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Global economic scenario and the Indian budget; By M. R. Sivaraman IAS (Retd.)

C3S Paper No. 0057/2016 


Economic Development is not merely a matter of setting targets but the ability to mobilise the mind, will and resources with a determination to achieve the targets. “When it is obvious that the goals cannot be reached, don’t adjust the goals, adjust the action steps”-  Confucius.

At the outset I would like to thank the MMA and Gr Captain for having given me the privilege of delivering this  lecture. I chose this topic as I thought this is of contemporary relevance particularly because India is also at the cross roads of moving into the upper middle-income country bracket. We have to see whether the government with all its promises is moving in the right direction devoid of semantics. Current year’s budget is a mid term budget of this government and has to be examined on the touch stone of it being able to serve the twin objectives of growth and welfare, sub- serving sustainability of the initiatives over a period of time.

The budget for the year 2016/17 being a mid term budget of this government has a number of policy initiatives that are expected to propel the country to a sustainable growth path of around 8% per year.

Before I comment on the budget I would like to consider the present global scene so that we can appreciate whether the budget would achieve its objectives. The present global economic scene is not encouraging. Former Governor of the Bank of England Lord Mervin King has warned in his book The End of Alchemy: Money, Banking and the Future of the Global Economy, that the world was on the brink of another financial crisis largely owing to the lack of banking reforms and serious imbalances in global liquidity.He has observed that systems to regulate banking have become complex in a competitive way amongst countries without any major impact except an increase in compliance costs. The thrust of the book is that the present system of banking based on the fractional reserve system has to be altered so the current malaise of banks creating money can be controlled. There is an overhang of large debt on most countries and BIS officials say that the debt burden of EMEs are increasing. Added to this is the sharp fall in commodity prices and particularly oil that has set the middle east on fire with Saudi Arabia wanting to sell some of its oil assets and impose taxation. The political situation is still tumultuous.

The latest world economic outlook of April 2016 identifies the following.

1)Important of which is a return of financial turmoil, Impairing confidence and demand in ‘a self-confirming negative feedback loop’. Despite the recent rebound in asset prices, financial conditions in the United States, Europe, and Japan have been on a tightening trend since mid-2014.

2)In the United Kingdom, the planned June referendum on European Union membership has already created uncertainty for investors; a “Brexit” could do severe regional and global damage by disrupting established trading relationships. How ever the UK in its recent budget has introduced innovative measures to stabilise their economy and also move toward a more healthy population.

3) Investment demand remains weak worldwide, but especially in commodity exporters, whose terms of trade have collapsed. China’s rebalancing process has subtracted measurably from world investment growth, and generally higher uncertainty about global growth prospects is also a factor. Weak investment demand, in turn, has been associated with slower growth in international trade, given the important roles played by capital and intermediate goods.

The advanced economies are weighed down by debt. The average debt as percentage of GDP of the non –financial sector for the year 2014, of advanced economies, that is the Euro Area, USA and the UK was 265, as against 167 of the emerging market economies with India having 125 as per the Bank for International Settlements. It is not declining but growing.

“There is simply too much debt in the world today” said James Caruna of the BIS. Martin King blames it on the uncontrolled powers of the banking system to create money.It is interesting to note that even in the nineteen thirties there was criticism of the fractional reserve system and the ability of banks to create money. Scholars had observed  uncannily that “you cannot permanently pit an absurd human convention, such as the spontaneous increment of debt (compound interest) against the natural law of spontaneous decrement of wealth”. (Entropy) Nicholas Georgesqu-Roegen a Romanian economist and mathematician believed that the second law of thermo dynamics operates in economic process as the transformation of valuable natural resources into valueless waste (high entropy).

These unconventional thinkers are being remembered now when no tool in economic theory seems to be working. There are also suggestions to divide banking into two groups a narrow banking system and a wide banking system the former absolutely risk free and the other that would assume risky banking operations. The BIS in its March 6 2016 report ‘Uneasy calm gives way to turbulence’ observed “Underlying some of the turbulence of the past few months was a growing perception in financial markets that central banks might be running out of effective policy options.”

Has the high interest rate regime in India curbed inflation or the overall global deflationary situation in particular the decline in the price of oil? As the RBI has no other tool in its box it claims that it curbed inflation by keeping interest rates high.

I want to highlight one point the velocity of circulation of money in India is quite low compared to its level of development. The question is why? It is because transaction sin the underground economy never get captured in the national income accounts. The NIPFP is reported to have estimated the quantum at 75% of GDP. Even if half the percentage is correct then it makes nonsense of our all our policies. May be that is the reason why the govt. has handed over the report to the SIT.

