COMMENTARY
Indian Economy in 2011:
Dualism in Policy Formulation
Pulin B Nayak
Our policymakers face a
dilemma: should we have
adequate food and nutrition for
all or should we have world-class
airport terminals? In an ideal
world, one could possibly have
them both. But if there are limited
resources and there is a question
of setting priorities, then surely
it should be possible to hold the
view that the former should
get precedence. Well-trained
neoclassical economists can often
employ much abstract modelling
to prove the opposite.
Pulin B Nayak (pulin@econdse.org) teaches at
the Delhi School of Economics,
Delhi University.
10
1  A View from
the Economic Survey
T
he Economic Survey 2010-11 has
drawn a picture of the Indian econ-
omy in the past year from which
one may legitimately draw some comfort.
The economy has substantially withstood
the shock of the collapse in world growth
arising due to the global financial crisis of
2007-09, the ripple effects of which con-
tinued through 2009-10 and indeed per-
sisted well into 2010-11. The problem was
compounded by two years of particularly
poor agricultural performance during
2008-09, when in fact there was a nega-
tive growth recorded, and 2009-10. Under
the circumstances an overall growth rate
of GDP of 8.6% during 2010-11 would seem
to be very creditable.
There are many other points of comfort.
Foreign exchange reserves in December
2010 stood at $297.3 billion, which is the
fourth highest after China, Japan and
Russia. From a level of Rs 50.95 per US
dollar on 31 March 2009 the rupee appre-
ciated to Rs 45.14 per US dollar by end
March 2010. This was largely brought on
by foreign institutional investor (FII) in-
flows, driven no doubt by India’s relatively
strong macroeconomic performance and
better return as compared to other alter-
native destinations across the globe. The
latest market rates, as on 11 March 2011,
put the $ at Rs 45.24, which means that
the rupee has held steady in the interna-
tional market over the past year.
But lest it be thought that we are here to
only sing paeans to the managers of the
public finances in the country let it be said
that the Union Budget 2011 has been pre-
sented under a cloud of two particularly
troubling sets of conditions. First, the
inflation rate in the past year has been
hovering in the double-digit range, and
the food inflation in particular has been
too high for comfort. The Survey makes
march 19, 2011  vol xlvI no 12  EPW   Economic & Political Weekly
the following claim: “…CPIs [consumer
price inflation] in fast growing countries
will rise relative to CPIs in slow growing
countries” (p 27). This thesis is deduced
from the Balassa-Samuelson hypothesis
which essentially posits that rapidly ex-
panding economies would tend to have
faster appreciation in exchange rates, but
it is well known that conventional econo-
metric tests have resulted with mixed
findings for the predictions of the B-S effect.
The claim would therefore seem to be far
from obvious.
At a minimum it ought to be conceded
that the recent spurt of food inflation ought
to be much better managed. The Survey
states on p 26:
On 7 January 2011, for instance, onions were
selling for Rs 30 in Agra and 57.5 in Delhi;
for Rs 35 in Nagpur and 62 in Mumbai; for
Rs 23 in Thiruvananthapuram and 60 in
Dindigul….What these price differentials
suggest more than anything else is not so
much hoarding as the cartelisation of trade
resulting in the prevention of entry of new
traders. The problem needs to be tackled us-
ing our Competition Act 2002.
Well, one might ask the policymakers at
the highest levels, what has been prevent-
ing them from using the Act these past
nine years? Surely they need some an-
swering to do, or is it enough that we have
passed the Act and should not really be
concerned about its implementation, just
as we have passed, for example, the Child
Labour Prohibition Act a quarter century
back in 1986?
The second particularly disturbing deve­
lopment is the daily barrage of scam-
tainted matters at the highest levels of the
government, which really means that vast
sums of public funds have been openly
swindled while at the same time it is
proving extremely difficult to fix responsi-
bility. Indira Gandhi had famously re-
marked that corruption is a global phe-
nomenon. Very true. The confidence of
the Indian aam aadmi in bureaucratic and
political probity and integrity has never
really been parti­cularly high. But it must
be conceded that in the aftermath of the
Commonwealth Games and the 2G scams,
perceptions about probity in government
have hit an abysmal low, so much so that it
is clawing into the innards of our polity.

