March 06, 2003

When Is the Right Time to Fix the Roof?

The Economist surveys India's public finances. The urban Indian economy is booming. The rural Indian economy is undergoing a (we hope) transitory drought. Because the overall urban-economy news is good, there is very little pressure on the Finance Minister to try to close the budget deficit. But by the time the economic news turns bad, it will be too late to be able to close the budget deficit without severe economic distress. The time to fix the roof is when the sun is shining, after all. Jaswant Singh will probably get away with it: as Rudi Dornbusch always said, unsustainable economic policies nearly always manage to sustain themselves longer than you would believe. But Rudi always added a second sentence: when the collapse begins, it almost always comes faster and is more terrible than you could have imagined.

It makes me want to bang my head against the wall...


Economist.com: ...The countryside, where 70% of the population live, has been afflicted with one of the worst droughts in decades, affecting nearly a third of the country. Agricultural production, still about a quarter of Indian output, is forecast to have fallen by 3.1% in the fiscal year that began in April 2002.

Yet the economy will still have grown by 4.4%?a snail's pace when compared, as it usually is, with China (especially if the official figures are to be believed), but not bad against most other yardsticks. Industry and services are both growing faster than before (at annual rates of 6.1% and 7.1% respectively), exports are up by a fifth, and the current account, after 24 years in the red, entered surplus in 2001.

Mr Singh was moderately generous, tinkering with direct-taxation allowances and with excise duties. The urban middle class will be a prime beneficiary, as befits an important constituency for Mr Singh's Bharatiya Janata Party. They will have more money in their pockets; and cars, air-conditioners and imported booze will all be cheaper.

But the government's critics worry that Mr Singh has not done enough to trim the public-sector budget deficit, which has been running at around 10% of GDP for the past five years (see chart). The World Bank and others have been worrying about the deficits for years. "They may result in higher inflation," fretted a recent Bank report, "push up interest rates, further crowd out private investment, weaken the health of the financial system and increase vulnerability to macroeconomic risks." And so they may. But for the time being inflation is subdued, interest rates falling, banks hungry for government debt, foreign-exchange reserves ballooning and external borrowings modest.

So Mr Singh, who was presenting his first budget since becoming finance minister, faced no really compelling pressure for radical surgery. He delayed the overhaul of the tax system recommended in the recent report of a government-appointed committee, though he agreed with it that the present regime is "exemption and discretion based", making it "suspicion-ridden, harassment-generating, coercion-inclined" ("corruption-riddled", too, he might have added)...

Posted by DeLong at March 6, 2003 03:26 PM | TrackBack

Comments

I don't know much about India's finances, but considering the Bush fiscal policies Dornbusch's second sentence scares hell out of me.

Posted by: Bernard Yomtov on March 6, 2003 07:45 PM

Successive Indian governments have got away ignoring agricultural reforms -- a really surprising situation in a democracy with over two-third of the population living on agricultural and related income. The government also refuses to find the money for primary education (a study by the government indicated that $1.5bn spent every year for eight years will do the trick of ensuring universal elementary eductaion) but spends over $13bn per year on defence. Over half the food subsidy ($6bn) goes in storage costs of an inefficient "food Corporation of India", and most of the other half goes to rich farmers of two rich states (Punjab and Haryana). And the irony is that there were cases of starvation deaths at a time when the FCI had buffer stock to feed the entire country for four months. Well, as Amartya Sen said it is not lack of food availability but lack of purchasing power which leads to starvation deaths; but he was wrong in thinking that this could not happen in a democracy.

Well, the fiscal deficit is surely a problem, but that could be excused during a downturn if it is used for opening up infrastructure bottlenecks (roads, power). The problem is that much of the Indian government's expenditure is on salary, interest, defence and mis-directed subsidies. And with all the focus on the deficit number, the government is too scared to spend on capital formation.

Public debt to GDP is near 80%. What is the danger level? Already past it? 100%? 150%?

Posted by: MRM on March 7, 2003 04:11 AM

brad,

i looked at the budget details and i don't get where the economist is getting its data from.

Its own EIU states that India's budget deficit is 5.6% of GDP, a number confirmed by the budget projections.

Unless I am missing something, where is the 10% of GDP coming from?

