Deputy Chairman of India's Planning Commission says foreign capital is flowing back into the country
Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, is backing Prime Minister Manmohan Singh's view that India will return to 8-9% growth in the medium term, since the country is on a strong wicket on many fronts. Once the global economy starts to recover, the return on capital will also be higher in an economy like India, which is poised to grow faster than its Western counterparts. And the entry of $5 billion into the country in the past two months is a clear sign of easing capital flow, he says in an interview with ET correspondents... Excerpts:
The Prime Minister mentioned that India will bounce back to 8-9% growth in the medium term even if developed economies do not recover... What are the conditions necessary to achieve this?
It is important to remember the supply-side constraints. A lot of people are concerned about the global economy. The impact of the global economy on us, primarily on the demand side, is less than would otherwise be the case. But as long as on the supply side, we are in a situation where productivity and domestic savings and the growth of capital and the growth of investment leading to the growth of capacity take place the way we want it, we should be able to grow at 8-9% as mentioned by the prime minister.
There the focus is on savings—whether we are investing enough, if there will be enough inflow of foreign investment and whether domestic capital will be able to achieve the productivity gains is what we have to look at. All known cases of high growth are not those where you just expand capital stock but also where you have high levels of productivity. On all these counts, India is in a very strong position. What has happened, though, is that the global economy will grow slowly, but over a medium term, we can overcome that problem.
In the context of India needing more foreign savings, do you think capital flows have already begun to ease? For example, if you look at the latest figures, there is FII inflow of more than $5 billion in the past two months?
It is quite clear that it has begun to ease. Last year, after the collapse of Lehman Brothers, there was a huge amount of uncertainty and a huge premium on liquidity. Global financial institutions were pulling back capital to reconstitute their own balance sheet. Now, there is some restoration of confidence that the system is not going to collapse. The news coming from the West is that perhaps, by the second half of the calendar year, the global economy will bottom out and start a gentle upswing.
No robust growth but there will be growth in 2010-11. This puts an end to fear and uncertainty. Once confidence is restored, global investors look for returns. Frankly, since the West will grow slower, the return on capital will be higher in economies which will grow faster, like India.
What are the key reforms that you would put on priority to drive investment-led growth in the next six months or one year?
It's not enough to talk about reforms that will have an impact in the next six months. Psychologically, you also have to look at the reform signal for the medium term; the actual impact of those decisions come only after two to three years. The signals you give today change investor expectations, and that's not necessarily to do with foreign investor expectations. Foreign investment is important but domestic investment is much larger. So what are those things?
Clear movement on infrastructure, which everyone regards as the major constraint in India's performance. It's a supply constraint in the two- or three-year horizon but it also addresses the demand constraint in the short term. Underlying that, there needs to be positive movement on social sector reforms because it is the progress on social sector and the promise it holds out for greater inclusion which create a social consensus for modernisation.
For example, we talk about setting up 30 universities. They won't start tomorrow and we will be lucky if they start operating in the next three years. So everyone in India who has a child aged 13 or 14 will know that the prospects for that child will be better when he is ready to go university. The expansion of private universities that we desire will signal optimism to many people.
There is also a view that we need to look at financial sector reforms because there is a need for Indian businesses to explore newer financial services and we need a lot more banking to have genuine financial inclusion in the domestic market?
Absolutely. I would put financial sector reforms very much on the agenda. There is a view that because there has been a global financial crisis, there should be rethinking on financial sector reforms. I think this is wrongly applied in India. What the world crisis shows is unthinking liberalisation of the capital account and an expansion of unregulated financial sector can be dangerous because it leads to a lot of leverage and it creates a lot of activity in areas where there isn't enough regulation. But that was never our intention.
We were always of the view that the financial sector must operate within regulations but within those regulations, they should have more freedom. For example, we have a well-regulated system and so we should allow private sector banks to expand more freely. Once you have the regulations, we should allow competition among banks. We have allowed capital inflows but have not suggested a balanced system with some restrictions, very few restrictions on FDI, some on short-term borrowings.
It presents a mixed picture. It would be wrong to say that we should not go in for financial sector reforms. There are lessons to be learnt but too many people are learning the wrong thing which is to stop everything. The financially over-liberalised economies are moving towards the centre of the spectrum but we were over-controlled and have to move towards less control in the sense of letting more players participate. It would be a great mistake to think that we must rethink financial reforms because of what happened in the western world.
On infrastructure, what are the lessons to be learnt?
We have done well in some sectors like rural roads in the North-East. The President's address mentioned Bharat Nirman-II and we will take up more of those over the next two or three years under public investments.
