## Wednesday, February 15, 2006

I wrote a column in Business Standard today titled Caution, dangerous curves ahead. I argue that while the Indian economy appears to be in extremely good shape, there are some important concerns about the period leading up to 2009:

• The resolution of global imbalances - which don't seem to be gently subsiding - and a potential reduction in the global GDP growth rate.
• The expenditure impact of the UPA's spending programs.
• The impending general elections of 2009.
• The FRBM deadline of 2008-09.

In the worst case, these problems could come together giving a `perfect storm' in 2008-09.

Hence, I argue that greater caution is called for, in fiscal policy and in economic reform. This perspective suggests that the bulk of the FRBM requirements should be fulfilled in 2006-07 and 2007-08 itself. I argue that fiscal policy will not stabilise, which emphasises the importance of stabilising monetary policy. This requires shifting away from the pegged exchange rate in order to obtain monetary policy autonomy. Finally, the present good times should be utilised to buy out pockets of discontent, and forge ahead with reforms, so as to build a strong economy, and be ready for hard times.

1. Sir I share your views expressed in the article today. I do believe that it will be too difficult to archive the FRBM objectives as we near the general elections. But I sometime wonder what exactly do we need to do. Should we reduce expenditure or we should go ahead with scheme like employment guarantee, which will increase the purchasing power of rural masses, which will enhance the growth in manufacturing sector. This growth will lead to better tax collection eventually a big part of the money spend on the such schemes will come back to the government as tax. In addition productive capacities will be developed which will create further income and employment. I will be thankful if you clear things for me.

2. It is quite clear that lifting capital account restrictions ,so that monetary policy can be a useful tool, is clearly a political decision. The two questions that I have are:One, will the current political and bureaucratic leadership will really act. It is quite likely that the Prime Minister shares the skeptic view that the people in RBI have (coming as he does from the same school of thought). Secondly, what will be the impact of free capital flows on the banking/financial sector as such? Some people hope that free capital flows will do to the financial sector what free industrial policy/delicensing did to the manufacturing sector. Is this necessarily true and will we see the same old "level playing field" arguments once again?

3. how is the growth & structure of our gdp doing vis a vis the potential gdp structure & growth as of today??
i think that has to be taken into consideration while calculating the overall scenario in 08-09.

4. Sir,

Why do we give so much of importance to fiscal deficits ? Is achieving FRBM targets really that important ? US and Japan are two of the world's largest economies. Yet, the one that is running large deficits is growing at a respectable (2.5-3% growth, barring the Dec-05 qtr), and the one that has enjoyed surpluses well over a decade now is struggling to stay afloat.

Textbooks teach me that poor fiscal mgmt forces govts to borrow more, and these deficits are usually financed by printing more and more money (thereby increasing money supply and therefore result in runaway inflation).

But, does that really happen ?

Doesnt the current global situation prove that otherwise - plenty of liquidity, money floating all around, asset prices across-the-board are at their life-time highs and yet no country is complaining of inflation ? The Federal Reserve keeps raising interest rates, in anticipation of the ever--alluding inflation ? And we keep following it, so that net capital inflows remain positive.

So while good times last can we not just forget (or rather not worry too much) about achieving FRBM targets or fiscal deficits and go about building more and more roads, ports, airports, etc. Instead of putting up our reserves with the Federal Reserve can we not build infrastructure with the same or even say raise money from the capital mkts by create SPVs and getting them listed on the bourses ?

-
Ravi Purohit.

5. I think that the "purchasing power of the masses" is best increased through economic growth, not through big government. The job of the government is to deliver an adequate quantity and quality of public goods, like national defence, police, judiciary, financial regulation, etc.

I think that the political economy which will shape modernisation of the monetary system is: Firms who don't like to be shackled. Politicians might not fully understand monetary economics, but they will respond to the needs of firms. Asking a firm to not access low-cost equity or debt capital isn't that different from asking it to buy high-cost steel. The firms understand this. The politicians understand the importance of cost minimisation.

Why FRBM? Because the debt/GDP ratio of India was on an explosive trajectory. A bigger and bigger fraction of every year's budget was going away in paying interest.

And, to build infrastructure, money has never been the constraint. The bottleneck has been institutional reforms. E.g. in Telecom, the private sector is quite able to raise debt & equity capital both domestically and abroad.

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