C Rangarajan, former RBI Governor and currently chairman of the Prime Minister?s Economic Advisory Council, was at the Express for an Idea Exchange. In this session moderated by Dhiraj Nayyar, Senior Editor, The Financial Express, Rangarajan explains why India has the potential to grow at 9%.
DHIRAJ NAYYAR: What is your assessment of the state of the Indian economy?
The Indian economy has done well recently. Economic growth has been strong in the five-year period beginning 2005-06. The average growth during this period has been 8.5% and per capita GDP growth 7%. I would think this is the best performance we have had in any five-year period after Independence. Looking ahead, I think the Indian economy will grow at 8.5% in the current fiscal. This will be because of a considerable jump in agricultural production. Even assuming that on an average we grow only at 3%, the pick-up in the current year in agriculture, if the monsoon is good, should be between 4-5%. So the overall growth rate can be 8.5%, assuming industry and services grow at more or less the same rate as last year. The question is if India has the potential to grow at 9%per year in a sustained way. I would say the potential exists: some of the macroeconomic parameters like the savings rate and investment rates are at levels which will support a 9% growth. The savings rate is close to 35%and the investment rate is above 36%. These will enable the economy to grow at 9% a year, even if we assume an incremental capital output ratio of 4:1.
MK Venu: What about the high inflation?
The high inflation is hopefully a temporary phenomenon. We need to bring down the inflation rate as quickly as possible.
MK Venu: Food inflation has been a persistent worry. What is your outlook on food inflation and the overall inflation?
Food inflation can be broken into two parts: the food inflation that is caused by an increase in the price of cereals and the one triggered by other non-foodgrain items such as milk and vegetables. The early phase of inflation was largely triggered by price increases in cereals, besides the strong price increase in pulses. Right now, the food inflation is being driven by the increase in the prices of other commodities such as vegetables and milk.
We need to handle this problem in two ways. First, we need to ensure that the available food stocks with us are used in such a way that they dampen the market prices. This can be done in two ways. We can increase the availability of the subsidised stocks of food, particularly for the weaker sections. We should also ensure that the food grain available with the public authorities are also sold at prices below the market prices so that it has a dampening effect on prices. State governments need to find additional channels for distribution of food grain. In Delhi, food grain is distributed through various outlets but such outlets are not necessarily available in other states. Therefore, management of the food stocks is one important way of bringing down food prices. I believe that monetary policy also has a role to play even in a situation where inflation is triggered by food prices. Some moderation of the demand may also become necessary which entails some monetary action on the part of the RBI. The situation warrants it and the timing is something that RBI has to decide.
Subhomoy Bhattacharjee: The decision to deregulate fuel prices has been a bold one. How did it all work out, given the political sensitivity?
I think we had reached a point where some action on the petroleum products had become absolutely essential. The provision of cash subsidy of the order that was required to cover the under-recoveries of oil marketing companies was simply not possible. More than freeing the prices of petrol, the decision to raise the kerosene prices was bolder or required greater political courage. But even after the price hike, there will be substantial subsidisation in the price of kerosene.
If we succeed in electrifying rural areas, the need for subsidised kerosene should come down further.
Gireesh Chandra Prasad: Despite the deregulation, there still exists a gap between the prices fuels are sold at and market-determined rates. What would be an equitable burden-sharing formula between the government, the upstream and downstream oil companies?
This is really an internal arrangement of the government because so long as kerosene and LPG is subsidised, there will be under-recoveries. Even if diesel is freed and there is no under-recovery on account of petrol and diesel, still there will be under-recoveries on account of LPG and kerosene. These have to be met either by direct cash subsidies from the government or from some discounts that upstream companies like ONGC can give. ONGC and other upstream companies are being paid at international rates as far as their production is concerned and so, they now have a benefit arising from external circumstances. Therefore, they can share some burden?either by offering a price discount or by direct subvention to OMCs.
Dhiraj Nayyar: Do you think the global crisis is over given the events unravelling in Europe? Would there be a double-dip recession?
As far as I see it, double-dip recession will not probably happen. The US economy is reasonably well established at a stage of recovery. The US economy is expected to grow at about 3%in this calendar year. The European economy, even before the Greek crisis, was expected to grow only at 1-2%. This could be somewhat affected by the Greek crisis but I believe the European Union is very much interested in maintaining Euro as an independent currency and would do what is necessary to help some of the countries which are in distress. I do not, therefore, think that the world will experience a second recession but the recovery is going to be very weak or even anaemic in some ways.
Coomi Kapoor: Who should call the shots on monetary policy, the Finance Minister or the RBI?
Ultimately, it is the RBI which should do it. There is always considerable amount of discussion between the RBI and the government because the government is also responsible for the decisions taken by the central bank. I do not think the RBI would announce some decision to which the government is totally opposed. It is the responsibility of every wing of the government to ensure that the inflation rate is kept low, growth is enhanced and financial stability is maintained.
Sunny Verma: Recently, the government passed an ordinance to settle the Sebi-IRDA dispute over regulating unit-linked insurance plans. Won?t such apparent arbitrary decision-making disrupt the synergy among regulators?
It is indeed desirable to have consultations before enacting any legislation or taking any decision that has a bearing on the working of institutions. The ordinance was issued in the context of a conflict between two regulators. It could have been left to the courts to decide, but that could have been time-consuming.
