Dr Rakesh Mohan, executive director, International Monetary Fund, in conversation with Govindraj Ethiraj at Growth Net.
Govind: There is political change on the Indian horizon. Does that also mean there's economic change ahead? What are the preconditions, as we sit here today, at much lower growth rates than ever before or at least in recent times? Is the stage set for a recovery or are there challenges still ahead? If I were to ask you to cast your eye on the economic landscape in India, what are the key challenges you see and what are the factors that augur well?
Rakesh Mohan: Let me divide my remarks into two segments: first macro-economic stabilization, and second more structural issues.
The first, what I might call standard macro-economic stabilisation, is that it is absolutely necessary to bring down inflation in the country. I think one of the facts that is not appreciated enough is that from around 1996-97 till around 2007-08, for almost ten years, we succeeded in maintaining an average inflation of around 4.5-5%. Not double digits, single digits, around 4.5-5%. When inflation is 4.5-5%, then normal interest rates could be lowered.
Govind: The single digit inflation was till?
Rakesh Mohan: From around 1996-97 till about 2007-08.
Govind: Okay, I meant the period after that.
Rakesh Mohan: I’m saying that point is not realised enough. That was a major ingredient of the kind of growth we achieved during those years, particularly, of course, from 2003 to 2008. As inflation came down, inflation expectations came down, and interest rates could also come down. And, therefore, you could have reasonable nominal interest rates.
You can’t have inflation at eight, nine, ten per cent, and interest rates, as often the private sector wants, at 8-9% because then the savers get nothing. And you’ve sort of seen our savings rate go down. So, let’s say the first issue really is, that both from the fiscal side as well as from the monetary side, we can’t think of getting the kind of growth we have achieved in the past, on a sustainable basis, unless we can get inflation down on a sustainable basis. Now I’m not going to go into what you need to do for that because that’s a longer discussion, but nonetheless, it does mean that you have to bring the fiscal under control. Of course, that’s been in action but one of the things that are very often not talked about is that our revenue-GDP ratio, tax revenue-GDP ratio, is no higher today than it was 25 years ago.
Incomes have increased tremendously in the last 25 years. So, even if you keep most things constant, just by the fact of incomes increasing, so much more transactions, both indirect tax and direct tax ratios should go up. And they have not. In fact, today, the revenue-GDP ratio is lower than it was five years ago. So, part of the deficit reduction is not just cutting expenditure but you have to increase revenue. It’s not raising tax rates, it just means greater efficiency in collection and much greater compliance. It has to be enforced. Taxes today are reasonable, they’ve been stable, relatively speaking. Maximum personal tax is thirty per cent thereabouts, similarly corporate tax rate, and those are reasonable tax rates.
Govind: So, you’re saying all the super rich and all of that don’t necessarily work.
Rakesh Mohan: That’s sort of you know, taxing super rich, there may be good social reasons for doing that, but you don’t get much in terms of revenue from that. I’m not saying you should or shouldn’t do that. There are good social reasons. It’s more the principles of tax. As far as revenue is concerned, it just means much greater compliance.
If you look at the number of cars sold, the number of cell phones sold etc etc, there is no reason at all why the direct tax ratio did not go up significantly in the last 15 years if not 25.
Govind: So, what should have been the ratio according to you?
Rakesh Mohan: No, I won’t give a number, just that the number should have gone up, compared to 25 and 15 years ago, because if you have the same tax ratio, many more people with higher incomes, taxes should go up. And it’s all to do with compliance and enforcement.
So, inflation, and that is connected to the deficit, you need to raise revenue, because capital expenditures have gone down, the public capital expenditures have gone down. You can’t get infrastructure without higher public capital expenditure along with PPP. That is, you need to be raising infrastructure expenditures overall. So, you need to do PPP, but at the same time, you can’t increase PPP, unless you increase public expenditure, capital expenditure.
So, let me first just come back, to bring down inflation, you have to get the fiscal deficit in order, and the old targets, of around 3% of GDP for fiscal, and revenue deficit of zero are some things that we need to get back to. The states have got to that; the average state fiscal deficit is less than three per cent. So it’s the centre’s fault, not the states.
So, that’s part of bringing inflation down. And as I said, it’s not just about cutting expenditures, you need to increase capital expenditures.
Govind: Would there be one or two reasons why you think this has jumped sharply?
Rakesh Mohan: On an average, the states have got it under control.
Govind: Some states are, maybe, on the surplus.
