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Can FM afford real austerity?

Finance Minister Pranab Mukherjee last week called for “some austerity” and “little bit of unpopular steps”.

It was perhaps the first admission by this Government that the current woes of the economy go beyond just Greece or the eurozone. Mukherjee’s remarks came on a day when the rupee slid to a fresh low of Rs54.5-to-the-dollar and stocks plunged.

However, the austerity measures reportedly under consideration do not inspire any confidence. It is hinted that there could be curbs on foreign travel and holding conferences in five-star hotels by ministers and officials. The measures might include a ban on purchase of new cars by departments, except those for defence purposes.

These measures are cosmetic and, in fact, old hat. The finance ministry had, last year, issued similar instructions. Now it may just issue orders for strict compliance of the austerity measures announced last year!

Such routine steps do not really amount to much. The government must realise that the falling rupee, dipping sensex and high inflation are only the symptoms and not the cause of India’s economic woes. They merely reflect the lack of governance, fractured politics and weak investment climate. The aversion of FIIs to Indian equities reflects the disenchantment of investors with the lack of economic momentum and policy inaction.

The rupee’s problems are largely structural. The secular inflation rate in India is at least four per cent per annum higher in India than in the US. This resulted in a real appreciation of the rupee. It has hurt domestic industry as foreign goods became cheaper, making both exports and import-competing goods less attractive. India’s current account deficit (CAD) has grown almost five-folds from less than $16 billion to roughly $75 billion between 2007-08 and 2011-12. Capital flows, which help bridge this gap, average around $50-60 billion a year. With eurozone in crisis, one cannot expect this year to be a normal one for capital flows as investors scramble for safe heavens. The measures that Reserve Bank of India took last week — forcing exporters to convert half of their dollar remittances immediately into rupees or raising interest rates on foreign currency-denominated NRI deposits — cannot be a durable cure for a structural problem that is bound to assert itself after brief moments of respite. In today’s depressed economic scenario the government needs to go further, sending a signal that it means business. One such signal would be full decontrol of the oil market and direct transfer of fertiliser subsidies to the targeted farmers. Not raising fuel and fertiliser prices has led to an artificial demand and growing imports of these commodities, even in the face of spiraling international prices. Deregulation, especially of diesel and urea, will bring down not only the current account deficit, but also the Government’s subsidy burden.

The food security Act, another wasteful scheme which will bloat food subsidies without any concomitant gains in food distribution, must be must be held up for now. The government can also mobilise funds with a bold strategy for sale of all loss-making public sector units including Air India. Such positive austerity measures would, in turn, inspire investor confidence and bring back capital flows that can fund CADs on a sustainable basis. They would also contribute to a structurally strong rupee, as was the case over much of the last decade. These are some of the real austerity measures that can restore the situation meaningfully, as against the cosmetic ones mooted by the finance minister. The question is: can this government afford that kind of austerity?

Views expressed by the author are his own and do not reflect the newspaper’s policy