C Rangarajan, chairman of the Prime Minister?s Economic Advisory Council, said Budget proposals for fiscal consolidation are realistic as they are based on the implicit assumption that fuel pricing will be revamped during the course of the next fiscal. In an interview with MK Venu for Rajya Sabha TV, Rangarajan said that if the economy starts picking up, the corporate sector, which is already geared up for further capacity expansion, will start investing almost simultaneously. He said he would not regard inflation at the projected rate of 6.5% for 2012-13 as ambitious. ?It is not a tolerable situation to have inflation rate running at 6.5% after it having remained at 9% for the two previous years. I think we must work towards having inflation at far lower levels,? he said. Edited excerpts:
The markets initially absorbed the Budget and found some of the assumptions, especially the fiscal deficit, actually realistic and achievable, but in the days that followed, some bit of scepticism came in about how subsidies will be capped at 2% of GDP, given oil prices that are hovering around $125-126 a barrel. How will the link between international oil prices and subsidies pan out?
The finance minister had two broad objectives before him ? one was to accelerate economic growth and second, to contain fiscal deficit so that it provides appropriate environment for sustained high growth. In many ways, he has delivered on both. I particularly welcome the strong statement he has made on containing the fiscal deficit. He has given a road map, too; deficit will go down by 0.8% in the next fiscal and will go down further from there and, perhaps within three years, we could get back to the FRBM target of 3%. Therefore, the finance minister has laid a lot of emphasis on fiscal consolidation. To buttress this preposition, he has also indicated that subsidies as a proportion to GDP will go down from the current 2.4-2.5% of GDP to something like 1.7%. It will go down to 2% next year and will be reduced further in the subsequent years.
But this would require correction in diesel prices.
There are three major subsidies ? food, fertilisers and petroleum. As far as food subsidy is concerned, the budget outlay may just be adequate because the full impact of the Food Security Act will be felt only by December-end. Certainly, the finance minister will have to provide much more for this subsidy next fiscal. But even what is provided for 2012-13 is higher than that for 2011-12.
As far as fertiliser subsidy is concerned, (budget estimates) are realistic and it is implied that action will be taken during the course of the year (2012-13). Such action may take several forms ? total decontrol of prices of diesel or some kind of arrangement under which prices are progressively reduced.
So, there are alternative ways of doing it but by and large the objective should be that direct subsidies by the government are pegged at the budgeted levels.
There is talk of some kind of dual pricing of diesel. The Samajwadi Party has said that farmers should be insulated from any sharp diesel price hikes since they are already facing problems of fertiliser availability and prices. Do you think some mechanism can be worked out to address this?
I think dual pricing in any commodity is going to be very difficult because it is very difficult to prevent slippages/leakages. Therefore, the best option might be straightforward increase in the price of diesel. There are some suggestions (on fuel pricing) that I have looked at very carefully.
But don?t you think this (diesel price hike) will have an impact on vulnerable sections of society?
There can be an alternative system, outside the price mechanism, like providing cash subsidies directly to identified beneficiaries, to address this concern. Even as prices are market-determined, these cash subsidies will provide a cushion (for the vulnerable). Ultimately, whether you provide cash subsidy directly or adjust the prices, the total burden on the government should not exceed the level given in the Budget. There are alternative ways, but dual pricing appears to be a very difficult thing to do.
Coming to the overall borrowings by the Centre, it appears that despite fiscal correction, which is quite substantial, gross borrowings for 2012-13 are envisaged to be higher than the amount borrowed in the current fiscal. Would this put pressure on interest rates considering that bond yields are already hardening? Do you think the markets will able to absorb this level of borrowing?
In order that the gross and net market borrowing during the next fiscal are lower than this year, the requirement for reduction in fiscal deficit will be even greater. Therefore, given the fact that the nominal GDP during the next fiscal will be growing close to 14%, the gross market borrowing programme being retained at slightly above the level in the current year should not pose a serious problem.
In the Budget, inflation is assumed at an average level of 6.5% for 2012-13. Don?t you think this is a bit too ambitious considering that there will be some cost-push inflation due to the excise and service tax hikes and also the fact that when oil prices get corrected, they will also feed into inflation?
I would not regard inflation rate of 6.5% as ambitious; in fact, we really need to reduce it further. It is not a tolerable situation to have inflation rate running at 6.5% after it having remained at 9% for the two previous years. I think we must work towards having inflation at far lower levels.
Let us look at the feasibility of this project: Since we are starting with a high base, that will probably show inflation coming down for the next year itself. After all, till December last year, we had inflation running at level above 9%. Therefore, one could see as a consequence some moderation in rate of increase in prices during the next year, till December. With the absence of other factors, I would expect inflation rate to come down to 6% or below 6% for the next year.
Monetary tightening by the RBI has slightly depressed demand and so we have the GDP growth for the third quarter of current fiscal at 6.1%. Do you think this (monetary tightening) will help moderate inflation?
