Saturday, 30 July 2016

Dengue should be prevented and not merely tackled when the epidemic sets in

Indian Express, 30th July 2016

In India, prevention of dengue is left largely to households, while the government offers a cure. (Source: Illustration by C R Sasikumar)

As hoardings across Delhi indicate, we are waiting for a dengue outbreak. Aedes aegypti, the mosquito that carries dengue, is also the carrier of zika - and chikungunya. Just as in case of dengue, India will offer a fertile ground for zika - the deadly virus that deforms babies when it infects pregnant women.

The eggs of the aedes aegypti survive the Delhi cold, the heat and the dryness for more than a year. When the right temperature and moisture conditions come in late summer and during the monsoons, they hatch. The larvae live in freshwater in tanks, ditches, pots and planters all around us. Eggs laid by an infected female mosquito carry the infection. Soon the Delhi air will be thick with dengue-infected mosquitoes. Dengue cases will be on the rise till October.

It is not as if the problem or the solutions are not known. Countries across the world, including poor ones, have attacked the aedes aegypti. Communication campaigns about cleanliness, insecticide-laced mosquito nets and repellents, while important, are not enough. This is particularly so in the case of dense urban communities. The adult mosquitoes fly up to 400 meters. No single household will bear the cost of cleaning all containers and treating water tanks and coolers in its vicinity. Communication is often inadequate as a strategy. For example, it is advised that all water tanks be emptied, cleaned and refilled every week. How many households, given the water situation in Delhi, will be willing to empty out their tanks every week? If your neighbour does not kill the larvae in her tank, you can be infected with dengue. If you live in a student hostel, there is little that you can do. In other words, the prevention of dengue is a public good; it has externalities.

Experts emphasise government intervention and a multi-pronged attack on the aedes aegypti. Fogging is not enough as it attacks adult mosquitoes and not the larvae. Everyday now, larvae will be turning into pupae and then into adults. You cannot do fogging every day, nor is it safe or economical to do so. One important line of attack is to kill the larvae before they develop into mosquitoes.

Internationally, one of the most important interventions for dengue control has been larvicide or killing the larvae in various water bodies. Even if one imagined that somebody would do all this personally to prevent dengue, it is hard to imagine that people would allow someone to walk into their houses and put chemicals into their overhead tanks. That would not be safe as well. For instance, the dosage of temefos, a WHO-approved larvicide that can be added to potable water, must not exceed certain levels.

Clearly government intervention is required. Community participation is required, but preventing dengue cannot be left to communities. Governments need to have a strategy after studying the pattern of the disease and examining ways of attacking it. The prevention of vector borne diseases has been a clear case of intervention in public health all over the world.

In India, prevention of dengue is left largely to households, while the government offers a cure. It offers tests and hospital beds, a strategy that is not only insensitive when compared with the benefits of a public health prevention strategy, but also costly. A number of studies across the world have shown that intervention by governments through a strategy of prevention is cheaper compared to the government paying for the costs of tests and hospitalisation.

Unfortunately, the Indian health establishment’s prime focus has been on healthcare. There is an attitude of letting people get sick, and then thinking about how to setup healthcare facilities to treat them. From a public finance point of view, however, it is much better to engage in traditional public health interventions which emphasise public goods. In this case, the critical public health interventions are focused on mosquitoes.

We don't need to wait for newspaper stories about people dying of dengue in order to know that the epidemic of October is on its way. We will get a surge in October 2016. The time to act on these is now, and actions should be grounded in public health and not in healthcare. Unsystematic fogging or only cleaning riverbanks is not going to be enough. It is necessary to embark on comprehensive public health initiatives in July, instead of waiting till October and trying to deal with a surge of sick people using a creaking healthcare system.

Public health today barely accounts for 10 to 20 per cent of most state governments' expenditure on health. Healthcare accounts for 80 per cent to 90 per cent of such expenditure. From a financial point of view, however, healthcare is very inefficient when compared with public health. The effectiveness of public expenditure is dramatically superior when money is spent on well managed public health programmes as compared with spending money on well-managed healthcare. But public health requires a different set of skills. In the example of dengue, attacking mosquitoes requires the state to manage hundreds of health workers walking over every square metre of the area. Public health requires management skills to handle large forces of field workers who perform simple actions reliably. As part of the degradation of the India's state capacity in recent decades, we have become pessimistic about our abilities in public health. In despair, we have emphasised healthcare.

There are epidemics that ambush us, and there are epidemics that we can foretell. North India will have an epidemic of dengue fever in October 2016, as it does every year. The question is: Will we able to rouse ourselves, and have public health interventions ahead of time?

(This article first appeared in the print edition under the headline "Public health, not healthcare")


Monday, 30 May 2016

The fall guy

Indian Express, 28th May 2016

Successful inflation targeting calls for more reform. Targeting Governor Raghuram Rajan is all too easy.

