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India's flawed economic policy needs change

Mihir Rakshit | August 05, 2003

One of the best things the new finance minister did was to discontinue the practice of a pre-budget meeting with economists. This, apart from saving government expenses and skilled man-hours and avoiding heart-burn of the non-invitees, dispenses with a pointless ritual.

In large gatherings economists seldom interact fruitfully, generally remain impervious to others' reasoning and leave the non-professionals thoroughly bemused.

Mercifully the meets were no more than public relations exercises: otherwise the authorities, with little scope for identifying (not to speak of judging the relevance of) analytical and empirical groundings of alternative views, might have been swayed by majority opinion or a speakers' eloquence-cum-confidence.

However, weaknesses in policy formulation remain. Apart from the ministry of finance, bodies involved in framing macro measures include RBI, Planning Commission, Economic Advisory Council and Finance Commission.

Though a permanent body, EAC meetings are rare; and lacking any office or research staff, its members have little opportunity to examine intensively and thrash out pertinent issues.

No wonder, EAC's contribution has been confined to reiterating currently fashionable views, aired ad nauseam in all officially sponsored fora.

Of late FCs are also being asked to suggest schemes for macro-stabilisation, budgetary balance and equitable growth. Unlike the EAC, FCs can have research back-ups and their members may arrange for focussed discussions; but with limited tenure and heavy constitutionally mandated responsibility, their policy inputs can hardly be significant.

Unsurprisingly the Eleventh Commission ended up, sans 'a macro-model incorporating the relevant structural relations', presenting an analytically poor approach in its report and churning out targets from thin air.

The primary task of framing macroeconomic policies lies with the MOF, PC and RBI. Their approaches to macro-management, official publications suggest, are not similar -- something which with honest exchange of views can generate positive fall-outs.

Unfortunately, such interaction to resolve basic differences and avoid gross policy inconsistencies seems almost non-existent. No less serious are endemic limitations in the three bodies' approaches to target setting.

Take for example the Tenth Plan document. There is considerable economic sense in the PC's reading of current macroeconomic problems and its overall recommendation relating to the public sector taking the lead in removing demand-cum-infrastructural constraints in the initial phase and thus paving the way for a burst of private initiative in subsequent years. But the devil is in details.

Without any well-specified model with estimates of crucial parameters, there is no way of assessing whether the plan targets are over-ambitious. Emphasis on legal-cum-institutional reforms for unleashing productive forces is well taken; but it is far from clear how the almost intractable problem of estimating their quantitative impact has been solved.

Despite its advocacy of market orientation and 'minimalist role' of the state, the PC glosses over serious difficulties of devising measures and ensuring policy coordination in order to attain overall, State-level and sectoral targets, including  'specific and monitorable' social objectives regarding poverty, employment, education and demographic stability.

The difficulty would have been apparent had the PC tried to investigate what went wrong with the previous exercise or why (with more than a quarter of the Tenth Plan period already over) there is little sign of the major macro variables moving toward their targeted trajectory.

In recent years, RBI reports have become focussed and have shown marked improvement in analysis, especially in tracing interdependence among major sectors of the economy. It is however a moot point whether their results can be or are actually used for effective policy formulation.

Despite the need for taking an integrated view of, and fitting monetary and exchange rate measures into the overall macro-policy package, the reports seem chary of identifying weaknesses of the package and suggesting corrective steps.

The bank's annual monetary and related targets are in fact based on some projected growth of GDP and other variables, even though RBI policies themselves produce economy-wide effects.

Without being intimately involved in overall macro-policy framing, the bank, it appears, focuses almost exclusively on strengthening the banking system, maintaining monetary stability and avoiding currency market turmoils.

By adjusting its policies to changing domestic and international financial situations, RBI has been successful in attaining its objectives, but at considerable macroeconomic cost. The reason lies in lack of policy coordination with other authorities.

Thus financial liberalisation and enforcement of prudential norms have not been supplemented with institutional and other changes needed for an economy-wide credit delivery network.

The result has been reduced availability of long-term funds, increased pro-cyclicity of credit supply and stiffer obstacles to small enterprises in accessing bank loans.

Again, ineffectiveness of easy money policy and sluggish public investment together have made RBI's 'successful' external-sector management counter-productive, with a poor country turning a lender to super-rich nations and foregoing substantial seignorage revenue despite its budgetary woes.

The most powerful among policy-making bodies is the MOF; but its technical expertise seems suspect. Except for a brief period after the 1991 crisis, the MOF views on major developments, incorporated in Economic Surveys, have been marked by inadequate macroeconomic reasoning, with different parts of Surveys lacking proper integration and often containing incompatible statements.

The budgetary exercise, it also appears, is not based on any coherent framework, or if there is any, no serious attempt is made to modify the model in the light of experience: otherwise it is difficult to explain large and systematic deviations between the budget and actual figures for major variables year after year.

That something is seriously wrong with the MOF's perception of macroeconomic linkages is also attested by the sharp rise in government consumption along with a cutback in capital expenditure, and by tabling of a grossly irresponsible Fiscal Responsibility Bill (which the parliamentary committee has fortunately revised in the right direction).

Our analysis underlines the need for explicit modelling; identifying policy instruments; and factoring in their effects on intermediate targets and primary goals. This does not ensure optimality, but is indispensable for hard thinking; locating sources of disagreements, fuzzy areas or zones of ignorance; and alerting policy makers to the nature of uncertainties and riskiness associated with alternative measures.

Having separate bodies like the MOF, RBI and PC helps avoid monolithic thinking; but it is essential to arrange intensive interaction among their staff to resolve thorny issues and avoid major policy inconsistencies.

Finally for HRD. Innovative thinking, starting from first principles and taking cognisance of major structural changes in domestic and international economy, is the essence of successful policy formulation.

Unfortunately, most official economists, appointed on a permanent basis and having little scope (especially at senior levels) for serious research or keeping themselves abreast of new ideas, soon turn bureaucratic. The problem is compounded by recruitment of staff with practically identical policy predilections.

The solution partly lies in fostering two-way mobility between policy-making bodies and academic institutions: such steps should sharpen the intellectual edge of government professionals and promote relevant, problem-specific research by making academics better aware of gaps in their thinking.

This may work provided top policy makers give up behaving like a governor of the Bank of England in the inter-war years -- Montagu Norman is reputed to have told his economic adviser, "You are not here to tell us what to do, but to explain to us why we have done it".

The writer is ex-professor, Presidency College and Indian Statistical Institute, Calcutta and currently director, Monetary Research project at ICRA

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