The second mode is by promoting public private partnership (PPP) projects. It took some time but the good news is that most of it is resolved. The new minister for transport, Mr Kamal Nath, says he wants to see 7,000 km of road per year. This is feasible through budgetary means and PPP. Meetings have been held with stakeholders. There are problems related to credit and banking and some of them can be addressed. With the restoration of normalcy in the rest of the world and robust growth in India, there would be a significant flow of private investments in roads and power sectors. We expect 70,000 mw to be added by the end of the Eleventh Plan, three times what we did in the Tenth Plan period.
Our savings rate is fine and over the last two or three years, we have not had current account deficit. I think we can boost investments in India's infrastructure sector at a time when global economies are growing at a slower pace and demand will be low. So it will have a contra-cyclical impact. We may have to do some more public spending and that will increase fiscal deficit but that's part of the contra-cyclical strategy.
Your take on fiscal expansion. How much of it is tolerable, going forward?
The increment mentioned in the interim budget of 0.5% to 1% is right. The interim budget already includes a significant increase in the pre-stimulus budget level compared to 2008-09. There is lot of confusion on India's stimulus. It is said that China gave 3% of GDP as stimulus and we provided only 1% of GDP. This is wrong. One way to look at it is how much has your stimulus increased compared to what was originally budgeted for. It is true that some of it was because we did not pass on the increase in oil prices and we subsidised it.
That is a stimulus as money remained in the hands of the consumer and the government took the hit. Against the originally anticipated fiscal deficit target of 3% of GDP, the actual fiscal deficit turned out to be 7.8%, including off balance-sheet items like oil bonds. The additional fiscal deficit is over 4%. This is a form of stimulus. You can call some of it an automatic stabiliser. You haven't provided for it, but it kicks in to compensate for the loss of demand. This is a big debate in Europe, too.
So, while US authorities have given big additional stimulus, the Europeans claim their automatic stabilisers are so strong that their fiscal deficit expands even if they do not do anything consciously. For example, the unemployment dole kicks in automatically in Europe as unemployment increases. This does not need a fresh spending programme. I have seen some IMF calculations and the stimulus provided in India is not very different from China—a little over 3 percentage points of GDP on an annual calendar year basis for 2009.
Is there a case for some more monetary easing? There is a talk of how fiscal and monetary policies should complement and not constrain each other?
In well-regulated economies, the fiscal and monetary policies are integrated. The one takes into account the consequences and constraints of what the other is doing. In a period of crisis, the notion of independence of monetary autonomy has to be kept aside. It is happening in the US and that's the case in India. Over the past six months, in response to the crisis, by and large, monetary policies have been supportive of the overall fiscal stance of the Centre. There has been healthy co-operation between the two. At the moment, a shortage of liquidity is not what is preventing credit from coming out. My recollection is that most banks, even today, are parking funds with the RBI under the reverse repo of the order of over a Rs 100,000 crore. The situation is very different from what it was in September/October, when there was a liquidity crunch. Once we know what the Budget numbers are, it is easy to give the right monetary signals. Besides, big capital flows last month have resulted in considerable liquidity infusion. Sebi has said $5 billion has come in the past two months.
So, whoever is conducting monetary policy will have to keep several balls in the air and make the right call at the right time with regard to liquidity management... There is no liquidity problem now. The real problem is that banks have an elevated risk perception and that is natural but as investors gain confidence and the government gives the right signals, and the so-called green shoots become evident, bankers will also begin to change perception.
What are the changes in ground realities-credit rating agencies have softened perception towards India?
That is because of a changed realisation that India continued to grow robustly compared to many economies even in the worst recession since the Great Depression. A greater appreciation of fiscal deficit and what led to this. But there has to be a medium-term plan to return to fiscal sustainability.
What could be done to restore revenue growth to achieve medium-term sustainability? Is disinvestment one such way?
Growth by itself will self correct the fisc. It will generate revenue in the medium term which will make all our inclusive growth programmes feasible. So when the PM says that 8-9% growth in medium term is sustainable, a good tax system will generate buoyancy. There is a good case for increasing expenditure this year but once it gains momentum we have to stabilise.
The extension of GST is the second. A major reform in the indirect tax regime that will not yield immediate results but will show gains in the medium term. We must have cautious expectations in the short term once it is rolled out on April 1 2010 but in the medium term (two to three years), this will make the indirect tax collections robust.
Last couple of years untargeted subsidies because of domestic prices not being linked to international prices. The integrated energy policy which was passed by the Cabinet talked of a transition. There is no doubt that there have to be subsidies for some sections of the society but a lot of our subsidies are wasted.
Like kerosene leaks out to the black market. Expansion of rural electrification should bring down the need for kerosene subsidies. Disinvestments are a way of creating capacities in the sectors that you need. There are sensitivities in the political spectrum but that is why the PM referred to building a consensus. If we could embark upon disinvestment of some of these companies, keeping 51% government holding intact, you could generate sizeable revenue over the next two to three years.