Posted by: Suresh Krishnamoorthy on March 7, 2003 06:42 AM

I actually liked the budget for several reasons:

1: Moving to a VAT may be a good thing in India, especially since it is matched with reduced income taxes (higher deductions)

2: Aggressively paying down debt may look like the wrong thing to do in the low interest rate environment, but the debt that is being paid down is at very high rates (10- 13%). I would like to see India finance it by rolling the debt over to a lower rate, but the 'perceived' political risk is keeping ratings poor and borrowing costs high.

3: Introduces universal health care. 30,000 rupees may not sound like much, but it buys an awful lot of health care in India

4: Liberalized FDI investment in Indian Banks, allowing private banks to have up to 74% foreign investment

I agree that these are baby steps, but this is a case where the elephant is dancing - that it is dancing at all is the miracle.

Posted by: Suresh Krishnamoorthy on March 7, 2003 07:00 AM

http://www.nytimes.com/2003/03/01/arts/01HUNG.html

March 1, 2003

Does Democracy Avert Famine?
By MICHAEL MASSING - NYTimes

Few scholars have left more of a mark on the field of development economics than Amartya Sen.

The winner of the 1998 Nobel Memorial Prize in Economic Science, Mr. Sen has changed the way economists think about such issues as collective decision-making, welfare economics and measuring poverty. He has pioneered the use of economic tools to highlight gender inequality, and he helped the United Nations devise its Human Development Index today the most widely used measure of how well nations meet basic social needs.

More than anything, though, Mr. Sen is known for his work on famine. Just as Adam Smith is associated with the phrase "invisible hand" and Joseph Schumpeter with "creative destruction," Mr. Sen is famous for his assertion that famines do not occur in democracies. "No famine has ever taken place in the history of the world in a functioning democracy," he wrote in "Democracy as Freedom" (Anchor, 1999). This, he explained, is because democratic governments "have to win elections and face public criticism, and have strong incentive to undertake measures to avert famines and other catastrophes." This proposition, advanced in a host of books and articles, has shaped the thinking of a generation of policy makers, scholars and relief workers who deal with famine.

Now, however, in India, the main focus of Mr. Sen's research, there are growing reports of starvation. In drought-ravaged states like Rajasthan in the west and Orissa in the east, many families have been reduced to eating bark and grass to stay alive. Already thousands may have died. This is occurring against a backdrop of endemic hunger and malnutrition. About 350 million of India's one billion people go to bed hungry every night, and half of all Indian children are malnourished. Meanwhile, the country is awash in grain, with the government sitting on a surplus of more than 50 million tons. Such want amid such plenty has generated public protests, critical editorials and an appeal to India's Supreme Court to force the government to use its surpluses to feed the hungry....

Posted by: anne on March 7, 2003 10:18 AM

December 4, 2002

As AIDS Spreads, India Struggles for a Workable Strategy
By AMY WALDMAN - New York Times

CHENNAI, India - This is the sight of a wave, years in building, crashing onto shore.

Women with H.I.V. plump women, skeletal women, always frightened women fill two wards of the Tambaram tuberculosis sanitarium in the southern state of Tamil Nadu. With few exceptions, they are not the commercial sex workers who helped spread the epidemic in its early stages and who have since been taught that condoms can help curb it.

Most of them are wives, or widows, infected years ago by their husbands, the only sexual partners they have ever known. Many have watched their spouses sicken, and die.

Now their turn has come.

Each month at this hospital, the Government Hospital for Thoracic Medicine and which has become the largest AIDS care facility in India, the number of patients with H.I.V. or AIDS, especially women, seeking care is on the rise....

Posted by: anne on March 7, 2003 11:09 AM

China appears to continually reforming and India needs to pay careful attention and reform in turn. Hopefully, China will be the spur India needs.

Posted by: dahl on March 7, 2003 01:05 PM

anne: Just to come to Sen's defense I think the real problem in India is that its democracy is being steadily poisoned by an opportunistic ruling coalition, with the BJP at its core, where provincial politicians are given every incentive to curry favor with the chauvinist electorate by saber rattling either against Pakistan or against Muslims and other minorities. Sound familiar? The result is that necessary domestic policies are neglected and near-famine conditions are allowed to take root in less populated (read less electorally important) provinces as long as no violent mass demonstrations break out.

