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Fiscal consolidation must begin this year

Fiscal consolidation must begin this year
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First Published: Sun, Feb 21 2010. 08 28 PM IST

Growth curve: Rangarajan says by the end of March, year-on-year inflation would be 8.5%. Ramesh Pathania/Mint
Growth curve: Rangarajan says by the end of March, year-on-year inflation would be 8.5%. Ramesh Pathania/Mint
Updated: Sun, Feb 21 2010. 08 28 PM IST
New Delhi: The Prime Minister’s Economic Advisory Council last week upgraded its forecast for gross domestic product (GDP) growth in the current fiscal to 7.2% with the expectation that it could rise further to 7.5%. In an interview, C. Rangarajan, chairman of the council, speaks about the Indian economy and its outlook. Edited excerpts:
The review is projecting GDP growth of 7.2% with an upward bias for the current fiscal. More importantly, for the first time, you have given a forecast for two years after—8.2% and then 9%. Tell us what is the basis of these assumptions?
Growth curve: Rangarajan says by the end of March, year-on-year inflation would be 8.5%. Ramesh Pathania/Mint
The Central Statistical Organisation has already come out with an estimate of 7.2% as a growth rate for the current year and we agree with that estimate. We have some differences on the sectoral growth rates, but by and large we agree with that growth rate projection. In the context of the strong industrial production data that are now available, perhaps the growth rate maybe slightly higher and that is why we say 7.2% with an upwards bias, it could touch 7.5%...
The reason why that we are projecting a much higher growth rate for the next year is that we think that there will be a substantial turnaround in agriculture.
Agriculture growth rate went down in the current year; it also did not do that much well last year. Therefore, there will be a pickup in agriculture next year and if there is a turnaround of around 5% in agriculture next year, that should give us the growth rate of almost 8.2%.
The following year we think that the growth rate will be even higher because we think by that time the world economy would have improved and the world trade would have improved and, therefore, that would have an additional beneficial effect on the Indian economy. Therefore, we think in 2012, we should be able to have a much higher growth rate of 9%.
So what you are saying is that it will take us around three years after the slowdown to go back to pre-slowdown levels of growth?
Yes, that is true. But the growth rate at 7-7.5% or 8% is not a low growth rate; it is picking up. To go back to the 9% rate of growth in the economy, we certainly need a better world environment; without such a beneficial, benign world environment, it is somewhat difficult to grow at 9%. But I think we will be there in two years from now.
Do you think the world economy is completely out of the woods? What is your assessment?
I think the industrially advanced countries are coming out of the recession. But the recovery is going to be very slow. It is not going to be very strong. But I do not expect a double-dip recession as some people expect to happen. I think the recovery is going to be slow, but it will be steady. I think we will see a positive growth rate in the year 2010 and 2011.
How imperative is it for the government to start fiscal consolidation and what would you advise it to do?
The process of fiscal consolidation must begin in the current year. The Budget provided for a fiscal deficit at 6.8% of the GDP this fiscal. This is a very high level of fiscal deficit and this level cannot be sustained over a long period.
Therefore, we need to bring it down, but we cannot bring it down in a very abrupt way. It has to be gradual because the need for providing adequate stimulus for growth is still there. Therefore, we should balance the need for stimulating economic growth and the need to bring about a degree of fiscal consolidation. The government should attempt to bring down the fiscal deficit by 1-1.5% of GDP next year. That would meet the requirement.
You have also called for expanding service tax coverage and unifying the rate structure of Cenvat (Central value-added tax) and service tax and pegging it between the current and the previous higher level. What does this imply?
What we have indicated is that sooner or later, we will introduce the GST (goods and services tax). It may or may not come this year, but certainly it will come by April 2011. Therefore, we need to provide a transition to that and there we felt that it may be useful to move to a position so that the transition may be easier. Therefore, some adjustment on the revenue side and rates would be appropriate for raising revenues and for transiting to a full fledged GST.
But is there a risk of inflation transmission?
I do not think so. After all, if the fiscal deficit is also reduced due to higher revenues, then one compensates for the other.
What is the outlook on inflation?
By the end of March this fiscal, year-on-year inflation would be 8.5%.
One can expect moderation of the (wholesale price) index and inflation can come down ahead as the prospects of the rabi crop are very good, including that of wheat. That will dampen inflationary expectations.
The review also calls for a new distribution channel to supplement the public distribution system.
What we have said is that we need other channels like Cooperative Societies and Kendriya Bhandars through which foodgrains can be sold. I am not talking about the private sector, but when government itself wants to sell foodgrains at slightly below market prices, you need such a channel.
You have also said the recovery calls for a more neutral monetary policy. Can you expand on this?
The Reserve Bank (of India, or RBI), like other central banks, adopted an expansionary monetary policy as that was what circumstances demanded (during the downturn) and a lot of liquidity was injected into the system. Therefore, from that point—they should move to a position in which they would operate as if they are under normal circumstances. It is not tightening that we are talking about but going back to pre-easing levels.
By when should this happen?
Well, they (RBI) have started the process. We do not know when, but it will all depend on...the behaviour of prices. If prices moderate, then they can do it over a longer period, but if there are signs of further price pressures in the next few months, then the RBI can act earlier. The central bank has the option to act at any time.
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First Published: Sun, Feb 21 2010. 08 28 PM IST