The credibility of any budget-making
exercise must then necessarily be judged
against a clear appreciation of this fact.
2  Dualism in Policymaking
No observer of economic policymaking in
India today could possibly have failed to
notice the sharp divergence in the policy
stance between the executive arms of the
government principally housed in the
ministries of finance and planning on the
one hand and the National Advisory
Council (NAC) on the other. Most of the
top-end economic advisors in the first
group are typically pro-reform enthusiasts
who are impatient with schemes directed
at the poorer sections of the population.
Such schemes are invariably dubbed as
“populist” and are judged to be inefficient
and unproductive and are argued to be
fiscally unsound.
In the aftermath of the financial melt-
down of 2008 there was a systematic and
well-orchestrated clamour from the captains
of industry and from the leaders of trade
chambers to be granted doles and tax
concessions. Editors of pink newspapers
would however typically regard these as
“stimulus” packages that are supposed to
enhance efficiency because they would keep
the wheels of production running. Hasn’t
Barack Obama been giving stimulus pack-
ages to large corporate houses in the US?
Ipso facto, therefore, it must be desirable in
India as well, the argument would run.
It is well known that the passage of the
National Rural Employment Guarantee Act
(NREGA) was brought about substantially
at the instance of the NAC in the face of
teething opposition from columnists and
leaders of public opinion in the influential
English language media. But anyone familiar
with the texture of political economy in
India today will note that it is the passage
of this act which was substantially behind
the return of the United Progressive Alliance
(UPA) to power two years back. It can be
nobody’s case that what is now the Mahatma
Gandhi National Rural Employment Guar-
antee Act (MGNREGA) is free of corruption
and does not harbour a certain degree of
inefficiency. But in the past five to six years
there is plenty of evidence of this scheme
delivering in those districts and regions
where the administrators are sympathetic
and sensitive to the needs of the local
Economic & Political Weekly  EPW   march 19, 2011  vol xlvI no 12
populace and are willing to think creatively
out of the box. There is a huge response to
this scheme amongst the disadvantaged,
dispossessed and women across the length
and breadth of the country.
The NAC has been pushing for a Right to
Food Act with universal coverage. The
proposal insists on “the physical, social
and economic right of all citizens to have
access to safe and nutritious food, consistent
with an adequate diet necessary to lead an
active and healthy life with dignity”. Surely
after 63 years of independence this is the
least that any citizen should legitimately
demand from a State that has been riding
on a high growth path over the past decade
and, according to some of the most voluble
of the opinion-makers, has become a major
“player” in the international arena. But as
we know, the right to food concept, as part
of a basic and fundamental human right,
is facing the toughest opposition from some
of the highest functionaries of the state
on the ground that it would be fiscally
unaffordable. And this when it has been
demonstrated time and again that the
country has the wherewithal, and it is only
a question of reordering priorities.
A very serious issue comes up here. This
has to do with the political mandate on
the basis of which the UPA was returned to
power after their first term. Self-appointed
referees of fiscal control are typically
secure with their well-paying sinecure
jobs and they enjoy the great privilege of
never having to return to the voting masses
to get a true check on how representative
their views are.
The obvious tension between the views
of these two opposing groups should be a
point of no small importance in our polity
today. The UPA government would be foolish
to disregard the sentiments of a huge mass
of the population, 77% of which, according
to the National Commission for Enterprises
in the Unorgansied Sector (NCEUS), spends
less than Rs 20 a day per capita.
To put the dilemma somewhat differ-
ently, one might ask whether we must
have adequate food and nutrition for all or
should we have world-class airport termi-
nals? In an ideal world, one could possibly
have them both, but if there are limited
resources and there is a question of setting
priorities, then surely it should be possible
to hold the view that the former should get
COMMENTARY
precedence. But well-trained neoclassical
economists can often employ much ab-
stract modelling to prove the opposite.
