India mismanaging its monetary & fiscal policies: NIPFP

The government has taken a lot of bold measures over the last few days. But Ajay Shah, senior fellow, National Institute of Public Finance and Policy (NIPFP) says these measures are not enough. “We have made some small changes on the subsidy on diesel. We have made some small progress on disinvestment, but this is a small change compared with the magnitude of the problem,” he elaborates.

In an interview to CNBC-TV18, Shah says all recommendations of Vijay Kelkar Committee need to be accepted.  The committee recommended sharp reduction in subsidies on fuel, food & fertiliser.

According to him, inflation, in the long-term, is primarily a monetary phenomenon. “If RBI wanted to get inflation under control they could,” he adds.

He further says India is mismanaging its monetary and fiscal policies. "It doesn’t do any good to monetary policy to try to blame fiscal policy."

Also read: Indian economy in perfect storm, says Vijay Kelkar

Below is the edited transcript of his interview with CNBC-TV18's Latha Venkatesh and Sonia Shenoy.

Q: There have been a bunch of reforms. But, on an issue, in which the entire economy will be impacted, fiscal deficit, there hasn’t been much. How would you access the entire move? Would you say that bunch of positive incremental moves in a series of things don’t entirely equate the big negative on the fiscal deficit?

A: I think they have made some progress. We have made some small changes on the subsidy on diesel. We have made some small progress on disinvestment, but this is a small change compared with the magnitude of the problem.

The Kelkar report is being portrayed as being a big alarmist. Actually, I worry that what the report envisages is not enough.

Q: What are the incremental reforms that are required by the government to be able to bridge the fiscal deficit gap? Where do you see the fiscal deficit at the end of FY13?

A: I think it’s important to focus on the primary deficit. So, my favourite indicator of understanding where we stand is the primary deficit, deficit net of interest payments. Under normal circumstances, a country should always run primary surpluses. This is just a basic ‘dharma’ of prudent public finance. In 1999, you had a Kargil war, you can run one or two years primary deficit. In 2008-09, you have a global crisis; you can run one year of primary deficit. For the rest, in every normal year, we should be running primary surpluses. That is prudent public finance.

The report that Kelkar has drafted take us to a primary deficit of over 1.5 percent over a couple of years. So, I would just say that everything that they have proposed in the report should be done, but, at the same time, we should not think that that is enough.

Q: What is the comment on inflation? If we are still going to create aggregate demand to the extent of 6% of the GDP through fiscal deficit and something more from the states then is inflation just going to remain where it is or get worse?

A: Inflation, in the long-term, is primarily a monetary phenomenon. We really do wrong, when we try to attribute inflation to public finance. In the long run, it is about how many rupees are chasing how much goods. What the government takes today? What the government access tomorrow? These things don’t change inflation in the long run at all. So, let us not bring inflation into that picture. Inflation is just monetary economics. If RBI wanted to get inflation under control, they could.

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Q: Obviously, you are not in sympathy with a CRR cut. Would your prescription be that RBI stays pat or even perhaps raise rates?

A: We, in India, are mismanaging both monetary and fiscal policy. It doesn’t do any good to monetary policy to try to blame fiscal policy. Monetary policy has to do what it has to do, which is to deliver lower and stable inflation.

Q: Now that it seems like current account deficit has troughed out and the balance of payments has moved into surplus territory, do you think there could be further appreciation in the rupee beyond the levels that we have seen? What is your general sense on how the money markets will react to this?

A: The dominant story on the rupee is the confidence of foreign investors. At a time, when India were saying that we will use GAAR to attack the Mauritius tax treaty, we will do retrospective tax amendments to go after Vodafone, that was making foreign investors very nervous and that gave us a sharp decline in the rupee.

Now that the government seems to be making the right moves in terms of establishing environment of rule of law, I think there will be more confidence on part of foreign investors. We have already reaped a significant impact of that in terms of a stronger rupee.

Q: You were very positive on the Financial Sector Legislative Reforms Commission (FSLRC) recommendations. I only have one cursory reading of, of that 35 page approach paper. It seems to come with the view that the regulators are almost fiendish. They need to be more conscious of several things. It seems to be hemming in regulators in some sense. From Justice Shree Krishna point of view, where he deals with common citizens and their problems with maybe police authorities and their atrocities, it may make sense. But the regulated entities in finance space are normally very smart people, always smarter than the regulator. Do you think this might end up watering down regulators somewhat?

A: I think there are serious problems with rule of law in Indian financial regulation. This has been talked about many times before. For example, if you look at UK Sinha working group on financial flows, it describes example after example of how the operation of capital controls in India is characterised by arbitrary exercise of power.

I think that we should be very careful about rule of law. There should be a fundamental constitutional perspective to everything that we do in government. Power corrupts absolutely. Nobody in India should be above the rule of law.

Q: What about the other architecture? Will it always be possible to give goals? That’s one of the points which the Financial Sector Legislative Reforms Commission (FSLRC) approach paper makes that all regulators should have goals by which their performance will be measured. Is it really possible for SEBI, IRDA? How do you really put these kinds of performance parameters?

A: The whole world does it. There is nothing radical in this report. Think about public administration as a contracting puzzle. If a government does something inside the government, that’s fine because the government has political accountability. MPs have to go face elections, ministers lose their job.

When you set up an agency external to government and you have unelected bureaucrats who are running it, how do you hold that agency accountable? So, you absolutely have to have clarity about goals and purpose. It cannot just be a jagirdari where somebody has some power and he can do whatever he wants with it. Think of it as a contractual thing that if you hired a contractor to do something for you, would you be clear on the goals of that contractor or would you say to the contractor, ‘oh you are a nice guy you are going to take care of my interest’.

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Q: But isn’t the rule of law often been thwarted because the finance ministry or ministry in charge has been able to actually get the regulator by the scuff of his neck? Is not the contrary also the case, where regulator actually is at the mercy of political executive?

A: You have to see both. On one hand, there is a question on independence. Do regulatory agencies have political independence? Do regulatory agencies have functional autonomy? We need more of that. But there cannot be one way bargain, we need accountability as well. What we have in India toady is dysfunctional third world environment where we have neither. We neither do the independence right nor do we do the accountability right. It is import to push both.

Q: Do you expect to see further liberalisation measures either in the form of opening up of FDI in insurance or lots of things being talked about like the creation of National Investment Board (NIB)? How much in terms of a follow through do you expect from here? Do you expect the economy to have bottomed out really?

A: I am very optimistic about the way the team inside the Ministry of Finance is being reconstructed. The recruitment decisions that have been made inside the Ministry of Finance are of top quality. I have very high confidence in that team. That team is going to deliver lots of good product to us.

That will partly be highly visible reforms like doing things that appear in the front pages, but actually equally important is the humdrum everyday activity inside the Ministry of Finance that most of us don’t see face to face. But I am really optimistic about how this is going. I think things will be much better one year from now.