Rakesh Mohan: Yes, that’s right. So, somehow, the fiscal regimes, the fiscal responsibility has been higher in the states. Then there is also the issue that the last couple of Finance Commissions have increased the devolution from the centre. That has also helped them out. Nonetheless, there somehow has been a degree of fiscal responsibility among the states.
It may also be that there’ve been a number of central schemes.
Govind: Yeah, I was going to ask you that. Is that what has caused the distortion?
Rakesh Mohan: There have been a number of central schemes, which in some sense have substituted central expenditure for state expenditure.
So, again, coming back to macro stabilisation, inflation, deficit, tax revenue, and as you do this, you’ll be able to have more consistent monetary policy, because there has been difficulty in monetary policy that in the face of fiscal excess, it’s been very difficult for the central bank to maintain a monetary policy which keeps inflation under control. Both have to go hand in hand. And I would fully expect central bank to do that, as they have been indicating, in terms of their indications that they are more focused on getting inflation expectations under control.
So, that’s kind of on the macro stabilisation side, and my point is that this is something that needs to be focussed on, emphasised and given importance. And communicated, like you know, we can’t do the kind of growth that we want unless this gets under control. Because what is often thought of is that this is not important for growth, so I think that is extremely important.
Then comes the structural side, infrastructure expenditure just has to go up in almost all areas. Since I have just submitted a report on the National Transport Development Policy to the Prime Minister, we have made detailed calculations, both in terms of projecting overall growth and then coming down to transport investment. You need to increase investment in transport from the 11th Five Year Plan of about 2.7% of GDP or thereabouts to about 3.3% or so in the 12th Five Year Plan, and then going up to something like 3.7% or thereabouts of GDP over the next 15 to 20 years.
But roughly speaking, transport forms about 40% of total infrastructure expenditure. Two specific points on that; one interesting thing that we found when we did our work on transport was that roughly over the last 11 to 12 years, that is since 2000 or thereabouts, relative to the previous 10-15 years, investment in roads has gone up from about 0.4% of GDP, roughly speaking, to around one per cent of GDP now. So, there has been a huge change in expenditure on roads, and you can see the consequences, the positive consequences of that. I mean a combination, both of the National Highways Project in the last 10-12 years, and also the Prime Minister’s Gram Sadak Yojana (PMGSY). At both ends, these have been relatively successful; there have been problems, but I think that if you take an overall view, it’s done quite well. So, you actually now have, the Golden Quadrilateral is essentially complete. You can quarrel about some of its quality but nonetheless, you have four lane highways connecting the Golden Quadrilateral.
At the same time, what is interesting is that investment in the railways has remained constant at about 0.4% of GDP whereas, in the 1980s-90s, investment in roads and rails was about the same. As a proportion of GDP, roads have gone up, we’ve seen the good consequences, railways have remained at 0.4% of GDP.
What we have recommended is, you really need to concentrate on the railways, and bring that up to about 1% of GDP. The trunk routes of railways are totally clogged now, both for passengers as well as for freight. What has happened in the last 20 years is that there have been a number of changes and improvements in productivity where from the same track length, you’ve actually been able to improve both passenger throughput as well as freight throughput. Now, you’ve come almost to the end of all those possibilities; so you have to invest. The good thing is that we have started the dedicated freight corridor projects, and those have to be accelerated. Once you do that, then the freight goes off the trunk route and the passenger traffic can be much faster, and also, you free up the existing track for all of passenger transport.
So, in some sense, the foundations for that are already there, but you have to accelerate it. As you remember, I had also done a report on railways 10 years ago, suggesting total reorganisation of railways. The kind of change that you need cannot take place unless you have major reforms of the railways system.
Govind: I remember in your 1996 report, the famous Rakesh Mohan Committee report
Rakesh Mohan: That didn’t include railways
Govind: On infrastructure, it talked about, the $150 billion dollar figure. To what extent do you feel that that has come your way?
Rakesh Mohan: I would say that many of the things that we recommended have come through. Telecom is one example, where in fact it has done much better than even we had expected. Roads have happened, power partially, ports partially, in the sense that you have had a good deal of private investment in ports.
That brings me to the second area where major investments that have been taking place are in ports, where today, India doesn’t even have one what I would call a “mega port”. So there is a lot of stuff that is trans-shipped from either Singapore or Colombo. If you look at the next 20 years, if you look at the kind of trade growth that we ought to have, you have to have much more efficient and much larger ports.
