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Raghuram Rajan, professor, Booth School of Business, University of Chicago and economic adviser to the Prime Minister of India, points out some of the elements of a good budget for India and bringing in larger sections of the corporate world into the tax net.
High deficits will willy-nilly translate into the external sector in the form of higher imports and hence higher current account deficits. But how much can the FM deliver politically? Can he raise taxes, can he cut subsidies and how much might hamper growth and hence tax collections.
In an interview with Lata Venkatesh of CNBC-TV18, Raghuram Rajan, professor, Booth School of Business, University of Chicago and economic adviser to the Prime Minister of India, points out some of the elements of a good budget for India and bringing in larger sections of the corporate world into the tax net.
He explains that it is no longer possible for politicians to get away with fiddling with growth. He warns about complacency on crude prices, despite an ease in the tension between the US and Iran.
Here's an edited transcript of the interview with CNBC-TV18. Also watch the accompanying video.
Q: What is your definition of a good budget?
A: I think for sure we have to be far more careful about expenditure, especially if some of the expenditure that is coming, is cast in stone - expenditure like on food security. If we are going to spend much more on food security, this is a good time to make a bargain.
More spending on some of those measures, but less spending on some of the other subsidies that we have. For example, fuel price subsidies, including on items like kerosene. Of course, that hits against the political environment and we have to see what is possible there.
Second, I would argue that we need a better way of distributing these subsidies and therefore a strong statement that allows us to start to thinking in significant ways of direct cash transfers rather than the way we get subsidies now, including for food security. Those would be important measures on the expenditure side. We have to rein in some of the stimulus we put in place, post crisis.
On the revenue raising side, I would hope that we focus more on broadening the base. Get more people who have not being paying taxes, get more companies that have not been paying taxes, into the tax net. Also focus on how we can raise user-charges across the board, where the user-charges are full- for example, power. But less on raising the marginal tax rate on salaried people, because that is the easiest to collect.
I would also look to see strong signals that something like the GST. We make a push for it again and again, and it all runs into the wall of political constraint. But I think our politicians cannot get away any more by saying “we have strong growth, we can fiddle away while Indian growth is burning” , they cannot.
Any responsible party has to come together and see the growth has fallen off in the last few months and they can’t hold just the government to blame. The government and the political parties have to come together.
Q: The politically tough act of controlling some subsides especially fuel subsides, misdirected fuel subsides. One thought would be nipped at least when the Congress Party came or the UPA came to power with actually a better majority, with less dependence on allies, but the last three years have been wasted. We have not seen the political capital used and now with a clear political reverses in the recent elections are you even hopeful that some fresh ground will be covered in terms of cutting subsidies?
Q: Fiscal deficit appears to be spiraling out of control. We have actually done a 6% plus fiscal deficit almost since the Lehman period. There was only one year when we came down to 4.7%, but that was because of an extraordinary earning on account of sale of spectrum of Rs 1.3 trillion otherwise politically we have not been able to control fiscal deficit to even sub-6% much expected that this year also the revised estimate would be 6%. What according to you could be the downside if we continued with it in the coming year as well?
Rajan: Two aspects, one of course is the stock of claims that build up on you, which is the government debt. Now fortunately because we have surprised the public with higher inflation and we have had some growth the public debt has come down over the last couple of years somewhat that hasn't grown, commensurate with the size of the fiscal deficit.
So at least on that front we are not as vulnerable as we were, but of course how long are people going to accept negative real interest rates. As inflation stays high they will start demanding higher nominal interest rates and that's going to make it more difficult for us to run large deficits. I think that the equally important question is from the perspective of inflation that if we run large fiscal deficits.
Essentially you are trying to fight inflation with just one weapon, which is the RBIs interest policy and of course that's going to have limited effect and political parties are recognizing that inflation does play badly with the electorate.
I think it's very important to understand that we need both tools fiscal and monetary to work to combat inflation. Also the third sort of variable that moves with our fiscal is the exchange rate to the extent that the world sees India as unwilling to embark on the path of fiscal consolidation. The exchange rate is going to be more volatile probably more of a downward drift relative to other currencies and that's not going to help inflation either.
I think from a variety of perspectives it's extremely important we get the fiscal under control and the big trade now seem to be on the subsidies front.
Q: Is the time right for the Reserve Bank of India to begin reversing rates. There have been indicating that rates have peaked. But is the time right to cut or will they have to worry about global crude prices even more?
A: I think not just global crude prices, the decline in inflation numbers that we are seeing has partially to do with base effects. Of course, the incremental numbers are also coming down. But the incremental numbers are very sensitive to what happens to oil and exchange-rates. I think we can’t be complacent about that.
Across the globe, crude prices have been rising. With tensions in Iran, it is hard to say how that will evolve. Fortunately it seems that the US is quite intent on a non-military solution at this point. Hopefully, there is some discussion which has begun to reduce tension. But I think we can’t be complacent on that.
We also have to be very careful on another front. If growth in the rest of the world starts picking up, interest rates in the rest of the world, certainly long term interest rates, are going to adjust, even if short trades are still kept low by the central banks. And that is going to put pressure on capital flows. Because one of the reasons capital flows have been going to emerging markets, is because interest rates in industrial countries are very low.
If that starts reversing, you will find pressure on the exchange rate also. Given all this, it seems to me premature to insist on significant rate-cuts by the central bank. I would doubt very much that, that is something that they would be contemplating. I think we will have to wait and see.
Q: Would you say that, given the kind of growth numbers we have, and Fedspeak, QE3 is pretty much ruled out?
A: For now, yes. I think first there is a lot of anxiety of about what QE2 achieved. It is not clear that it did have an important effect on bringing down long term rates. The Fed has, of course declared victory with QE2 and said it did what it was suppose to achieve. But for most observers outside, it is not clear what that was. It certainly achieved far less than QE1 did.
And that basically goes to the point, that as you pump more and more liquidity to the world economy, it is less and less clear what the incremental amount of liquidity is achieving.
People are now worried about how you withdraw that liquidity and when growth starts becoming stronger, the expectation is that employment will become stronger and stronger over time.
What happens, when you have to withdraw that liquidity; when you made all these promises, people are making long term debts on those promises and suddenly, you find that you’ve made one promise too much.
So I think there is very little appetite at this point among some quarters in the Fed for QE3, which means that it has to be a dramatic slowdown, before they actually do something about it.
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