Well, the demand pressures, particularly what you would call as monetary demand, will be impacted given the moderation in money supply growth continues during the year and this would help (in containing inflation). As I said earlier, in the absence of other factors, I would have expected inflation to come down below 6%. But we will have to take into account the impact of increase in excise and service tax and adjustment in a number of prices, all of this will push inflation up. But it is still possible to get an inflation rate of 6.5% during the next year. But this is also based on one big assumption that the monsoon and agriculture will be normal next year. Should the monsoon behave reasonably well and as we have the bumper crop of the past year and expectation of reasonably good crop in the next year, there could be a dampening of food prices and so, food inflation could remain low.
Coming to manufacturing inflation, do you think it is moderating?
In February, we saw headline inflation rising slightly over the January inflation (6.95% versus 6.55%) but manufacturing inflation came down by 1%. It is still high but it has come down. The only thing which can push the manufacturing inflation is rise in excise duty and if administered price of diesel gets adjusted, it will have some impact on manufacturing. Therefore, the manufacturing inflation may come down for next one or two months, but is likely to stay at that level during the rest of the fiscal.
Some manufacturers that I spoke to like Maruti Udyog chairman RC Bhargava say that they are operating at 100% capacity but still have not planned on new investments. Manufactures in several sectors are a bit sceptical about whether demand will pick up, even as they are operating at 80% capacity or above, the threshold you normally start planning new investments. Do you think this situation could put pressure on inflation?
Even if they decide now, the impact of that investment in terms of additional production will be felt with a time lag. Investors should always anticipate demand. I think if we grow at 7.5-7.6% in the next fiscal, further capacity addition in many sectors will start. Therefore, investment rate which has dropped in the last two years can pick up in 2012-13.
In 2008-09, you had said that recovery will be fast-paced as a lot of investments were in the pipeline due to high growth registered in previous three years. You had said investment-led recovery would continue and consumption would soon follow investment and pick up. Does that belief hold today as new investments are seemingly drying up?
Yes, the situation is different right now. In 2008-09, due to high growth in the past three years, lots of investments were in the pipeline but those investments have slowed down. But I think that if economic growth picks up during the next year, then companies will invest very quickly.
In some of the sectors like coal, other minerals and fertilisers, there is in fact a lot of demand, but it is the supply that is lagging. Could you throw light on what are the supply side bottlenecks in these sectors, which, if sorted out, can boost GDP?
I expect GDP growth for the next fiscal to be 7.6%. Inflation will be somewhat moderated which can lead to easing of the monetary policy during some point in the year, which will help both in terms of stimulating growth and facilitating new investments.
Could the monetary easing that you are talking about happen in the policy review on April 17?
I?m not sure what will happen as it would depend on the inflation number for the month of March. But during the course of the year, there is a possibility (of a rate cut by RBI). Investment requirements in some of the key infrastructure areas like coal, power, and road and also in fertilisers will be met during the year with the incentives announced in the Budget. These investments will itself act as a stimulator. So stronger action on the part of government will act as a catalyst for the private sector investments to happen.
Can you give us an estimate as to how much investments in these four sectors could contribute to GDP?
I think about 1% can be contributed to GDP if capacities are expanded in these four sectors. Also, there could be greater clarity on land acquisition and environmental issues during the next year. All of these can lead to larger investments. But as I mentioned a while ago, if the economy starts picking up, the corporate sector which is already geared up for further capacity expansion, will start investing almost simultaneously.
What is your expectation of the current account deficit for the next fiscal as you have projected a deficit of 3.6% of GDP for the current fiscal? Will capital inflows be stronger next fiscal?
There was some fear in the quarter ended December 2011 over whether capital flows will be adequate or not. The CAD was high and capital flows were inadequate and so the rupee started depreciating. But since then, that is from December-end onwards, capital flows have resumed both in equity and there are indications that FDI investments are also increasing. Therefore, my current estimate is that the capital flows for the whole year will be adequate to cover CAD that is 3.6% of GDP. But the addition to the reserves will be very minimal. If capital flows are not continuous and they come in bits, then it will again put pressure on the rupee for months in which capital flows are not adequate to cover CAD.
As regards 2012-13, our current estimate is that the CAD will come down to 3% of GDP. This is partly due to the fact that gold imports which are very high in the current year will come down. One of the reasons for this is the higher import duty. The other reason is if inflation moderates then gold as a hedge against inflation will also become less relevant.
Why is there such a strong demand for gold this year?
See, one has to decompose the import of gold into three parts ? imports for the purpose of export of jewellery, those for domestic consumption of jewellery and imports for pure investment, which is quite substantial for this year because of high level of inflation. The third category of imports (for pure investments) will moderate next year with inflation coming down and return on financial assets being reasonably high. Therefore, our estimate is that CAD will come down to 3% of GDP and capital flows may still be adequate to cover CAD.
So if you take away the gold imports that are a pure investment as hedge against inflation, then CAD will be roughly about 2.5% of GDP.
Well, if you take away all gold imports then we are almost on balance. But it may not be right to reckon so because there is always a need to import gold due to the desire of people to have gold. If you take away $15-20 billion (due to incremental gold imports), then CAD will come down to 3% or below 3% of GDP.
So you are suggesting current account/capital account balance may not be a problem at all in the next fiscal, since gold has become expensive ….
My point is the next year CAD at 3% may still be high but capital flows may be adequate. There is a note of caution that we cannot afford to continue with a CAD at 3% of GDP indefinitely. I think we really need to move towards reducing CAD.