Subramanian Swamy's comments, though aimed at RBI governor Raghuram Rajan personally, have significance for the inflation targeting framework of the RBI. In the Budget Session of parliament, the RBI Act, 1934, was amended as part of the finance bill. Inflation targeting has now become law. Soon, the government will notify the level of inflation it wants the RBI to target in the next five years. I argue here that in the present circumstances the target inflation rate should be five per cent. Successful inflation targeting requires reforms that have not been implemented so far. Without a well-functioning bond market, end of financial repression, a competitive banking sector, an independent government debt manager and full understanding and commitment on part of government to low and stable inflation, inflation targeting will be a pipe dream.

In the last 25 years, the RBI has sometimes raised or lowered policy rates in order to control inflation either of its own account, or, since last year, as part of a formal agreement with the government. The Monetary Policy Framework Agreement (MPFA) signed in February 2015, for the first time, put in place an inflation target agreed upon by the RBI and government. As a first step towards making a commitment to low and stable inflation, this was a significant step. Many an expert committee had recommended that India should do what most other countries, including emerging economies, had done, and adopt inflation targeting as the objective of monetary policy. This framework was formalised with the signing of the MPFA.

In the past, the RBI had not systematically used either Consumer Price Index (CPI) or Wholesale Price Index (WPI) as the inflation target. However, the MPFA made CPI the mutually agreed target. Since then it was no longer Rajan's unilateral decision to move from WPI to CPI, as Swamy believes. More so, last week through the amendment to the RBI Act, Parliament made CPI the target. But the main reason for Swamy's unhappiness with the target appears to be the high interest rate regime under Rajan. This, no doubt, is hurting industry and employment.

What should the government do to help ensure that the objective of low and stable inflation as well as economic growth is achieved?

First, the government has the responsibility of notifying the inflation rate that it wishes to achieve. This rate is to be set every five years. The inflation target in the MPFA chosen by government and the RBI was 6 per cent by January 2016 and then 4 per cent for 2016-17 and thereafter (with a band of 2 per cent). This sudden jump down in the inflation rate appears at odds with the stated intent outlined in the Urjit Patel Committee report of setting a glide path to inflation. A glide path in the case of other countries such as Chile and the Czech Republic, cited in the report, was slower and smoother and a lowering of the target was done when the existing target was achieved and stabilised.

For India, a glide path would have meant that the economy reaches a stable 6 per cent, becomes comfortable with it, and then only the target is lowered to 5 per cent. If 4 per cent is the long-run stable target, as argued in the Urjit Patel Committee report, it would be unrealistic to jump straight to it.

Second, the government and the RBI should together review India's first experience with formal inflation targeting. One of the well-known problems with monetary policy in the past one year has been the lack of transmission. It appears that given the lack of other reforms in the financial markets such as the creation of a well-functioning bond market, a competitive and market-oriented banking system, and a bond-currency-derivative nexus, monetary policy transmission does not happen easily. In this set-up, it is unlikely that the three-year path to a low and stable inflation envisaged in the MPFA can be achieved in a hurry.

It is important that we ask whether more reforms are needed before the target is lowered. Even if the government decides to lower the target, it should consider moving it from the present 6 per cent to 5 per cent. After transmission improves, inflation stabilises at 5 per cent and inflationary expectations come down, in the next setting of the inflation target five years later, the target could be brought down to the long-run target of 4 per cent.

Third, if the government wants to give the country low and stable inflation by adopting an independent monetary policy, it should clearly signal that it does not want the RBI to peg the exchange rate. One reason for the high interest rate regime has been the reluctance to ease liquidity after the shock to the rupee following the taper talk in May 2013. The unstated mandate of the RBI seems to be that it has to manage the exchange rate and prevent it from depreciation.

Fourth, the government needs to put an end to the foolish notion that the RBI can target WPI. The bulk of the items in WPI are tradables. Their prices are determined in international markets. WPI inflation closely follows the US producer price index based inflation rate. Inflation in WPI is determined by global commodity prices and not by domestic monetary policy. In other words, targeting WPI would be akin to targeting global commodity prices, something no central bank has control over. It is not surprising that no country ever tries to target it.

From the point of view of the domestic mandate, inflation measures based on CPI are the most common target for inflation-targeting countries. A couple of countries strip CPI of volatile food prices, but most central banks mainly use such a concept of “core inflation” in their internal models. CPI is the measure consumers relate to. WPI does not represent anyone’s basket, and at best, represents the price of inputs and outputs for producers. The choice of CPI is superior to the WPI because it measures the cost of living for consumers. Even though food is volatile, but because it matters to households, it is the rise in cost of living they care about. After all, governments adopt inflation targeting as the mandate they give to central banks because they want voters to have low and stable inflation. Incidentally, they also hand over this task to central banks so that if people get unhappy, such as with rate hikes, it is the central bank that gets blamed. Swamy seems to be doing pretty much that.


Saturday, 9 April 2016

Sort out the tax maze

Indian Express, 9th April 2016

The government has ordered a probe into the leaks. But there are thin lines between the legal and the illegal.

