Government spending cannot directly affect the level of reserves, unless the Reserve Bank of India adopts a policy of killing exports and inflows by allowing the rupee to appreciate and imports to flood the market. Even that would take time to work on the reserves.
As I argued in these columns (FE, Nov 25), the issue of the level of reserves is intertwined with the behaviour of global capital markets, the current threat to the dollar and to the conduct of macroeconomic policy in the context of expected large inflows into the economy. I had argued that further liberalisation of the capital account was not desirable and would not work. Thus, the measure of liberalising individual outward investment flows of up to Rs 25 lakh per year, last year, expectedly only added fuel to the fire.
But the question of government expenditure to take infrastructure forward is not a red herring when delinked from the issue of reserves. An assumption in most discussions is that India is infrastructurally constrained. There is no argument that infrastructural costs in India are high and have hurt manufacturing. Though that is no explanation for the slowdown since 1998 and the ‘weak’ pick-up since late 2002, despite the renewal of income growth. The appreciating rupee (the RBI’s lack of commitment to hold the rupee at its post-stabilisation 1993 real values and its continued monetary conservatism in targeting money supply rather than interest rates) may have been responsible.
The slowdown in overall infrastructural spending from the demand side is most important. Public investments used to account for 50% of capital formation in the economy. In the late ’80s, this share began to decline and the rapid growth of private investments right up to 1997 ensured overall investment pressure was kept up despite a fall in the share of public investment.
Unfortunately, that great run of private investment could not be kept up. Doing so would have meant private investments getting into infrastructure sectors that are also investment-intensive, like electricity, water, roads, irrigation and urban infrastructure.
The demand-depressionary effect of the slowdown in investments is the big story. That, with the monetary and exchange rate policy, has kept industrial growth rates lower than what the economy is capable of. So, if we are so incapable of correcting our frameworks and rules, why not get the government to spend in these sectors in a big way again?
Such spending would today be beneficial. Not because it would reduce infrastructural constraints (that would take years), but because it would crowd in demand. In investment-intensive areas, where the linkage with productivity is high and direct, the lack of regulatory clarity and a muddled policy that attacks non-problems, while the open wounds of distortionary subsidisation remain, have kept private investment out.
In such circumstances, should the state force the investments? Not with the kind of delays and cost overruns that public investment in these areas has shown — 60%, which knocks off a straight 0.04% from the growth rate of the economy for every percentage point rise in the share of public investments in physical infrastructure and manufacturing.
To bring back the public sector in manufacturing would be quixotic. What, then, are the options for the government today? Why not actually bring about policy and regulatory clarity in electricity, for example? That can bring in large investments, since the pent-up demand at cost-to-serve prices is suppressed by at least 20% today. Similarly, the denial of the poor, who have huge demand even at high electricity prices, would come into the reckoning.
In irrigation, there are over Rs 40,000 crore of not-yet- completed projects that would become productive overnight, with the right approach to subsidy and a framework for private investments. Ditto in areas like sewage and sanitation, where additionally the social (health) benefits are large. Such developments are possible. But when ‘reformers’ chase the form rather than content, then reform itself turns blind.
The government has the strategic option of buying oil and gas fields to use up, say, about $25 billion of forex reserves. Oil is, after all, India’s most important complementary asset. Alas, the time is not right today with oil at $50 per barrel. Tragically, our babus could not make up their minds when oil ruled at $8 a barrel and fields were available for the asking, repeated pleas from IOC and ONGC notwithstanding.
Other purchases that would be worthwhile would be not-too-well performing companies in aeronautics, design, computers, software, thin films, etc., which are vital for the unfolding of India’s long-term comparative advantage. Imagine the kind of competitiveness we could bring forth in high- tech industries if our leading companies owned McDonnell Douglas or Oracle today?
Similarly, India could give external credit to other countries, the workability of which would be to her advantage, though this would depend upon the exchange rate. Another option could be to take a chance on the high taxes on oil products, reducing these to take advantage of high elasticities in demand for petrol, to protect government revenues.
But if, on a simple thing like oilfields acquisition, the Indian state could not exhibit strategic thinking, it is best to forget these options.