Why Chidambaram may not swallow the Kelkar pill

What is Palaniappan Chidambaram’s real gameplan for the economy? Is it about taking those hard decisions to fix the fiscal mess, or is it about somehow creating the space and resources needed for Sonia Gandhi to force another great spending spree on social projects before the next elections?

The Economic Times, which published two interviews today - one with Chidambaram , and another with Vijay Kelkar , the man who’s drawn up a fiscal consolidation map - provides us with a study in contrasts on what needs to be done, and what may actually get done.

In the interview, Chidambaram makes all the right noises, but his priorities tell us what he may end up doing.

So what are his priorities?

Chidambaram lists three of them. “One is the stability of the exchange rate. Two is larger capital inflows, both FDI and FII. And the third is strict monitoring of expenditure.”

The first two are actually about the same objective: only if we get foreign investment, both direct and portfolio flows, will the exchange rate stabilise (the rupee is strengthening). To get in more flows, Chidambaram is doing things to make the stock markets buoyant - and this already happening.

But stabilising the rupee (or raising its value against the dollar) is not going to help boost exports. Given the high current account deficit (gap between what the country earns and spends abroad), Kelkar said: “The options are either we boost exports, drawn down our reserves, or borrow from the world.”

For now, with the rupee rising, exports will be tougher, and borrowing from the world will be the riskier option in the short run, especially given the easing of rules on external borrowings.

Now, contrast this with what Vijay Kelkar talks of as the first and foremost priority.

He told ET: “The Gangotri of growth deceleration and macroeconomic problems is the continued high fiscal deficit which also leads to high inflation. So we need to take corrective action swiftly.”

And the corrective actions he recommends are to cut down subsidies and improve tax compliance. He said: “You can attack inequitable subsidies, focus on greater tax compliance…The core of our argument is that India needs more growth, more public investment.”

But Chidambaram seems to agree only partly. He would like to improve tax compliance, but is wary about cutting subsidies. He said: “We can’t wish away subsidies, but can improve their delivery. So, the PM has now announced an authority for cash transfers and we have a timetable that we intend to push forward.” And further: “The key to managing those subsidies is to target them better…”.

Kelkar would agree on the cash transfers and targeting, but targeting is precisely what UPA-1 and UPA-2 have been unable to do. In his very first budget, in 2004-05, Chidambaram announced cash-like transfers through a food stamps scheme, under which “every eligible family will be entitled to collect its monthly quota of food stamps from a designated distribution centre, and such stamps could then be used to buy foodgrains from any food shop. I propose to introduce a pilot scheme for distributing food stamps, instead of distributing food through fair price shops, in two or three contiguous districts in a selected state. I sincerely hope that one of the states will come forward to associate with the Central government in this experiment.”

We haven’t heard much on this scheme, and no state has shown great enthusiasm for cash transfers yet.

The problem is political: identifying the poor is politically hazardous, and one wonders if the Congress is going to pledge itself to doing this before an election.

The chances are Chidambaram will push for share sales, and Kelkar has proposed sale of excess land with public sector companies. Asset sales are what Chidambaram will attempt, and for this it is the stock markets that matter.

As for Chidambaram’s third priority, strict monitoring of expenditure, the question is not which expenses are somehow cut, but what expenses are chopped.

Kelkar wants efforts to boost investment (both public and private) and a cut in wasteful expenditure. He said: “It is still possible to boost public investment. The railways have been underinvesting. But we have also been lagging in power, roads and a number of areas such as airports, seaports and universities and urban infrastructure. We need to speed up investment…It’s important to remove obstacles in terms of regulatory and business climate to encourage investment.”

Reading between the lines, it is clear Kelkar wants subsidy expenditures cut, and investment expenditure boosted.

Chidambaram is likely to do the opposite - keep subsidies more or less intact, with some marginal cuts, and slash capital expenditure to reduce the fiscal deficit. This will have the net impact of slowing growth.

Chidambaram’s Economic Affairs Secretary, Arvind Mayaram, has already ruled out going slow on the Food Security Bill or faster progress on subsidy cuts. (Read here )

Another point of difference could be in the nuance: Kelkar seems to suggest that interest rates will come down as a result of good policy action and growth. He said: “Once we have higher growth, there will be a virtuous cycle - deficits will come down, interest rates too, and there will be higher private investment which will boost growth and employment. The engine of growth has to be greater momentum in public-private investment which will boost growth.”

But Chidambaram seems to think interest rates have to be cut first to boost growth. He said: “In our view, government and monetary authority must point in the same direction.”

The question is: what is the direction? If it is about fiscal consolidation, we have a long way to go since the government has only now announced baby steps in that direction. If it is about controlling inflation, rate cuts are not going to help. If it is about growth, it will not come from interest rate cuts alone, but from improving business confidence.

Chidambaram’s conclusion about Kelkar’s remedies are that “he has presented the worst-case scenario” since the projected fiscal deficit of 6.1 percent is when the “government does nothing.”

Chidambaram certainly cannot be accused of doing nothing. But a sobering thought is this: in the past four years, baring 2010-11, when spectrum revenues came to the rescue, it is the worst case scenario that has been worsted.

Can Chidambaram turn the tide in 2012-13? The jury is out. The most likely scenario: Chidambaram will swallow the Kelkar medicine in homoeopathic doses.

He is, in fact, trying to goose the markets first. Says Rajeev Malik, Senior Economist at CLAS: “My reading is thatChidambaram’s gameplan is all about perking up capital markets from now through February when a populist budget will be announced….After Greenspan, Bernanke, Draghi and Shirakawa-san (BoJ Governor), it is the turn of India’s Finance Minister Chidambaram to target asset markets (all others were central banks).”

(Read the full Chidambaram and Kelkar interviews here and here .)