A year after India ushered in reforms in 1991, C Rangarajan, then a member of the Planning Commission, was picked by then finance minister Manmohan Singh to steer Reserve Bank of India for five crucial years till 1997.
Then, Rangarajan, who had taught in University of Pennsylvania and management institutes in India, headed the Twelfth Finance Commission, which paved the way for fiscal consolidation, and also the Prime Minister's Economic Advisory Council (and was, for five years, Governor of Andhra).
In an interview with Business Standard's Sapna Dogra Singh and John Samuel Raja D, he says there are some encouraging signs in the economy, but the real recovery will come only in 2010-11.
How do you see the current situation? Is the worst behind us?
We need to distinguish the situation as it prevails in the industrially advanced countries from India. Perhaps, these countries have seen the worst and there are some signs of recovery, but not very strong. The real recovery will come in 2010-11 only.
In my view, the industrially advanced countries may be at the beginning of the start of recovery.
The situation here is very different from advanced economies, there's slowdown in growth and decline in production. Perhaps the Indian economy may grow at 6-6.5 per cent in the current year (2009-10). This is very low as compared to the growth rate we have seen in the past. But what is happening in the advanced countries would have an impact on India.
It would have an effect on India through two routes - trade and capital flows. Our exports are dependent on the performance of the economy elsewhere. The continued recession in the advanced countries will have an adverse impact on our exports, which is already seen in the numbers.
Perhaps, slowdown of growth in exports would continue this year. To some extent, the low crude oil prices will benefit India as our imports bill would be correspondingly less. But the impact on exports is the most important thing and that will have a severe effect on overall growth.
Capital flows have slowed and Indian corporates would find it tough to raise funds abroad. The cost of external borrowing may also rise, the foreign institutional investors have been reluctant to bring funds, but some signs of them returning to the market is visible.
However, on the whole, one cannot expect very positive growth in FII inflows in the coming years, therefore, the external situation is not going to be very conducive for higher growth in India, but the recovery would certainly help. That's why my estimate for the growth rate for 2009-10 is around 6-6.5 per cent.
When do you think it would be possible to get back to the 'trend growth rate'?
Even in 2010-11, one could expect only a slightly improved performance of the economy. Perhaps we can go to a 7-8 per cent growth rate in 2010-11, but much depends upon the world economic situation.
To achieve anything like a 9 per cent rate of growth, it would be possible only if there is true recovery of the economies in the rest of the world. Until then, we would be able to achieve a growth rate of between 7-8 per cent.
Looking at the GDP composition, nearly 60 per cent is private consumption. Can this drive the economy to a higher growth rate?
It is because of this reason (domestic consumption) that our economy is able to register the current level of growth. Other economies, which are dependent on the rest of the world, are affected more than us. Only because of strong domestic demand would we be able to achieve 6-6.5 per cent growth this fiscal.
So, you are saying the gap between 6.5-7 per cent and 9 per cent is derived from the external sector?
Absolutely right. If the external sector is buoyant, then we would be able to manage a high growth rate. By managing the domestic demand, if we can achieve a growth rate of 7-8 per cent, then it would be a significant achievement.
External factors are critical to reach high growth rate. . .
I am saying that by managing domestic demand, we can get 7 per cent growth but for reaching 9 per cent growth, the external situation should be conducive.
On the fiscal front, it is feared that excessive borrowing might crowd out private investment. What are your thoughts?
We need additional government expenditure because private demand is not adequate. But the government should slow down its expenditure when private demand is ready to fill the gap. Six per cent fiscal deficit of the central government is not a sustainable level over a period of time.
Already interest payments as a proportion of revenue receipts have started rising. But the need of the hour is to sustain the aggregate demand at a high level and that's why a high level of government expenditure is warranted.
But as the economy recovers and as private investment demand grows, that is the time for the government to reduce expenditure and create a low level of fiscal deficit.
What would you prefer, tax cuts or spending on infrastructure?
As you know, in the Keynesian prescription there is no distinction made between capital expenditure and consumption expenditure of the government. But in our context there's need for a distinction between the two. The additional expenditure should be used to build capabilities that would facilitate growth.
A larger proportion of additional government expenditure should focus on investments.