A new thinking on economics known as complexity economics is emerging, which sees the economy as never in equilibrium but as always in motion because of the actions and interactions of individuals, organisations and the environment that require constant adjustments. It is that kind of situation we are witnessing now. In addition we have global liquidity imbalances.  In terms of foreign exchange reserves 10 countries hold more than 10 trillion dollars. One report says that large corporates have nearly $5 trillion as reserves. They are not investing.

There is deflation in most advanced countries and interest rates cannot go down further. Inequality in incomes has increased in some countries and according to Eurostat nearly 40% of total income goes to people belonging to the highest (fifth) quintile. “We have reached a tipping point. Inequality in OECD countries is at its highest since records began,” said the OECD

Secretary-General.

Still there are those who subscribe to the theory that negative interest rates will force investments and consumption. The IMF has recommended accommodative monetary policy in countries with deflation. The EURO area has gone to negative rates in addition to quantitative easing of 75 billion Euros a month hoping to push up investments and demand Despite all these measures the aggregate demand in these countries is not showing an optimistic rise so as to enthuse investors to increase production. There has been no major technological breakthrough as in the past, when the world saw a series of transitions, from agriculture to industry, from the automobile age to the jet transport age which brought markets closer and led to their integration, the dawn of the digital age which smashed all national boundaries leading to globalisation and integration of commodity, products, services and above all financial markets.

While it was a boon it also became a curse in as much as economic trouble in one country spread fast to others. We can see the progression of the intensity of the contagion effect from the East Asian Crisis, which was only feebly felt outside SEA countries, to the shock waves of the collapse of the financial system in the advanced countries in 2008 that affected all the countries. The later crisis has been felt across the world including in India and China, which had weathered the earlier storms. In India we had high inflation, falling exports but reasonable growth. China had low inflation and reasonable growth but now showing signs of slowing further.

Trillions of dollars have been pumped into the economic system by the US, Japan and the Euro countries with rates of interest at the bottom and even negative in many countries. And yet when one looks at the rates of growth of the advanced countries they are just above one per cent in the Euro area and around two per cent in the US and this is after their economies had contracted by about 15% during the crisis. No one dare say that the crisis is over as China the biggest economy of the world is having a bumpy ride. One is still reminded of Keynes whose phrase animal spirits have been used and abused in many contexts. Keynes attached great significance to expectations and sentiments in determining investments that is what the investors expected in return for their risks. What is there for investors to expect now in the advanced economies as well as in the commodity exporting countries when they see no demand and probably householders deleveraging their debt?

Deflation continues to haunt all these countries and A simple explanation for deflation in these countries is that there is no demand but stocks have to be liquidated. Would there be any increasing appetite for debt in the context of the experience in the immediate past? Very unlikely as the household debt to GDP ratios of many countries are above 100 %. IMF World Economic Outlook shows that Sub-Saharan African economies will contract by around 5% in 2016 and so will the oil exporters in Africa by 2.4%, the middle income countries in Africa by 4.8% and the low income countries by 11.8%. World trade in volume terms is expected to show an increase of 3% but in value terms it had declined from 23.47 trillion dollars to 21.188 in 2015 and may increase only marginally in 2016. The value decline may be due to a sharp decline in the price of oil and other commodities but in general prices have not increased.

So world trade is in doldrums and even China that was considered the factory of the world has had a sharp decline in exports and imports. Latest report is that china has seen some growth in exports in the last month unlike in Feb.  To this depressing scene we have to add the political uncertainties in the middle- east although there is a silver lining in the form of a cease-fire in Syria but the ISIS is still operational. If peace gets restored in these regions it may not lead to any immediate spurt in oil or other commodity prices. The technological breakthroughs that are coming in the field of solar energy, auto sector and also in aviation are not going to help oil prices at least that is the current logic. China is downsizing its production in many areas and a Wharton report expects China to retrench five million workers. This may affect all commodity prices for sometime to come.

To a common man like me it seems that the advanced countries are in a state of secular stagnation. When I looked up as to whether there has been any thinking on this, I found that Larry Summers in his address to the National Association of Business Economics in Feb2014 referred to secular stagnation in the industrial economies. He said and I quote “In sum I would suggest to you that the record of Industrial countries over the last fifteen years is profoundly discouraging as to the prospect of maintaining substantial growth with financial stability”. There are negative rates of interest, huge liquidity injection but no spurt in investment or demand on any perceptible scale. So where has all the money gone? Are people holding cash in the absence of any positive rate of interest? Is there a liquidity trap like situation as was envisaged by Keynes. I feel and am no economist, the population of the advanced economies have reached a satiety level and with aging there is no increasing demand for goods to generate expectations. So all this stimulus is unlikely to result in any sustainable recovery from the current state. We must also take into account that there is a Paris commitment to reduce environmental pollution, which also has a cost in terms of growth.