3  Budget 2011-12
It is against this background that we ought
to assess the Union Budget for 2011-12.
Union Finance Minister Pranab Kumar
Mukherjee has tried to marry the two al-
most unmatchable strands, and under the
circumstances has done a commendable
job. For most parts in the fiscal and other
major sectors, it is business as usual, with
some minor tinkering. His principal prior-
ity seems to have been to continue on the
growth momentum, with the GDP growth
rate possibly moving up again to the 9%
range in the coming year.
One must acknowledge here that the
finance minister is a consummate politi-
cian and has a clear understanding of the
political compulsions of the day. But he is
also a great realist and an old hand at
budget-making. He has gone for continui-
ty and stability and has opted to go for fis-
cal consolidation. He can be hardly fault-
ed for this. The fiscal deficit is set to be
limited to 4.6% of GDP, down from 5.1%
this year. This will certainly go some way
towards containing the inflationary trends
witnessed in the past year. Public debt for
the next year is targeted at 44.2% of GDP,
well lower than the 52.5% target set by the
Finance Commission.
This has been at least partly achieved by
cutting overall expenditure as a propor-
tion of GDP from 15.4% of GDP in 2010-11 to
14% in 2011-12. But the worrying part here
is that capital expenditure by the govern-
ment is going to come down from 13.4%
of total expenditure to 12.7%. Capital ex-
penditure in recent years has been under
2% of GDP, and in a situation where is a
great need to build up economic and social
infrastructure, this should be a matter of
serious concern.
Much of the infrastructure build-up is
expected to be carried out by the private
sector, for example, by raising FII invest-
ment in medium-term corporate debt for
infrastructure fivefold to $25 billion. Tax
sops have been extended to some more
sectors by classifying them as infrastruc-
ture. These include agricultural storage
and fertilisers. Pranab Mukherjee has also
proposed creating tax-free bonds worth
11
COMMENTARY
Rs 30,000 crore for infrastructure, on top
of a 23.3% step-up in the government’s
Plan expenditure.
The finance minister has done well to
end tax holidays for developers of special
economic zones (SEZs) and companies
located within such zones. He has also re-
sisted pressure from companies housed in
software technology parks to extend the
tax holiday on export profits beyond 2011.
Also, both companies and developers will
pay a higher minimum alternate tax –
charged on companies that enjoy exemp-
tions and pay no tax at all – of 18.5% start-
ing this year. They will also have to pay
dividend distribution tax of 15% after
1 June this year.
On the direct tax front, Pranab Mukherjee
has set April 2012 as the deadline for
implementing the Direct Taxes Code. The
broad philosophy of this rests on the
received wisdom of tax theorists and prac-
titioners across the globe. This is based on
two simple features, following the pioneer-
ing work on optimal taxation by James
Mirrlees, which are to have broad-based
and moderate rates. This indeed informed
the recommendations of the Tax Reforms
Committee set up in 1991 under Raja J
Chelliah’s chairmanship, and this has
been the guiding principle of tax policy
ever since. After nearly 50 years of stagna-
tion at around 3% of GDP direct taxes have
only now come around to nearly 6% of
GDP in the past five years.
One of the aims of the Chelliah Com-
mittee was to increase reliance on direct
taxes while simultaneously reducing the
relative importance of indirect taxes. It is
only in 2007-08 that direct taxes at the
centre for the first time tipped indirect
taxes. With greater rationalisation in
union excise and gradual reduction of cus-
toms duties, indirect taxes at the centre
now account for around 4% of GDP, down
from 5.6% of GDP in 2007-08. Union ex-
cise used to be the single biggest revenue
earner till 2005-06 (3% of GDP). It is now
corporation tax (3.8% of GDP in 2010-11)
by a long margin, with excise duties stand-
ing reduced at 1.7% of GDP in 2010-11.
