In the prevailing circumstances, handling the fiscal problems in the country require a technical approach

When Mr Pranab Mukherjee took over as the finance minister, there was considerable hope that his Machiavellian talents would help to achieve fiscal correction in the fragmented coalition polity. Unfortunately, with all his political experience, he was not able navigate the fisc to safety. He leaves behind a legacy of a slowing economy and untamed inflation. The fiscal deficit has continued to balloon and the subsidy bill is capped only in the budget speech. The much-talked-about austerity is, at best, symbolic. With the over-optimistic projections on revenues and inability to phase out unproductive expenditures, there are serious question marks on the ability to rein in the fiscal deficit even at the budgeted level. On the legislative side, several bills remain to be passed even after the Standing Committee has given its recommendations. We no longer claim that the ?fundamentals are sound?, instead we keep repeating ?we have to bite the bullet? and when the credit rating agencies downgrade, simply dismiss them. There is no point in blaming the eurozone crisis or recession in the western world for our inaction. The situation is as bad and, in some respects, even worse than the one in 1991 and the new finance minister does not have the luxury of time on his side. At the time, the crisis was converted into an opportunity by the technician finance minister. The critical question is whether the country will be better off having a technician finance minister at the present juncture.

To be fair to the outgoing finance minister, it must be admitted that he did inherit a messy economy. The fiscal largesse from the loan waiver and increase in public sector wages combined with expansion of rural employment guarantee in the budget of 2008-09 had created a large imbalance. The sharp escalation in the price of oil, touching $165/barrel in July 2008, and the inability to correspondingly adjust domestic prices created even a larger hole in the budget. These, combined with the reduction in the excise and service tax rates as a part of the stimulus, resulted in the slippage of the fiscal deficit relative to GDP from 2.5% in the budget estimate to 6% in the revised estimate (which finally ended up at 6.5%). That should have caused enough discomfort to motivate action but, unfortunately, the bonanza from spectrum auction proceeds created a sense of complacency and the much-needed reforms went off the radar. With crude oil not showing signs of abatement, the subsidy bill went on mounting.

Complacency set in for another reason as well. The huge fiscal expansion (and, of course, election spending) helped the economy to soft land during the crisis and it started its recovery within two quarters of the Lehman episode. As the economy recovered, to grow at 8.4% in 2009-10 and 2010-11, the policymakers presumed that everything was fine and nothing needed to be done. Unfortunately, what they failed to realise was that the recovery was due to a large extent on fiscal expansion. As much of the expansion was on consumption-type expenditures, the impact on the GDP was immediate. Furthermore, an overwhelming proportion of the expansion was irreversible. With political sense prevailing over the economic logic, the finance minister preferred to shift the goal post?the fiscal deficit target in the medium-term fiscal plan (MTFP) was tweaked to 3.9% of GDP in 2014-15 instead of striving to achieve the original target of 3%. In the process, the MTFP has ceased to be a commitment but only a ritual, eroding credibility further.

It is important to reclaim policy dynamism, much as it existed in 1991 when the economy had to be steered through on both external and domestic fronts. The situation is not very different now with the consolidated fiscal deficit close to 8% of GDP and current account deficit at almost 4% of GDP. The major difference is that we have foreign exchange reserves of $285 billion now, but this cannot prevent the slide in the rupee. In the last one year, the reserves have fallen by $27 billion and the next few months will see an outgo of another $5 billion for repayment by Indian corporates. The recent measures to liberalise the capital account by increasing the limits for foreign investment in government bonds and external commercial borrowing will only expose the country to greater vulnerability.

In the prevailing circumstances, handling the fiscal problems in the country require a technical approach. Both from the viewpoint of credibility and communicating the reform to the public, we need an astute technician finance minister with the full political backing of the Prime Minister and the Congress party. The reforms in 1991 were carried out by the then finance minister with the full backing of the Prime Minister and the party and we need to repeat the process now. Rejuvenating growth, taming inflation and arresting the declining value of the rupee will have to receive immediate attention. Accelerating growth requires improving the investment climate. This requires better management of infrastructure, particularly the coal and power sectors and fast-tracking clearances on infrastructure investments. Liberalising foreign direct and institutional investment policies can bring in much needed investments. Both inflation control and exchange rate stabilisation requires taming the two deficits?the fiscal and current account. The government will have to unleash a host of reform measures without much loss of time and these include phased decontrolling of prices of petroleum distillates and fertiliser, clearing the backlog of foreign investments, liberalising multi-brand retail, withdrawal of retrospective amendments and ensuring safeguards in the application of GAAR. Now that the finance minister has cleared the CST compensation to the states, the reform on the GST front could move faster, but this is a reform that will take time.

The important thing is to reverse the prevailing sentiment and bring back investor confidence. There is only a small window of a maximum of one year that is open to this government if at all the present government entertains the idea of coming back to power. The reforms, therefore, are important not merely to lift the economy; they make eminent political sense as well. Time is running out and, hopefully, good sense will prevail.

The author is director, NIPFP. Comments at mgr@nipfp.org.in