Then taking into account what Mr Ahluwalia was saying also in his intervention, that our energy dependence is very high, so that the increase in both petroleum imports, plus one thing that he didn’t mention was that if you project the demand for energy, and therefore production of electricity, even if domestic production of coal grows as it ought to, which is not currently because of all kinds of problems, even then the projections suggest that coal imports will go up a lot.
So, you need ports which can take petroleum imports, coal imports, plus the increased trade in other non-bulk commodities. So what you need is at least one, if not two, major ports on both coasts. And you need major, mega ports because you need to dredge depth etc for mega tankers to come, for coal to come. The big container ships can’t come to India because the depth is just not there.
And then you need to have the domestic connectivity with rail and road. That can’t happen without a good deal of reforms in terms of the port structure. I won’t go into the detail of that, but, the overall point, I was saying the structural issue is that you need to increase total investment in infrastructure, by a couple of percentage points as a proportion of GDP. Part of it, of course power and other infrastructure, and a good part of it in transport, and this needs structural reforms.
So, that is something that the new Government will need to come to grips with immediately. One detailed point on that which is extremely important is to do with coal. Just think of the following: if we grew at say 7% a year, for the next 20 years, that means, two doublings, that means you’re quadrupling GDP in 20 years. It means that the demand for coal, even if you allow some substitution of energy sources for electricity production, will go up probably by a factor of 3, minimum of 3, minimum 2.5, more likely 3.
This means you have to transport 3 times the amount of coal that you are transporting today. The system is clogged today. If you don’t invest in the railways, you can’t produce energy, and if you can’t produce energy, you can’t grow.
So, this is not a side issue on transport. It is a core issue for transport that you have to invest in transportation.
The second structural issue on which I am puzzled is as to why there isn’t more discussion in the system, which is that manufacturing has collapsed. If my recollection is correct, I don’t think that we have had two successive years with less than 2% manufacturing growth ever since 1950. And zero today as you are saying.
One would have thought that there would be huge amount of noise and concern in the private sector, from the Government, but there isn’t. I’m totally puzzled by that. When you also think over the last 10 years or 15 years, can you think of any new significant company in manufacturing in India? I can’t.
Now, there’s this general business of giving the “Best Entrepreneur Of The Year” award. In the last 5 years, no manufacturing company has got it. So it’s a real puzzle to me. Mr Ahluwalia had talked about labour reforms, I think that is an ingredient but there has to be much more to that. Why? Well, I can understand manufacturing growth coming down from 10% to 5% because of all kind of reasons. But I don’t understand zero.
You can’t achieve sustainable 7-8% growth for the next twenty years, unless manufacturing grows by 10% a year. So that is something that I don’t have an answer for but it is something that the new Government has to focus on, otherwise there’s no way for us to grow the way we want to grow.
Govind: Last question Dr Mohan, are you looking at the future and particularly the near future with optimism or pessimism?
Rakesh Mohan: Oh optimism! I think I would come back to what Mr Ahluwalia said, that despite everything, we still have a 30% domestic savings rate, which has come down from around 35% five years ago. Of that, about 2-3% is a fall in public sector savings, which is essentially to do with revenue deficit.
So, my first point was, you have to bring down the revenue deficit to zero and that will give you another 2-3% spurt in public sector savings rate. What is much more worrying actually is, and this is connected with the manufacturing issue also, is that the private corporate sector investment rate has come down from around 17% of GDP to about 7-8% of GDP, in the last five years.
It’s partly because corporate profits have got hit because there is only so much, there is also connect with the macro, that given the kind of increase that took place in the fiscal deficit, it crowded out the private sector. So you bring down the fiscal deficit, then much more resources also become available to the private sector. So that’s connected actually.
But I’m still going to say that I am totally puzzled by the collapse of manufacturing.
I’m certainly looking at the future more optimistically in that I think it’s feasible to take savings back up to 35% or thereabouts. And I think 2-2.5% of current account deficit is sustainable.
Govind: Inflation and tax rates.
Rakesh Mohan: These are connected. It is only if inflation comes down can investment go up and then normal interest rates will come down. If the fiscal deficit is controlled, resources will become available to the private sector to invest, so investment can go back up. That is the first thing I said. And also lower inflation reduces uncertainty for the private sector.
Govind: And the structural points that you made, which in some ways I’m almost feeling a déjà vu from your earlier report in the mid 90s, but I guess both are headed in the same direction, which is to build a robust infrastructure base for this country.
Rakesh Mohan: I would again emphasise this issue of the railways. It’s just not appreciated enough and it is not a side issue, you will not be able to grow.
Govind: Or move coal
Rakesh Mohan: If you can’t move coal, you can’t grow.