Given this global scenario what do I see as the prospects for India? India does not have a demographic problem as in the advanced countries. We can harness this power both for increasing production and increasing demand. In the present global scenario any economic policy in India which has its objective of increasing the incomes of the people to a level of convergence with those of the developed countries have to necessarily be oriented toward increasing demand within the country. This is possible only by:

Providing sustained skilled employment to an increasing number of youth this requires increasing facilities for training–   the budget provides Rs 1804 crs for it.

Augmenting facilities in the country to create an environment conducive to increasing investment in manufacturing and services—GOI has put emphasis on ease of doing business –the states have to cooperate in eradicating corruption at all stages. At present we are ranked 130 a slight improvement over the last year of 134 but we are below 170 rank in delivering construction permits, power supply, in registering property, almost at the end of the table in enforcing contracts and 157 in paying taxes. GOI is almost pleading with the states to improve their systems to take out India out of the quagmire of corruption in these areas. But unless the CMs decide that they will not allow corruption in these areas nothing much can be achieved.

Improving agriculture with a view to modernising it, and insulating it against the vagaries of monsoon so that there is a perceptible increase in net income of farmers enabling them to share prosperity that also leads to a movement of people from agriculture as a source of income. So what has the budget done? It has set apart a total of nearly Rs 500,000 crores for the four main areas of the economy namely agriculture and irrigation, social sector, rural development and drinking water and infra structure and energy Almost 64000 crs have been provided for agriculture and irrigation against Rs 26000 crs last year. But will the states use it as they have to implement programmes on the ground? If I remember right the AIBP was introduced in 1995 budget but surprising to note that the FM has stated that the 89 projects under the scheme are languishing. Had it been monitored properly on the guiding principle of allocating money only to those that will be completed within the fiscal year this problem would not have been there. He has assured that 23 of them will be completed before end of this fiscal. He has not spelt out the objectives of the Long term Irrigation Fund. One redeeming feature is the promise to take up the construction of 5 lakh farm ponds and dug wells in the rain fed areas under the MGNREGA.

The budget for the year 2016/17 has provided substantial sums in other areas like education, health and infrastructure, which will lead to employment generation and increase in incomes to facilitate demand creation for growth. Here I have to refer to the problem of Indian growth rate numbers. While some economists agree that the Indian methodology reflects correctly the value added others disagree that it does not reflect growth in real output. Why could it be so? Because the cost of production has gone down owing to decline in prices and consequently the value addition has increased. This is clear from the fact that there has been only a 2% growth in the eight core industries that account for 38% of the IIP between Jan 2015 and Jan 2016.However the services sector, which accounts for 51.3% of the economy, is reported to have grown at a healthy 10.6% in 2014/15.There is growth in other sectors also but subdued. The budget for 2016/17 seems to address some of these issues.

I wonder whether any one has noticed that the FM seems to have faith in the magical number 9. He has talked about nine pillars of the economy, nine areas of taxation, there are nine main paragraph divisions in part A of his speech and to cap it all there are 189 paragraphs in his speech the numbers adding up to 9.But he is targeting only a little over 7% in growth. I wish he had aimed at 9% growth for the economy.

The programmes in the budget are at present the good intentions of the government but when it would reach the farmer in full scale is a question that has always remained unanswered. There is a huge time gap between the budget and the actual receipt of funds at the district level where the action lies. The practice of direct placement of funds at the district collector’s level has been given up, as there was no proper accountability. Now the funds will go through the channels of the state government. The problem is with the rickety implementation machinery. When properly implemented these schemes should make an impact on increasing farm incomes in a sustainable manner.

Despite implementation problems I have noticed that there is a silent transformation taking place in the farming sector. Five hundred and ninety two FPOs with a membership of nearly nine lakh have been organised so far. They are meant to make farmers alive to technology, motivate them to cooperate in procuring inputs, machinery, sale of produce and eventually even joint farming. We are talking to some FPOs whether they would also cooperate in doing joint farming to reap the advantages of scale economy and get over fragmentation and sub division of holdings. The PMs vision of doubling farmer’s income in five years is not a pipe dream as many have criticised it. I have seen that many farmers are able to double their incomes within two to three years if they consistently follow modern cultural practices.