But investment expenditure by government will have a lagged impact on the economy.
There is a lag only in terms of output. But there is an immediate demand generation for raw materials used and also through payments made to people engaged in the projects.
Should the government focus on specific sectors while spending its resources?
The composition of government expenditure should be such that it stimulates demand in sectors that are badly hit. For example, increased government expenditure on vehicles will lead to increased demand for the automobile sector.
Similarly, increased expenditure on infrastructure will stimulate demand for steel. Even in sectors affected by a fall in export demand, we can try substituting it by domestic demand. Textiles could be one area where domestic demand can replace export demand.
But this is not possible in other sectors like gems and jewellery. So, expenditure should be done in a way that demand is stimulated in a particular sector which is affected.
In your estimate, by how much more can government expenditure increase? In two or three steps, the government expenditure has been increased substantially.
The revised estimates for 2008-09 were 20 per cent higher than the budget estimates. The budget estimates for 2009-10 are higher than the revised estimates of the last financial year by 6- 7 per cent. There's been enough increase in government expenditure.
That is why I say that the time has come to pay more attention to the composition of expenditure and fine-tuning in such a way that it stimulates demand in sectors affected by crisis.
So, whatever the government has planned in budget estimates is more than enough?
I think the amount contemplated is sufficient. What we really need to focus on is the composition and the efficiency with which it is spent. There's always a slack due to a variety of reasons.
Some additional expenditure can be done to take charge of sectors badly affected, but overall spending is good enough. Let's now focus on composition and efficiency.
With government borrowing at high levels, there is a demand for direct issuance of bonds to RBI. Is this a way to avoid the crowding-out effect?
It's true that the contemplated level of borrowing is substantially high than what it was a couple of years ago. This puts pressure on interest rates. The better way for RBI is to undertake open market operations through which liquidity can be injected into the system.
I think we should avoid direct financing by RBI. Open market operations achieve the same objectives, by injecting liquidity into the system and providing commercial banks with adequate reserves.
There could be some slack in private demand right now and so it is easy for the government to borrow from the market. But once private demand picks up, then the high level of government borrowing can crowd out the private sector.
Why do you argue against direct financing by RBI?
Earlier, we had direct financing of government deficit. We got out of automatic monetisation of the fiscal deficit through legislation. It's better not to go back. Even if the deficit is monetised, there needs to be some understanding between the government and RBI as to what level of borrowing needs to be monetised.
More important, the discretion should still lie with RBI.
Coming to the Union budget, industry lobby groups are arguing for more sops and at the same time we have a high deficit. How should the government balance both?
The fiscal deficit for 2009-10 is 5.5 per cent, but it's likely to increase. Some incentives can be provided to private sector to enable it to enhance the level of investment. But it would be imprudent to take the fiscal deficit higher than 6 per cent of GDP.
What role can RBI or monetary policy play in a situation like this? Is there scope for further reduction in key interest rates?
The signal rates or policy rates of RBI play a dual role. First, they have an impact on the behaviour of commercial banks and also provide signals regarding perception of RBI, which is critical. If a lower level of interest rates is desirable, then RBI should send signals on this from time to time, so that lowering of policy rates some time in future cannot be ruled out.
But, RBI has also to see that its actions are taken up by commercial banks in the right direction.
It seems RBI, commercial banks and the real sector are operating in three different silos. The reduction in policy rates has not benefitted the real economy.
Commercial banks have taken the cue from RBI. They have tried to lower deposit rates and prime lending rates, but the fact is that the reduction is nowhere near what happened in policy rates.
That is because commercial banks are locked in deposits with higher interest rates. Any reduction in rates can happen only in new deposits.
I think now the banks will be able to lower lending rates.
Do you think the current economic crisis gives an opportunity to initiate reforms? Will this lead to more regulatory powers?
The crisis has opened the eyes of regulators in the western world. It has been a regulatory failure of two types. First, some segments of financial markets were loosely regulated. The regulatory framework should apply to all segments of the financial market. The second failure was imprudent understanding of financial innovation by the regulators.
In India, to some extent, the regulatory framework has moved into almost every segment of the market. We really need to look into the framework and see that all segments of the market are supervised by one authority or a regulator.
