioned earlier, the growth rate in agriculture between 1992-93 and 1996-97 was 4.7 per cent while between 1997-98 and 2001-02 it was 2.3 per cent. The period since 1996-97 is marked by a decline in investment rate. While public investment declined from the peak of 8.7 per cent of GDP in 1993-94 to 7.1 per cent in 2000-01, the private corporate investment declined from the peak of 9.6 per cent in 1995-96 to 5.9 per cent in 2000-01.

In raising the growth rate of the economy we need to focus on investment. While investment demand is part of aggregate demand, it is not so much the stimulation of overall demand as that of investment which is crucial for ensuring and sustaining faster growth.

In enhancing the level of investment, I would like to emphasise four critical factors. First, all investment decisions are based on future prospects. Continuation of economic policy thus becomes the key to sustaining expectations in the right direction. There has to be a consensus on the core elements of economic policy among decision-makers, legislators and political leaders.

Second, if the feel good factor is to be restored as a stimulant of animal spirits, good governance has an important role to play. Investors need to be assured of dynamism and efficiency in overall governance. Good governance implies not only transparency in administration but also effective implementation of decisions. This will also result in effective use of resources.

Third, for generating a general mood of optimism, it may be useful for the government to bring together in one place in the Budget the investment that will be made by various departments and ministries. A consolidation of this can be called investment Budget. The present classification in the Budget of capital and revenue expenditures does not correspond to economists concept of investment.

Fourth, one important factor contributing to the confidence of investors is stability in the rates of taxation and tariff rates. Unexpected downward revisions in tariffs make a lot of difference to profit calculations. While reduction in tariff rates to bring them in tune with levels prevailing in other developing economies is an important element of the reform process, there is need to inject stability in the rates. When the next change is made, it must be made clear that rates would remain at that level for at least a period of three to four years. A stability in tariff rates can have a significant favourable impact on investment decisions.

Liberalisation programme to be successful must ensure that the benefits accrue to all sections of society and that it commands the acceptance of a wide constituency. Efficiency and equity should not be posed as opposing considerations. They must be taken together to produce a coherent pattern of growth. There is no conflict between the process of liberalisation and the social obligations of the State. There is nothing inherent in the liberalisation process which should hinder the special responsibilities of the State in relation to the poor and under-privileged. In fact, a more efficient economy which should be the outcome of the process of liberalisation would enable the State to meet better its responsibilities in the socio-economic arena.

(C Rangarajan is Chairman, Twelfth Finance Commission. This is excerpted with the authors permission from his 15th Intelligence Bureau Centenary Endowment Lecture.)