If incomes of farmers improve demand automatically goes up for goods and services. Expenditure on education and health also has positive implications for employment generation as tens of thousands of teachers and health workers are needed for the expanding middle and higher education schools. A report submitted to the Ministry of HRD IN 2005 itself estimated that the universalization of education up to the tenth class will require from 2015 5 lakhs additional class rooms and around 8 lakhs additional teachers that is assuming that their recommendations for the previous years have been achieved. This does not take into account the additional teachers required for classes eleven and twelve and in the increasing number of colleges. Unemployed graduates could be motivated to take to training to be teachers as there is also ample scope for advancement in that profession. If the central and the state governments cooperate a systematic approach in this area could generate millions of additional jobs for the educated at the same time improving the quality of education. It is my personal experience that in many interior areas the panchayats are showing keen interest in developing their schools.

The allocation of 72000 CRS for 2016/17 does not show any appreciable increase. Hopefully the states will provide more as many of them are financially stronger than the central govt. It was gratifying to note that the UP govt. presented a revenue surplus budget for 2016/17.Accordingto the RBI all the states together had a revenue surplus of 0.4% in 2014/15 B.E. Instead of wasting the revenue surpluses on freebies the states could use them for education and health.

The minister for roads and shipping has recently promised 5 million additional jobs in the two sectors but here again the cooperation of the states is a sine a quo non. If state governments do not allow quarries to the road contractors and raise flimsy objections then the job will be ill done. Our City has monuments to this non-cooperation. Development of inland navigation could boost not only employment but also relieve road congestion. We nostalgically think of those days when we saw barges moving along the Buckingham Canal and the Cooum River. Inland Waterways Authority is however busy in developing other inland navigation systems for which also there is a provision. India has almost 14,500kms of navigable inland waterways, of which 5,200kms are major rivers and 500kms are canals suitable for mechanized crafts. It has five declared National Waterways (NW 1 to 5), out of which three are operational with an annual cargo movement of 7mn mt. The Parliament passed the National Waterways Bill only this March making 101 rivers as national waterways. Involvement of private sector and more particularly foreign companies who have been running such waterways in Europe will surely be new source of large employment opportunities in the rural hinterland of India.

The amount provided for drinking water and health and sanitation is around 18% more than for last year. There is also 30% increase in amount provided for urban development which if spent wisely by the state govts. will generate employment in the urban areas.

I observed that by and large there is an intelligent allocation of funds keeping in view the needs of the economy. As India is still at the bottom of the list in regard to tax related issues from the point of ease of doing business the I expected the FM to make some radical changes in spite of the obstructionist approach of the opposition in regard to the GST. The policy changes in taxation although in keeping with the current requirements seem to be ignoring the cardinal principle of simplicity, in so far as it introduces new cesses and adjusts tax rates to suit specific purposes. For example many excise duty rates have been tweaked or reduced to zero for facilitating make in India. What would happen if the GST Bill gets passed? The rates may have to be adjusted again. There was an opportunity for the FM to make suitable changes in the Services tax and excise duty laws to make both the taxes seamless to give them an appearance of GST when taken as a whole. The infrastructure cess is not to be shared with the states. Officers of the Finance Ministry informed me that several minor changes in procedures have been effected to simplify the excise procedures to make them less discretionary. A new levy called the Equalisation Levy has been imposed on consideration for certain digital transactions received by a non –resident from a resident for a specified service at the rate of six per cent to be collected by the IT officers.

This is as per the suggestion of OECD. But being a tax on service why it has been given to the CBDT to administer has not been explained. The tax is presumably under the residual entry of the union list of powers to tax. Last year the Finance Minister buried the idea of having a Direct Tax Code and appointed a committee to make recommendations on the changes required. He is reported t o have made use of the report in making certain changes in the Income Tax Act to make it more tax payer friendly and less discretionary. As the present one dating from 1961 has become too complex with thousands of amendments in the last 55 years it would have been better to replace it. One noteworthy feature of this budget is that it has increased the tax burden on the higher income group by the levy of additional excise duty and cess on expensive motorcars, a ten per cent tax on dividends above Rs 10 lakhs in addition to the DDT and an increase in surcharge from 12% to 5% on individuals. There are also incentives for increasing employment through tax concessions as well as govt. agreeing to pay EPF for three years of new employees.

A number of health measures for the poor most important of which is the National Dialysis Programme and a health insurance for BPL people. But how this will work along with many such schemes, which states have already launched in the health sector, is not clear. While the budget is well oriented it will not achieve its objectives of insulating India from the grim global economic scenario unless there is complete cooperation from the states and intentions are translated into actions.

(The writer is Mr. M.R.Sivaraman IAS (Retd.), former Revenue Secretary, Ministry of Finance, Government of India and is presently an Associate, Chennai Centre of China Studies. Email- madras.sivaraman@gmail.com)

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