As chairman of the Prime Minister’s economic advisory council since 2004, Chakravarthi Rangarajan is the economic conscience keeper of the nation.
The former governor of the Reserve Bank of India (he held the post between 1992 and 1997) has been the governor of Andhra Pradesh and is currently the chairman of the 12th Finance Commission.
In an interview with Mint, he spoke on a range of issues, including a radical overhaul of fertilizer subsidies and said that he expected India’s blistering pace of growth to moderate marginally in the coming year. Excerpts:
Is there an overheating of the economy? Do you think growth will slow this year?
The growth rate in 2007-08 would be around 8.5%. This essentially means the growth rate in agriculture will be the same as last fiscal and (there will be) perhaps somewhat slower growth in industry and services. Last year’s growth of 9.2% was sustained by very high growth in manufacturing. Nevertheless, we will grow at a minimum of 8.5%. Whether it will be higher than that largely depends on the performance of agriculture. If the monsoons are good, we could get that too. Even though the overall global growth rate is likely to decline, the external environment should be conducive to higher growth.
I think overheating is a term that has been much overused. It represents a situation where actual growth is running ahead of potential growth and when capacities are fully utilized. We do see some signs of overheating and we do see some slowdown in industrial growth.
Manufacturing growth was a record 14% even in March. Will that drop?
I think so. It may reach very high growth in certain months, but that doesn’t mean it can be sustained over a longer period.
Has the inflation genie been bottled yet?
Inflation is a concern. How the prices will move this year depends largely on the level of procurement (of foodgrain) as well as the expectations and the behaviour of monsoons. I think the procurement is slightly higher than last year, as per latest information, but unless there is a significant rise in it, inflation may not ease quickly.
Now that the economy has moved to a higher growth and investment level, is it time to accept a higher inflation rate?
The acceptable level of inflation is not related to the potential level of growth. I don’t think there is a trade-off between growth and inflation. The degree of tolerance to inflation is determined by several factors. Over the medium term, a low inflation is more conducive to growth. The medium-term inflation rate should not exceed 4% because the domestic inflation rate also depends on what is happening in the external world, which is settling down to much lower inflation.
Do you then see interest rates rising further?
I cannot predict interest rates. But they will be determined by inflation. If prices soften in the course of the year, there would be no need to hike rates again. But monetary policy takes several factors into account. If the capital flows are very strong and impact money supply, then the course of monetary policy will be determined by both the impact of capital flows and the price level.
Do you, too, feel RBI is struggling with the problem of managing exchange rate, capital flows and inflation rate simultaneously?
The exchange rate policy is a corollary to the policy of maintaining price stability. That’s the dominant objective for RBI. So they either have to take action on the price front or on the sterilization front. Even how the rupee behaves will depend upon inflation and the capital flows. If the latter is very strong, it becomes extremely difficult to prevent the appreciation of the rupee. To some extent, the flows can be absorbed and a higher money supply growth tolerated, if the economy is growing faster. All capital flows don’t necessarily impact prices.
But on the exchange rate, there are several concerns. The rupee can be allowed to appreciate, provided all other currencies are doing so. Our immediate concern is China; and the renminbi is not going up, so our hands are tied.
How serious a concern are exports with a rising rupee?
Industries that have a higher content of imports will not be impacted much. But there is also an indirect benefit for all from the resulting lower inflation. The direct impact will depend upon the margins of the companies and those with low margins can be affected. Some appreciation of the rupee can be absorbed because of improved productivity. The impact on exports will also depend on the rise in the real effective exchange rate (REER) of the rupee. At this point, Indian industry may be able to absorb (this).
Beyond this, one will have to look at the balance of effects.
Do you see capital flows into India continuing as strongly?
All international estimates show that capital flows will continue. And if they continue as strong as they did last year, then action will be needed. There are three choices on exchange management. One, let the rupee appreciate and take the full brunt of capital inflows. Second, absorb some of the capital flows in the form of reserves and sterilize the rest in the form of market stabilization scheme or cash reserve ratio. Three, some action can be taken on some types of capital inflows, without being seen as intrusive or reversing policy. A judicious balance of all the three is needed. At this point, the RBI’s intervention is not strong.
How strong is the improvement in the fiscal situation of the (Union and state) governments?
The improvement is very sustainable in the case of the state governments. Revenues are very buoyant. The Central government will also achieve the fiscal deficit target, but not the revenue deficit target. But expenditure also needs to be controlled.
What have you suggested on rationalizing the fertilizer subsidy?
The problem with the fertilizer subsidy is that it remains untouchable. But the demand on the government for social expenditures is increasing. If fertilizer subsidy is treated as support to agriculture, a better mix would be to cut this and raise investment in agriculture. There are ways of dealing with the problem. One way is to provide every poor and marginal farming household a minimum of 120kg of fertilizer at a subsidized price or the present price and leave the rest to the market. This would reduce the subsidy bill by half.
The real question is how to implement it. Some amount of dual pricing is unavoidable if we have to protect the poor. Some kind of an identity card—the same we had suggested for kerosene in the petroleum pricing committee—is essential as there are so many subsidies.
With many states growing richer, what are the evolving problems for the next finance commission?
The old questions about how the funds will be distributed will remain. What is happening now is that the richer states are finding their share dropping so fast that there is little scope for further reduction. This is a problem that will come up sooner or later. The other issue is of goods and services tax. We haven’t even decided on the distribution of the services tax yet. However, the thinking on the GST has to become sharper—there are so many models. I don’t see it coming by 2010 anyway.