Will Chidambaram Manage to Clean up the Economy?

When P. Chidambaram took over as finance minister of India for the third time on July 31, last year, he inherited a slowing economy, high inflation rates and an acute state of policy paralysis.
Though the Harvard educated, right-wing minister has kicked in a few reforms – liberalising foreign investment rules in a retail and aviation, bringing out new bank licensing norms, cut oil subsidies, and generally tried to stem the rot by getting cabinet to clear long delayed projects, the story remains the same – India’s economy is still in a mess and perhaps in some respects in a worse mess.
India grew at 6.5 per cent in 2011-12, the last year that Pranab Mukherjee ran North Block. In the current fiscal, under Chidambaram’s watch, the economy is expected to grow at 5 per cent, a straight growth slowdown of 1.5 per cent.
The fiscal deficit, or the gap between what the government spends and earns,  which Chidambaram has bravely tried to rein in by pruning not only wasteful subsidies but also defence spending, is still going to be 5.3 per cent of GDP. When that figure is coupled with state government deficit, the actual deficit of the government sector would amount to a high of 8-9 per cent of India’s economy. To put it in perspective, India’s fiscal deficit is three fourth’s the size of Pakistan’s entire economy.
This obviously means, that despite pressures from party colleagues, Chidambaram will have to be cautious about spending splurges and better at garnering revenues – which stand at a tad below 18 per cent of GDP (with taxes contributing to just half of the earnings) compared to 35 per cent for Brazil, 38 per cent for Russia, 39 per cent for the UK and 28 per cent for the US, not to speak of the 40 per cent of GDP which the Germans manage to collect. Of course, part of India’s dismal tax collection ability comes from the fact that a mere 2.5 per cent of its population pays taxes. The rest simply say they don’t earn enough to cough up any money. But then this is a year which runs up to a General elections, next year, and most of Chidambaram’s colleagues still suffer from a hangover of Socialism inherited from Indira Gandhi’s rule. Checking populist spending will be one tough task – especially when India showcases it’s `Right to Food’ bill which could sap up more money in subsidies from the budget than any other. 
Chidambaram will certainly have to work harder to earn more. One way would be to fast track the Goods and Services Tax. Another to  cut out various exemptions which corporates’ enjoy, roll back some of the excise and service tax cuts given to industry in the post-global meltdown period. A surcharge on the incomes of the `super rich’ is considered highly likely as is a commodities transaction tax on the lines of the securities transaction tax, to partly generate taxes and partly regulate a wildly oscillating commodities market.
This year, sales of shares in state run lumbering giants like  NTPC and Oil India, could not earn the government its targeted Rs 30,000 crore. But Chidambaram will probably bank on an improving stock market to try earn more from aggressive sales of PSU stocks. Similarly, poor appetite for a badly managed auction of radio-waves fetched India less than Rs 10,000, a fourth of its targets. North Block in conjunction with Sanchar Bhawan, home to the telecom department, will certainly try again.

NTPC Power Plant

Last year, the country’s current account deficit or the difference between the dollars, Euros and Yens we earn or which flows in by way of investment or debt and dollars, Euros or Yens we spend on importing oil, gold, jet aircraft and power plants, bloated to 4.2 per cent of GDP. The Reserve bank of India, tasked with managing our foreign exchange reserves, considers this to be alarmingly higher than what is prudent, which pundits at the central bank say should be 2.5 per cent of GDP.
This year that current account deficit figure is likely to be 5.2 per cent, far bigger than what Mukherjee had left the country saddled with. To put it in perspective, in 1991, when India ran into its worst foreign exchange crisis forcing the country to pledge gold to pay off impending debt closures, India’s CAD was 3 per cent of GDP. India’s rising import bill and weak exports has seen the rupee value falling from about Rs 44 to the dollar in April 2011 to over Rs 53 to the dollar as of today.
No wonder that earlier this week, Moody’s rating service warned that India’s widening current account deficit and the spurt in its external debt meant the country risked a downgrading of its credit rating  outlook.
Last year, under Mukherjee’s watch, India had received a similar threat from Standard & Poor’s  which had announced there was a one-in-three chance of a sovereign rating downgrade to junk status, leading to much consternation at North Block. Given that India’s total debt to GDP runs at a high ratio of 70 per cent, similar to the United Kingdom’s whose rating was cut today by Moody’s, India needs to perk up and try attract more dollar and Euro inflows.
This should mean more sops for foreign investors, more easing of rules for debt inflows, perhaps Sovereign status for rupee denominated bonds to be issued by public sector companies (but paid for in dollar or Euros) and certainly more concentrated attempts at encouraging value-added exports.
Not to speak of steps to stall the import of more gold, the single biggest item of import after oil and to check import of cheap telecom and power gear by posing higher taxes on them or by encouraging local manufacture of substitutes. India had last month raised import duty on gold and platinum to 6 per cent from a previous 4 per cent in a bid to break the country’s huge appetite for imports of gold. However, what the Reserve Bank and finance ministry would like to see would be a scheme to monetise India’s estimated 20,000 tonnes of gold reserves worth around $ 1.16 trillion, stashed away in household hoards.
One way out, could be gold banks, suggested by the RBI, to collect household gold against bonds, whose value went up or down with the value of bullion.  The gold so gathered could be on lent to jewellers, reducing imports.

India's Gold Obsession

Chidambaram will also have to be mindful of the savings rate which has been falling like never before, putting at doubt India’s ability to reach the professed goal of 9 per cent GDP growth. The RBI estimates household savings have plummeted to 7.8 per cent this year from 12.2 per cent in 2009-10. North Block, many aver, will certainly be looking at ways of encouraging middle class Indians to save more by giving larger tax breaks for pension and insurance products and to buy houses. Some say total exemptions for the `aam admi’ could well go up to a princely sum of Rs 3 lakh.
But then, how much the scion of the Rajah's of Chidambaram will risk and how much he will bow to popular sentiments will be something which will be revealed in just a couple of days.