'Can the Budget boost growth and curb inflation?', by invitation, The Economic Times, 27 February 2007.
The Union Budget for 2007-8 is being readied against a background of record growth.
But all is not rosy, as the growth is uneven across sectors and the inflation rate is
accelerating. Should the FM go beyond the FRBM targets? As the presumed effects on
growth and inflation of a budgetary deficit go in opposite directions, the answer to this
question depends upon which is chosen as the binding constraint. As inflation affects the
wider constituency, and manufacturing is currently displaying a robust appetite for
growth, I expect that he will choose to lean on inflation. Orthodox macroeconomics
prescribes a tightening of the screw on the budget deficit in such a situation, as in “going
beyond the FRBM target”. But this can yield very few anti-inflationary points in the short
run as food-price inflation is inertial, being maintained by the low price elasticity of
demand for food. In any case, aggregate demand management is a blunt instrument for
inflation control. It works via the round-about method of getting at the demand for goods
by engineering a reduction in output. Only supply management will work benignly in the
context, and with stocks low only imports can increase supply.
Should tariffs be brought down to the level in ASEAN? Lowering tariffs is not a
sufficient long-term anti-inflation strategy, so we need only focus on the growth potential
of such a move. On the issue of growth we should note that the tariff barrier has been
lowered substantially since 1991. Manufacturing growth and associated exports have
accelerated without, at the same time, a serious worsening of the balance of payments.
However, for a quarter of a century at least now growth in India has been led by services.
It is not clear how closely industrial tariffs impact services production if at all. More
generally, we should not allow ourselves to be led by the belief that what is good for
ASEAN, or China even, is necessarily good for us. Trade liberalisation has more or less
run its course here. Nevertheless, a zero tariff for non-competing capital and intermediate
goods would yet help with export competitiveness. This would, however, drain the
exchequer a bit.
Finally, infrastructure for productivity growth. It is obvious that productivity is
highly dependent on infrastructure and that infrastructure is woefully inadequate in India.
More money will help, but we must seriously resist the temptation of throwing good
money after badly-run infrastructure projects. Development economists have long
realised that ‘how you use it’ is at least as important as ‘how much you have’ when it
comes to infrastructure. Much of public infrastructure in India needs re-organisation and
superior management before it can absorb the moneys. The FM is a little short of
instruments here as much of the poorly-performing infrastructure is in the hands of the
state governments. However, there are routes to productivity growth other than public
infrastructure and there are things that the FM can do to encourage such investment. In
the euphoria derived from the global success of our software we have missed the point
that the Indian economy is a producer of IT rather that a user of the stuff. Only greater
use of IT can lead to an internationalisation of the promised gains of this general purpose
technology. Large swathes of India cry out for a diffusion of information technology
within their production process. The FM could consider an investment subsidy in the
form of a tax rebate on IT capital enhancement during 2007-8 for firms below a certain
size. This would also ensure that more units are brought into and remain within the tax