The challenge in the case of the Centre is the rising crude oil bill

The Prime Minister's Economic Advisory Council, headed by C. Rangarajan, has several eminent economists as its members. Its reports on the economy — the Economic Outlook and the Review — are widely referred to, not the least, because they are much simpler to read and easier to understand than many comparable reports.

The Council's views carry plenty of weight although it is purely an advisory body. The most recent Economic Outlook 2011-12 is much more than a commentary on the economy. With refreshing candour, it analyses the reasons why the Indian economy has not grown to its potential. It blames bad politics for holding India back. After the crisis, India emerged relatively unscathed. Rather than use its relative strength to push through an ambitious but the much needed reform agenda, including, among others, a roll out of physical infrastructure and better public expenditure management. Indian policymakers became complacent and missed a golden opportunity.

To quote from the Economic Outlook: “The combined momentum of a stable government after the May, 2009, general elections and the successful navigation through the crisis was a good opportunity to take those necessary steps to energetically get back to the imperatives. However we have lost time. Besides, a slew of corruption related controversies over the past one year has consumed the energies of the government and has led to a slowing down of initiatives to restore investment and economic confidence.”

What has not been specifically stated is that decision makers in government are unable or unwilling to take decisions; that there is a big drift in policy making; routine file noting may land the official in jail. It is going to take some time before the government snaps out of its stupor. Meantime, economic growth is bound to suffer.

State of the economy

In 2010-11, the economy grew by 8.5 per cent, which was in line with what was forecast by the Council. For the current year, however, as against its earlier forecast of 9 per cent (first made in July, 2010, and reiterated in January, 2011), the Council has lowered it to 8.2 per cent. Agriculture will grow at 3 per cent, industry at 7.1 per cent and services at 10 per cent. The Council attributes its downward revision to inflation and investment slowdown. It is, however, the structural factors at home that need to be attended to on a priority basis. Fixed capital formation has weakened noticeably — initial estimates for 2010-11 place it at not more than 29.5 per cent. High rate of domestic inflation, excessive government debt and political instability have eroded business confidence impacting asset creation adversely. A fixed investment rate of 33 per cent plus is needed to achieve a growth rate of 9 per cent. Domestic savings too has come down to 33.7 per cent in 2009-10 and is unlikely to be more than 34 per cent in both 2010-11 and 2011-12. The Council expects that the headline Wholesale Price Index-based inflation rate would continue to be at 9 per cent or higher in July-August. Thereafter, it may start easing but even in December the headline inflation will remain high. However, in the last quarter of the year, inflation may come down.

The target rate for inflation for the year-end is 6.5 per cent, slightly below the RBI's 7 per cent. On government finances, although the Centre and the States have made substantial progress towards fiscal consolidation, the Council feels that achieving the targets set in the 2011-12 budget estimates will present significant challenges. Structural reforms in the finances of the Centre and the States are necessary.

In the short-term, the challenge in the case of the Centre is the rising crude oil bill, which creates an upward pressure on the subsidy bill, while lower taxes on crude and diesel are impacting revenues. In the case of State governments, the deteriorating finances of the electricity utilities are creating substantial liabilities. In the medium-tem, several social sector legislations will place a huge financial strain on the government.

It is imperative to introduce expenditure reform and initiate steps to augment revenue. According to the Council, “introduction of the Direct Taxes Code will be useful but the real gain will come from the introduction of the Goods and Service Tax (GST).'' The Council has touched on other key issues such as convergence of growth rates of States, sustainability of the current account deficit and the power sector. But what has made headlines is the Council's lowering of the GDP growth rate and its frank assessment of the state of governance today.