On the overall position of indirect taxes
at the central and state levels, the country
still awaits political acceptance of the
goods and services tax (GST). The overall
rationale of GST seems to be in the right
12
direction. In order to avoid the phenomenon
of cascading of taxes in a sequential pro-
duction process, it makes sense to tax value
added and to pitch the tax at some uni-
form moderate rate, enough to meet the
expenditure requirements.
Three further points are in order. First,
I think it is fair to say that through a variety
of schemes and programmes, including a
substantial allocation for NABARD, expan-
sion of agricultural storage capacity, and
interest subvention for small farmers,
among others, the finance minister has
shown that he is sensitive to the prime need
for substantially supporting the agricultural
sector. Second, there is a substantial step-
up in the allocations for the rails, roads
and the port sectors. Third, the increase in
the exemption limit in personal income
taxes from Rs 1.6 lakh to Rs 1.8 lakh is
very much welcome, keeping in view the
recent spate of inflation. It must however
be conceded that this is only in the nature
of a minor tweak, and for any comprehen-
sive reform in direct taxes one would have
to wait for the implementation of the
Direct Taxes Code.
4  Balancing Act
On the strict mechanics of budget balanc-
ing, one can hardly take issue with Pranab
Mukherjee. He has on the whole managed
to achieve a deft balancing act between
competing ends. Since his purported aim has
been to maintain the growth momentum,
he has been much helped by the handsome
savings rate of 33.7% of GDP recorded for
2009-10, of which the household sector had
a savings rate of 23.5% of GDP. The figure
for gross capital formation (investment) is
in fact even higher, at 36.5% of GDP in
2009-10. It is this which is at the heart of
the robust growth rate in GDP of 8% plus,
arising simply from the crude Harrod-
Domar formulation of the expected growth
rate being the ratio of the investment rate
to the capital-output ratio, supposed to be
in the region of a bit more than 4.
This also means that if the growth mo-
mentum is assured, a caring finance minister
has to be seen to deliver on distributive
justice, even though at the margin there
might be some trade-off involved with the
growth rate. But we need not make a fetish
about the growth rate, and certainly the way
one sees some top functionaries waxing
march 19, 2011  vol xlvI no 12  EPW   Economic & Political Weekly
eloquent about double-digit growth rates
makes one wonder as to what is the kind
of social reality they are living in.
If, as a mature and sensitive finance
minister, Pranab Mukherjee is to consider
some serious major priorities, then possi-
bly some of the following concerns, in our
view, ought to be paramount. First, public
expenditure on health in India has been
abysmally low at under 1 percentage point
of GDP for more than a half century after
independence. It is only in the very recent
past that the figure has tipped 1% of GDP.
But we need to go much further than this,
possibly to the range of at least 3 to 4%
over the next 10 years. It is this alone
which will ensure the health of the masses
in this country, and not further recourse
to some market-based clever health insur-
ance strategies. Second, there has to be a
much greater explicit push for manufac-
turing, which comprises a mere 16% of
GDP in India, compared to 40% in China.
This is the sector that lends dynamism to
an economy and offers the potential for
employment generation. The services sec-
tor now accounts for more than 55% of
GDP in India, but unfortunately this is not
the sector in which one can expect as rapid
a growth of employment generation as one
can expect in the manufacturing sector.
Third, the government has to explicitly
back up wages in all central and state-
funded activities to meet at least the state-
wide minimum wage norms. Without that
the minimum wage legislation would be a
peculiar mockery of our notion of social de-
mocracy. Finally, agriculture now com-
prises under (or less than) 15% of GDP,
down from nearly 60% at the time of inde-
pendence. Yet, more than 60% of the
country’s population is still substantially
dependent on agriculture. It is this which
is at the heart of the increasing inequality
of incomes as well as the growing immis-
erisation. This can only be combated by a
massive influx of funds into agricultural
infrastructure building. If funds are limit-
ed, and if we must keep the fiscal deficit
under acceptable levels, then maybe we
may have to give up some world-class air-
port terminals expected to be built across
India, and maybe have much fewer
swanky malls in the mushrooming new
townships all over the country. We should
be prepared for this discomfort.