Wednesday, 4 March 2009

The Original Reformer!!

In 1991 our budget deficit was at around 12% with dwindling forex reserves. In stepped a silent Prime Minister(He spoke least number of times in Lok Sabha for any PM who has completed the full term of five years) and a bold reformer as Finance Minister who was given a mandate to reform. The reformer started the chain (although some would argue that it was Yashwant Sinha who took the first step but could not do anything as he lacked the political backing) the silent PM watched, clapped and kept the reformer untouched from any political bickering.

Thus we opened our market, allowed FDI and slowing we started integrating our economy with rest of the world. Taxes were streamlined and we started discussing what role Govt should play in setting up of industries or investing public money to create companies (thus started talking of disinvestment). Although he tried but could not create the needed environment for more ‘controversial’ reforms in labour laws. First three years were good for reforms. But then came a bit of lull as the party started loosing elections.

Then came new Govt and another reformer as FM who was one of the best qualified for the job. He was bold enough to push tax reforms (streamlining them further), push disinvestments and he did present the dream budget.

We had another change of guards at the top and then we had couple of guys (one after another) manning our Finance Ministry with a full fledged Disinvestment Minister as well. They tried to push further economic reforms, streamline taxes, tried to create an environment for more FDI in different sectors, more modernized labour and land laws.

All along since the start of process of opening up we had Govts from different political camps but there were certain underlying themes and understanding as every successive Govt tried to reduce our fiscal and revenue deficit, tried to pull Govt money out of sectors were it should not be, tried push easier monitory policies, reduce the unplanned expenditure of Govt, of lowering the interest rates. We even put a mechanism to limit our fiscal and revenue deficit and defined a time frame to reduce it to a manageable level,

It seemed we are out of the old says of high un-sustainable deficit and high inflation / high interest rate period.

Then politically even something better happened. The erstwhile reformer was now the Prime Minister and the man who last presented the dream budget was our Finance Minister again. Together they took the country to new heights of growth and our GDP growth started touching 9% mark.

Everything looked ‘happening’. The income of average Indian was growing very fast infact some reports say that it has actually doubled in first seven years of new century.

We even inacted a law for Financial responsibility. Fiscal Responsibility and Budget Management (FRBM) Act, with terminal goals in 2009-10 of a revenue deficit/GDP ratio of 0.0% and fiscal deficit of 3%.

But then somewhere down the line it seems the Govt gave quiet burial to economic reforms.

Slowly but surely high interest/high inflation regime came back (albeit it was more of a global phenomena rather than any Indian doing).

Disinvestment was dropped from any Govt jargon. Tax complications, Labour laws and land laws almost remained as it is without any serious push to modernize them. Some of ‘shinning’ sectors which were the success stories of era of economic reforms like real estate became over heated.

Then in last one year everything started unravel. Although the budget estimates for 2008-09 promised a revenue deficit of 0.5% and a fiscal deficit of 2.5% which were in line with our FRBM act. But then there are too many big ‘off-budget’ items (accounting for almost 3-4% of the GDP) like loans waivers to farmers many of whom were loan defaulters (although they in the first place were given a loan which they never had means of paying it back), sixth pay commission and the flag ship program of rural employment (National Rural Employment Guarantee Act (NREGA)).

This is coupled with a year of low growth which has an impact on tax revenues. Govt also announced stimulus packages for industry.

It started showing on Government’s statement of accounts as well as it showed it contains the seeds of a larger fiscal mess, gross market borrowings for the current fiscal year 2008-09 has balooned to Rs 3,06,000 cr ( to put the numbers in perspective its Rs 838 cr daily every 7 days of the week), which is multiple times of the original estimated Rs 1,33,300 cr.

Compare this with previous (NDA) government which had left behind a deficit of only 4.8 per cent of the GDP at Rs 1,32,103 cr while the current Government’s interim budget has a deficit of 6 per cent of the GDP at Rs 3,26,515 cr.

All this combined would push the deficit levels to 8-9% (combine with with deficit of states which could account for another 3%) and we have deficit level of 11-12% which is similar to levels of 1991.

As fallout, which we experience in our daily life, all this deficit (and borrowing by Govt) is pushing (or keeping) the interest rates at a high level (mostly in double digits or high single digits). Govt borrows from the market (by issuing short term and long term government securities (bonds and gilts) and with this high demand of money, the interest rate paid on bonds (and gilts) will remain high, which in simple term would means that Govt is a far more attractive borrower for banks than common man (or industries). So the loans for us (and industries) will still remain very costly thus impacting our ability to invest for example to buy a house or invest in something productive.

For other effects (which we hardly notice), India’s attractiveness as investment destination is directly linked to its fiscal health. Not directly but the fiscal health determines the sovereign rating and the rating impacts the investments. With the fiscal health going down inflow of foreign investment and currency bound to be lower. Throw in the global slowdown into this and you get a far more complicated picture.

So we are probably back to square one with new Govt will have to take some urgent measures to put the things back in order. Perhaps we need yet another Reformer who can match the ‘magical wand’ of our original reformer.


  1. Very nice and detailed analysis. The combined effect of the communists who paralysed reform thanks to the arithmetic of seats that made them indispensable and the unprecedented global slowdown has hit hard. Let us hope whoever comes to power after the elections does not need the commies.

    PV Narasimha Rao was no doubt the original reformer who got put life into a dead economy. Despite some controversies like the suitcase one and the deal with JMM, that dimmed his contribution, he is easily one the fine PMs that we have had.

  2. You are right Vinod .. i always feel that it was PVNR who was real started the reforms.. compare his five years with MMS' five years.
    ..and think of it on some other fronts as well PVNR achieved a lot .. but he seems to be a forgotten man (none of the new schemes are announced in his name not even in AP) ..

    Lot more was expected from MMS given his previous stint as FM .. but then we are almost back to where we were in 1991

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