Devil is in the roadmap

Indian Express, 19 February 2010

Budget 2010 will be the first budget of a new decade. In the last decade India grew fast, much faster than we expected. But it globalised even faster. A rapidly growing and globalising economy faces many new challenges. Many of these have unfolded over the last decade. There is an overwhelming sense, both in India and abroad, that the next decade will bring even higher growth and a more radical transformation of India. The budget speech for 2010 should use this opportunity to present the government's vision of India in the next decade, and along with it, the fiscal, financial and monetary policy reforms that are required to meet the unique challenges of this decade. This should include specific actions on fiscal consolidation, achieving a mature financial system, creating an independent and accountable monetary authority, and a framework for maintaining financial stability. The budget speech should outline a road map for the implementation of the Direct Tax Code and the Goods and Services Tax. Finally, it should embark on radical reform of government expenditure, moving away from existing strategy of spending more on government programs that do not work, to one focused on outcomes, impact, accountability and bang-for-the-buck.

India has moved much faster on trade liberalisation than on capital account liberalisation. The story of the capital account is a more tortuous one as rules continue to be highly restrictive. The Chinn-Ito database, which gives us across-country and across-time measurement of capital account restrictions, shows India has not moved forward since the 1970s, while all our peers have moved strongly towards openness.

While the rules have `de jure' restrictions, reality has changed greatly. India has taken a path where many capital account transactions are feasible, but only after complying with complicated rules and procedures. Increasing trade, growth of Indian companies, the slow but steady opening up of various avenues for movement of capital from abroad has meant that, on the ground, there has been a considerable opening up of the capital account. It is now time for the rules to catch up with reality: to create an environment where households and firms are able to frictionlessly do the things that are presently done in tortuous ways. A strategy of further changes in laws and regulations needs to be drawn up to reflect the higher globalisation of India of the coming decades.

More capital account openness is inevitable and but we need to make sure that increased globalisation does not make our economy vulnerable. For this reason there is a need to create a resilient policy framework so as to cope with shocks. This requires creating appropriate policy frameworks for fiscal, financial and monetary policy.

On the fiscal front a number of steps would need to be taken. The road map for fiscal consolidation, the creation of a modern well functioning market for government bonds, the setting up of a debt management office, moving away from financial repression (such as the SLR requirements of 25 percent through which the government pre-empts the savings of the household sector) should be elements of this roadmap.

There is a strong consensus surrounding the path for financial sector reforms as sketched by key committee reports. The task of the finance minister is to overcome the bureaucratic politics that has bedeviled financial reform, and to translate these reports from recommendations to action.

On the monetary front, the RBI is saddled with multiple objectives such as controlling inflation, managing the exchange rate, regulating banks and managing the government's debt. These objectives involve conflicts of interest. Most advanced countries have separated out the functions of the central bank such that the central bank is able to focus on controlling inflation. Over the next decade, the government will need to modify the role and function of the RBI, to get away from the combination of functions in its 1934 legislation. The monetary policy framework that was acceptable when India was a stagnant closed small economy is out of touch with the needs of India as a fast-growing, big and open economy. In the past, government could get by with small changes to capital controls to manage the exchange rate or control money flowing into India. But in India's future, there is no escape from facing up to the impossible trinity. The sooner we accept this reality and draw up a framework to work towards, the more resilient will the economy become.

All advanced economies, other than the US, have a Goods and Services Tax. The case for a GST and its impact on growth has already been made and today there is agreement on the idea. The government has repeatedly made announcements of a start date, but has failed to back these announcements with either the requisite political consensus or the project management capability. The problem of administration is going to be a big challenge when the GST is implemented. The GST is not like business as usual in traditional tax administration. The GST has to be a sophisticated IT system. The only way to implement it is to view it as a time bound project with a dedicated team that is focused on getting the GST up and running.

Finally, the Minister should turn to expenditure. The core functions of government are law and order and local public goods such as roads, water and sanitation. The prime focus of expenditure should be on these core functions: the police, the judiciary, drinking water, sanitation and population-wide health programs. The government needs to shift resources -- both money and the time of civil servants and politicans -- away from extraneous activities towards these core functions of government.

Once resources are being devoted to core public goods, the question becomes one of redesigning government structures and programs so as to achieve accountability and bang-for-the-buck. The UPA has unfortunately had a long tradition of focusing on expenditures and not results. This has simultaneously given fiscal excess and failed to deliver local public goods. It is time to reject these traditional approaches and bring a new approach to getting outcomes on local public goods, at the lowest possible cost, through agencies which would be held accountable for delivering measurable results. We need to see a blueprint for such reform.

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