I have little knowledge about Indian politics and welcome correction, but I think Sen's argument is sound, provided you talk about healthy democracy as opposed to Potemkin democratic institutions that are run by self-seeking demagogues.

Posted by: andres on March 7, 2003 10:08 PM

Suresh:
As is usual in the budget speeched there is a catch in almost everything the Finance Minsiter says:
1. The budget deficit of the central (federal) government is 5.6% of GDP. Add that of the 28 states and other government accounts, and it crosses 10%.
2. The healthcare scheme talks about a premium of "just Re1 per day). That is Rs 365 p.a. to get a cover of Rs 30,000. This is not too different from what commercial general insurers charge. And given that private firms have been allowed into this sector, I guess the government could let them take care of the insurance bit. What the government needs to do is to spend more on setting up primary healthcare centres (and of course primary schools).
3. Permitting higher FDI is a good step but this is well short of what a government appointed committee proposed recently.
4. The key is also expenditure management. An expenditure revire commission was appointed (with senior economists and bureaucrats) but their reports have been buried. (You can find all these in at http//:finmin.nic.in
5. A tax review committee presented its report after two rounds of deliberations and feedback from the public (kelkar Committee reports also available at the above website). The aim was to simplify and rationalise the system, and remove discretionary powers from tax officials. None of these recommendations have been accepted.

6. The sad part is that the new Finance minister could have got away politically with implementing some reform programmes. And he could certainly have increased public investment in infrastructure (say power). Instead, he announced schemes for Rs 600bn ($12bn), of which the government will be spending just $400mn (yes that is million) per year; the rest to come, hopefully, from the private sector. Whoever heard of private sector putting up roads (48 projects), imrpoving railway infrastructure (which is a govt. department) etc..?

Posted by: MRM on March 7, 2003 11:07 PM

Hi,

I think Mr Andres's argument about a "chauvinistic" govt is incorrect and completely besides the point. I am no fan of the present govt, but its economic policy is pretty much a continuation of the policies of previous govts. The problems with public finances are the consequence of many years of neglect and politically expedient policies of subsidies and excessive govt spending.

Mr Krishnamoorthy, the fiscal deficit is 10% of the GDP if one takes into account the indebtedness of the states. Most of the states in India are deeply in debt and have no money for development projects. They have barely enough to pay salaries. A recent example was that of the state of Kerala where salaries to about ~1-2 million govt employees constituted about 40% of govt spending. The state of Bihar has even less and has problems paying its employees.

The present govt has invested heavily in key infrastructure areas-roads, ports and telecommunications. It has also with some success disinvested in a lot of the big public sector industries. Hopefully, this will be a driver of more economic growth.

Regarding defence spending, the Indian govt is spending moneys on defence after a long gap of 6-7 years in the early nineties wherein defence spending was frozen. A lot of this money has gone into refurbishing and replacement of material which is no longer usable. Additionally, the Govt of India has also spent a lot of money on defence technology, which has tangible economic spinoffs.
I think it needs reminding that India does not live in a particularly friendly neighbourhood and faces significant threats to its national security.

I agree that the govt record on education has been very poor and one of neglect. However, in the last ten years there has been a distinct shift in governmental emphasis onto primary education. I think the allocations for education are also being increased.

The problems with starvation deaths are not very new or recent. I remember that when the late Rajiv Gandhi was the Prime Minister, he made a visit to Kalahandi district in Orissa, where starvation has been endemic, to look into this very matter. There are still reports of starvation in this district. I think that this is a failure of the Public Distribution system set up by the govt, and at a larger level a failure of the State Govt machinery.

It is true that democracy does offset famine, India has never suffered the horrors of the famines of the magnitude of those during the British raj, which occured once every couple of decades and killed millions, but it is probably not true that democracy is a perfect mechanism in this regard-i.e it may not completely get rid of famine. It is very likely that a big and powerful bureaucracy may be responsible for offsetting the effects that a democratic setup may have. After all bureaucracy in extreme typified the stalinist state, and did kill lots of people (read solizhenitsyn's gulag archipelago for a description of this.).

Posted by: krishna on March 9, 2003 04:36 PM
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