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Need to check fiscal deficit, use forex reserves wisely

Ashok V Desai

Foreign exchange reserves have crossed $64 billion, and are rising rapidly. If they continue to rise at this rate, they may cross $75 billion by March, and $100 billion in a couple of years.

They already exceed domestic money supply; they will far outstrip it.

I am sure (Reserve Bank of India Governor) Bimal Jalan is under pressure from illiterate Hindutwists, who ask, why does he keep the reserves in foreign currency?

Why can't he keep them in Bharatiya rupees? Why does he not lend the reserves to the government, so that it can run even bigger deficits?

Literate economists like Suman Bery add to his woes by asking: why does he need reserves at all? Why doesn't he let the rupee float up?

As Jalan said in his speech at the Bank of England last July, reserves are necessary because the whirlwinds of international instability are powerful and because a country must be able to withstand them on its own.

They are the price for avoiding such disasters as Indonesia and Argentina have witnessed. But accumulating reserves also incidentally keeps the rupee down.

Keeping it down is a good idea; it improves the current account, and provides a welcome stimulus to the sagging economy.

The problem lies elsewhere: that stimulus is dissipated because the expansion in the banks' lending capacity arising from reserve accumulation is being used to expand government consumption.

The answer to that lies in the fiscal field, to which I shall come later. But the reserves can be put to some good uses.

(a) Dismantle NRI deposit schemes: These deposits are a pure scam: anyone who can trump up an Indian-sounding name can borrow from a local bank abroad, go to the branch of an Indian bank abroad, and place that money on deposit, and pocket the difference between the interest rates.

This effortless game is a favourite of shady NRIs. But it is a pure racket, and the earlier it ends the better.

The Reserve Bank should prohibit the taking of all fresh NRI deposits and repayment of existing ones when they mature. That will reduce reserves by a third at least.

(b) No more Resurgence: The Resurgence Bonds of 1998 and Millennium Bonds of 1999 were similar scams: so-called NRIs borrowed money from sources abroad, earned high interest on it from the bonds, and took the difference.

Millennium bonds got into trouble with the Federal Reserve, which ruled that they discriminated against non-Indian Americans.

So State Bank collected money from them in Europe, and asked its NRI clients in America to siphon their money through London.

Both bonds should be repaid on maturity if not before.

State Bank of India, which will lose the use of those funds, will lobby hard for issue of another Bombastic Bond. BJP politicians who depend on NRI money will lobby too.

All such lobbying should be resisted; there should be no further issue of these bonds for racketeers.

(c) Remove import barriers: Reserve accumulation can be slowed down by encouraging imports. India had a golden opportunity of doing so when it finally abolished import licensing.

It muffed the chance: it increased duties on agricultural goods, on so-called luxuries and miscellaneous other goods, began to monitor import of 'sensitive' goods, most energetically began to impose anti-dumping duties and invented ingenious new import barriers.

Sukumar Mukhopadhyay has shown how Yashwant Sinha, while announcing that he was reducing duties and the number of duty rates, was actually increasing both; the collection rates given in the Economic Survey themselves testify to the rise in duties.

The new finance minister should accelerate duty reduction: he should abolish duties on all internationally competitive goods and all essential consumer goods, and reduce the peak on the rest to 15 per cent.

He should go through anti-dumping duties with a toothcomb, and remove all duties on goods produced by local monopolies and cartels.

Remember that changes in the exchange rate are equal to a combination of import duties and export subsidies (or their reduction). So higher reductions in duties can be made more tolerable by devaluation.

Fiscal policy: The fiscal deficit is the culprit; this is the cause of diversion of personal financial accretions into government consumption and for the fall in industrial investment.

It is on the point of getting worse, for a number of states are close to financial collapse, and they will gang up to make the Centre bale them out. They have the political clout to force the Centre.

In the Ahluwalia report on states' indebtedness to the Centre, they have the precedent: it recommended a substantial write-off, which Sinha raised even further.

There is no immediate solution, but the problem can be resolved in a few years if the direction is set.

(a) The first element is to introduce a hard budget constraint at the Centre: the expenditure during the year should not exceed the budget, there should be no supplementary grants, and any increase in the expenditure of a ministry should be accompanied by a simultaneous cut in the budgeted expenditure of another.

There will always be undisciplined and uncontrollable elements in the government: the prime minister cannot be prevented from giving Rs 400 crore (Rs 4 billion) to Narendra Modi and Rs 1,000 crore (Rs 10 billion) to Rajnath Singh.

But such indiscipline must be anticipated and reined in: there should be a large prime minister's discretionary fund with which he and his senior party colleagues can play politics.

(b) A cap on subsidies: Abolishing subsidies is impractical; instead, they should be capped at the past year's level. That will force the food ministry and the fertiliser ministry to work out how best to use the money available to them.

Fixed subsidies would be inconsistent with price controls and minimum price support; the Agricultural Price Commission should be abolished, and producer pricing should pass to the relevant ministries.

(c) From product to personal subsidies: The numerous subsidies on food, fertilisers, electricity, irrigation water etc are neither equitable nor efficient; states should be forced to integrate and target them.

They can all be subsumed under two subsidies: a personal subsidy varying inversely with personal or family income, and a negative agricultural income tax varying inversely with agricultural income.

States should be forced to convert their subsidies into these two basic forms.

The Centre can itself work out a model subsidy for the poor and land subsidy that can be financed with its food and fertiliser subsidies, work out each state's entitlement and pass it on to the states for them to do whatever they like with the money.

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