The law on fiscal targets should be “more biting”, said former Reserve Bank of India governor C Rangarajan in an interview with ET’s Deepshikha Sikarwar. He also said that accelerating investments is critical for India, and that the government should work towards increasing efficiency in the use of capital. Edited excerpts:
Budget has alluded to transitioning to debt to GDP ratio. What is your view on the suggestion, and is there a need to strengthen FRBM law to ensure that both the Centre and state governments adhere to the prescribed targets?
I think the need to contain the fiscal deficit at a certain level is important and, therefore, we must make the law more biting than what it is now. These are two independent issues. One is whether fiscal deficit is the right thing, or is it reducing the debt to GDP ratio? But that is a very mistaken notion that the two are different. Debt to GDP ratio can go down if the fiscal deficit goes down. Fiscal deficit is only borrowing, and if borrowing goes down, then debt to GDP will go down. Therefore, this is a wrong distinction that is being made unless you want to water down the fiscal deficit criteria because the target level for debt to GDP ratio is not clear. But if you make the reduction in the debt GDP ratio mild, then you’re finding an escape route for the fiscal deficit.
How big a risk is the middle-income trap for India?
It is not clear why all countries should go through the middle-income trap. It is true that once a country reaches the middle-income level, the further efforts needed to go beyond will become a little more difficult, but that doesn’t mean that all countries need to get into that kind of a trap. The point really is that one of the important things for the economy to grow is to have a level of investment which is necessary to push the economy forward. And once the middle-income level is achieved, the amount of investment required will become larger in order to move further. Therefore, there is an inherent problem, but that does not mean that the country cannot ensure at that level of investment. So the critical point is achieving a level of investment that is needed in order to push the economy beyond the middle-income level.
In fact, calculations show that in order to achieve even the level of a higher-income country-a developed country-the rate of growth required is maybe around 7%. And for that the investment that is required, assuming an incremental capital-output ratio of 5:1, which itself is high, is about 35% of GDP. In India’s case, it is close to 33% of GDP. Therefore, I do not perceive any serious difficulty in moving further and getting beyond the middle-income level.
There are discussions on next gen reforms. What is your view?
The need for accelerating investment is critical, and at the same time, we should also work towards reducing the incremental capital-output ratio.Until a decade earlier, we used to talk in terms of incremental capital-output ratio of 4:1. But in the last decade, people have started talking in terms of a much higher capital-output ratio. The two elements that are needed for a faster growth is a higher level of investment and lowering of the incremental capital-output ratio. You should work on both additional investment and increasing efficiency in the use of capital so that the incremental capital-output ratio comes close to 4. Then achieving a much higher level of income will become easier. Because, if you have 35% and if the incremental capital output ratio is only four to one, then we almost get an 8% rate of growth. That’s a much higher level of growth that we’ll get. Therefore, we should focus on both–not just on additional capital. Nowadays, much of the talk is focussed on increasing capital expenditure.There have been discussions around how India can attract overseas investment in view of China Plus One shift. But some other countries seem to have done better on this count.
In fact, attracting investment depends upon a variety of factors, including how fast we are in clearing them and how good our infrastructure investment is. Therefore, it is not just the overall increase in investment. We should also be somewhat more specific about the kind of… Earlier, we used to talk about infrastructure investment as being critical. We have channelled more investment into infrastructure in the last decade or more. We are talking less about it, but that’s not correct. I think we should. We should also look at the composition of capital and must continue to emphasise on infrastructure investment, so that probably will also lead to a reduction in incremental capital output ratio.
There’s a concern on deposits in the banking sector and that has been flagged by policymakers. How big a concern is this and how can banks address it?
One misconception needs to be removed. The misconception is that all deposits come from only the active behaviour of the households in terms of keeping deposits. That’s not true. Even the textbooks in banking teach you that every credit creates a deposit. Therefore, the deposits do not necessarily come only through one route.
Do you think it is the time for a rate cut?
Cutting rates will not automatically bring down inflation. Many other things have to go alongside in order to get the inflation down. It is both cause and effect. The point is that if the inflation is going down, then we are reacting to the fall in inflation. We are now saying that for several months the inflation has come down and, therefore, people are saying why are you paying a much higher rate of interest? This is one thing. The other is that it can also play a catalytic role in bringing down the inflation rate–once the interest rate starts coming down, some element of the cost will also go down. If the central bank or the commercial banks start reducing the rate of interest before there is a definite tendency for overall inflation to come down, we may be anticipating something which is not happening.