KG Narendranath: The fiscal deficit reduction target under the FRBM Act is 3%. In the 13th Finance Commission report, the target is again pegged at 3%. What is special about the 3% figure?
There is some logic to fixing the fiscal deficit of the Centre at 3% and the fiscal deficit of the states or taken together as 3%. This would mean the overall fiscal deficit of the governments, Centre and states taken together, would be 6%. Despite the high level of the savings rate that we have, if you look at household savings, the savings in the form of financial assets is about 11%. This is what we call transferable savings, which can be transferred from households to the other two sectors?the corporate and government sectors. Therefore, this 11 per cent has to be shared between the corporate sector and the government sector. Of the 11 per cent, 6% goes to the government, some parts to the public sector enterprises and the rest go to the corporate sector. So long as the household assets are around 11 per cent I think the 6% target is a good one.
Sandip Das: Don?t you think there has been laxity in the last few years in creating additional storage capacity for food grains?
What requires to be done is to release the stocks by as much as possible and as fast as possible through additional channels so that there is a dampening effect on the prices. I think we should have two channels through which the stocks should be flowing. One is the public distribution system (PDS), through which subsidised food is distributed. In addition to that, we need to sell the stocks at prices which are lower than the market price, but are not necessarily highly subsidised.
Dhiraj Nayyar: Do you favour the Tobin tax?
I think there is a lot of misconception about Tobin tax. The original Tobin tax was conceived as a levy on all financial transactions, on all inflows and outflows in the foreign exchange market. This was intended to be a disincentive for short-term capital flows. At present, there does not appear to be a need for a Tobin tax. I find the capital inflows into the country at a modest level.
Dhiraj Nayyar: Has the global financial crisis fundamentally changed the state of affairs in favour of the state as against the market?
I do not think so. What has really changed is that financial markets need greater regulation. When you look at the broader question of state and the markets, the market in that context includes not only financial markets, but the entire gamut of markets that produce goods and services. I do not think there is any change in that side of the market.
In the case of financial markets, regulation was truncated. There were some segments of the financial markets that were either loosely regulated or not regulated at all, particularly in the industrially advanced economies. For instance, rating agencies, investment banks, hedge funds and some of the financial institutions were not regulated in any significant way. Therefore the important lesson from crisis is that all segments of financial markets should be regulated to avoid what may be called regulatory arbitrage. What is clear is that financial markets left to themselves are prone to excesses.
We really need to strike a balance between financial innovation, which are badly needed in our economy, and regulation which is needed for financial stability. But in India, I think there is a danger of financial innovation being impeded in the name of regulation.
Coomi Kapoor: Shouldn?t subsidies be phased out as most of these reach unintended beneficiaries?
Same kind of subsidies can benefit both weaker sections of the population and the middle class. For instance, the fertiliser subsidy benefits both the small and marginal farmers as well as those with larger land holdings. Since large farmers consume more than the smaller ones, in effect, the former benefit more. That is why there is the argument that there is a case for targeting subsidies. There are two classifications that are needed. One is that some activity needs to be subsidised?say, agriculture or fertiliser use. But the another classification is what class of consumer has to be subsidized.
For example, in the case of fertiliser and LPG, one can think of a mechanism by which we subsidise provision of LPG to a particular level above which market-determined pricing mechanisms sets in. The expenditure commission had earlier recommended that a certain quantity of fertilisers should be made available to all at subsidised rate. But if any farmer requires more than that, he would have to buy at market price.
MK Venu: Do you think that time is ripe for India to move away from its present policy of managing exchange rates to a complete free exchange rate management?
I think there are very few countries in the world that fall in the system that you are describing. Everybody is managing it in one way or the other. In emerging market economies, it becomes, to some extent, necessary. But by and large, I believe that the exchange rate now is being determined by market forces. The intervention would become necessary when capital inflows are very large and that requires some action on the part of the monetary authorities.
MK Venu: One gets the sense that the UPA and the Congress party have reached a point where some high inflation has to be tolerated to drive an 8.5-9% growth. Real incomes are rising despite rising inflation. There seems to be a shift in mindset on how much inflation can we tolerate.
I do not think so. I think the Prime Minister is certainly not of that view. He had always held the view that the inflation rate needs to be brought down. Therefore, the phenomenon of inflation in India, at least in the last two years, has been happening somewhat independent of what is happening in the real sector. It is being driven by the fall in agricultural production and expectations relating to prices.
Subhomoy Bhattacharjee: What is the next big challenge in reforms?
There are reforms required in almost all sectors. But one important issue that becomes urgent is improvement in governance. This is not necessarily a reform issue in the particular sense of the term, but more efficient administration, timely policy decisions, things will become more critical as we go along. The role of the government in the social sectors is expanding. We really need to get the maximum out of the money that we are spending. I think the issue of governance would become more important as we go along. Land is one resource which is limited. Therefore, there would be competing demand for land as we grow. The land policy will assume importance in balancing the interests the economy?agriculture on the one hand and infrastructure and urban development, etc, on the other.
?Transcribed by Gireesh Chandra Prasad and Anto Antony For longer text, visit http://www.indianexpress.com