Budget 2013: NIPFP's Ajay Shah prescribes 3-point plan to fix economy

The Budget could be a game changer at a time when the economy is grappling with low growth and high inflation, feels Ajay Shah, Senior Fellow, National Institute of Public Finance and Policy (NIPFP). In an interview to to CNBC-TV18, Shah says the fundamentals of the economy remain strong and the ongoing problems can be fixed with a responsible fiscal and monetary policy.

Below is the edited transcript of his interview to CNBC-TV18.

Q: I know you don't trust the Central Statistical Organization (CSO) data but nevertheless as a broad indicator expecting GDP would be as bad as 5 percent this year. What is your broad sense? Is the worst for the economy over in terms of output growth or will we feel the pain for a couple of quarters more?

A: The news is quite bad on the data front. If we see company level data and quarterly results of all the firms who are not present in oil and finance space, then we get a seasonally adjusted top-line growth of around 10 percent, and after excluding 10 percent inflation it roughly comes to zero. So, news in the July-September quarter was bad. I am anxious to see the October-December quarter data which will be out in next few days.

Q: Budget will be the next big trigger for the market. How much of a game changer will it be with respect to announcements that will come out and going forward what it mean for the macros be it GDP, inflation, food security bill or anything else?

A: The Budget is the most important single information packet which will come before the next elections. Fiscal consolidation is a major question that we are waiting to see how the finance minister will achieve significant fiscal correction this year.

Secondly, Budget is a work plan for across ministries and particularly the ministry of finance (MoF) for the year. Narrowly, the business of finance ministry is to work on fiscal, financial and monetary reforms. The Budget speech is important because it gives us a sense of what projects in policy reform that are lined up and for which ministries.

Q: No taking away from the fact that fiscal irresponsibility should stop and reversed. Yet, as you delineated yourself we are in an extremely weak growth scenario as far as private investment is concerned. Monetary policy is also not exactly helping and if you have a fiscal policy that is tightening where planned expenditures and even consumption oriented fiscal stimuli are slashed. Do you think we are building in for an FY14 that on growth terms is likely to be weak?

A: There are two elements to the story. We are in stagflation with high inflation and low growth. Indian economy saw growth lowering from 10 percent to 5 percent and inflation increasing from 5 percent to 10 percent. This is a dramatic breakdown of macro policy.  

I think responsible economic policy is the need of an hour. Taking right steps on fiscal and monetary policy will change the climate of pessimism which the country is facing. 

In India, the dominant story on business cycle fluctuations is investment. Investment to GDP, particularly corporate investment to GDP is a big number and it has everything to do with confidence. If people believe that the economic policy establishment is working well, is responsible, ethical then it will set the foundation for confidence on how India will do and it will set the stage for investment which will pull us out of the present mess.

_PAGEBREAK_

Q: The CAD is likely to be around 6-6.5 percent for third quarter, early trade does not look very good. What is your view on this? How debilitating can that be and does it show any signs of reversing? There are points from government sources that all limits on Foreign Institutional Investor (FII) investments in debt will be removed. Are we reaching a stage when that leeway will not be available because you mentioned that when confidence in the currency shakes because of CAD then adding debt to bridge the gap could be dangerous?

A: There are three pointers to this. First, we should never lose sight of the link between the fiscal deficit and the CAD. Government dis-saving is making claims on scare pool of domestic savings and some of it is spilling over on the external side. If we do well on fiscal consolidation today, then it will help us claw back our CAD.

Second, while large CADs are dangerous there are two elements that would protect us, First, the exchange rate element is in place. Countries get into deep trouble when there is a large CAD, financing crunch and don’t let the exchange rates move.

If exchange rate is allowed to move, then it depreciates to a point where in the eyes of a foreign investor an asset in India looks cheap and it attracts capital flows. If exchange rate is not allowed to move then one can be stripped off preserves and it can turn into a big mess.   

There is a wisdom that large CADs are dangerous but it is closely linked to exchange rate policy. We have relatively modest threat that we will get a large currency depreciation that will kickoff more inflation.

Thirdly, suppose there is a problem and a hiccup in foreign inflows and the rupee depreciates, then debt capital will be most attractive to respond to small currency depreciation and stabilize capital flow. 

So, I am very sympathetic to liberalization of all restrictions on foreign investment in rupee denominated bonds. As long as money comes in to rupee denominated bonds, one don't have the so called 'original sin problem' if there is a large currency depreciation that risk is borne by foreign investors.

Q: What would be the growth expectations for next year? How would FY14 look with respect to parameters like GDP, inflation, rupee movement, as you were pointing up in context to the CAD?

A; I do not have a clear picture but couple of considerations can be given. With current structure of capital controls and large current account deficit, if there are hiccups – either on domestic or offshore front, then we will see sharp currency depreciation. This is one picture of the currency. 

In the upcoming Budget if the government shows good work plan then many investors will feel comfortable and confident. India is on a right track. We have a strong economic policy establishment and capable of making right moves. If we are more responsible on fiscal and monetary policy then the basic foundation for a recovery will be laid. Ultimately, India has great prospects. The fundamentals of India are extremely sound. We just need an economic policy strategy which is half way decent.