The Panama Papers reveal that countries with much simpler tax laws, lower costs of compliance and a stronger administrative capacity to enforce laws than India have not been able to prevent the use of tax havens. In India, tax rates are higher, the system is complicated and capital controls restrict foreign financial transactions. Tax havens are more likely to be used not just for illegal activity but even for legitimate businesses.

The government has ordered a probe into the leaks. But there are thin lines between the legal and the illegal. The difference between tax evasion and tax avoidance is one such line. Tax evasion involves not paying taxes on your income and is illegal. Tax avoidance, on the other hand, is about managing your taxes across different tax jurisdictions to take advantage of differences in tax rates, such as corporate tax rates, in tax treatment of different kinds of income, such as capital gains, and in tax treaties among countries. Tax havens such as Panama, the British Virgin Islands and the Bahamas try to attract business by offering low tax rates and easy compliance.

Officials from OECD countries on the Panama list are under public pressure because they have been advocating that tax avoidance, though legal, is cheating. A number of OECD initiatives have been taken to reduce tax avoidance: An agreement on Base Erosion and Profit Shifting (Beps) aims to prevent companies from choosing low-tax jurisdictions to book profits in. The Automatic Exchange of Information (AEOI) framework will facilitate information flows among signatories. The Foreign Account Tax Compliance Act (Fatca) targets non-compliance by US taxpayers and compliant countries have to provide customer information to the US government.

In addition to tax avoidance, as tax havens have laws to ensure greater confidentiality of companies and banking secrecy legislation, the companies may be used for money laundering. In general, there is a widespread perception that offshore companies are conduits for money laundering, illegal transactions, tax evasion or parking unexplained wealth. While offshore companies may be used for illegal purposes, law-abiding citizens may hold them for making investments in other countries to help navigate the complex maze of tax treaties and multiple jurisdictions involved in managing tax liabilities. Hedge funds that manage money in multiple countries often use tax havens to reduce compliance costs arising from different tax treaties among jurisdictions.

The Indian case is more confusing than those of OECD countries. It has been made complicated by a set of tax laws that makes compliance more costly than in the OECD. We rank 157 in the ease of paying taxes. Further, the effective tax on profit is higher: The corporate tax rate and the dividend distribution tax put together make the tax rate on profits nearly 50 per cent. The capital gains tax makes financial transactions even more unattractive. This regime is made more tortuous by an onerous set of capital controls.
As a consequence, companies operating globally have every incentive to set up companies in such jurisdictions.

There are some cases in which the actions are clearly illegal. The first, for example, is when the underlying activity is criminal,
say, drug or arms trade. These activities are covered under the Prevention of Money Laundering Act. As a member of the Financial Action Task Force, India works with other member countries to prevent the use of the proceeds of crime.

The second is when there are cases of tax evasion: A person does not declare to the tax authorities in her home country her income, which is paid into a bank account of her company in Panama, and no taxes are paid. Here, a distinction between tax evasion and avoidance is relevant. If taxes have been paid in the tax haven at its lower tax rate, then there may be no illegality. When India introduces the General Anti-Avoidance Rule (Gaar), some of these activities may become illegal.
The third case is if there is a violation of capital controls. This is an India-specific issue. Under the Liberalised Remittance Scheme (LRS), every Indian resident is allowed to invest $2,50,000 abroad every year. In 2004, the limit was one-tenth of this. Money remitted abroad is from income on which tax has already been paid. If the amount invested abroad exceeds the amount allowed by the RBI, it is a violation of the law.
Fourth, the illegality may be the non-declaration of assets held abroad. A provision in the Finance Bill introduced in 2015 made it criminal not to declare foreign assets in annual tax returns. If the assets held in tax havens have been declared, then it is not illegal to hold them.
OECD countries have simpler tax laws with lower tax rates and lower compliance costs than India and no capital controls. The focus of the authorities is to broadly keep business in the country and to tax the income of its residents. Yet, the Panama Papers show that even with much simpler systems and more effective enforcement, it is a challenge to prevent illegitimate cross-border flows.

In India, it is not just entities engaging in crime and tax evasion that have offshore companies. Reports suggest, for example,
that many Indian technology start-ups are moving their headquarters to offshore locations due to our complexities. These muddy the waters as both legal and illegal activities move abroad.

Looking forward, first, rationalisation of capital controls should be a top priority. Many government reports have laid out the path forward. Second, India must move to a simple tax regime with lower compliance costs. The blueprint is ready in the Direct Taxes Code. When countries with simpler laws and better enforcement are not able to prevent violations of the law, we cannot hope to do so with our labyrinth of capital controls, maze of tax laws and much weaker tax administration.


Thursday, 3 March 2016

La-la land budget

Indian Express, 2nd March 2016

Official GDP data is embedded in its vision and strategy. But the numbers seem wrong.

Finance Minister Arun Jaitley presented his first two budgets amid high expectations. He was supposed to usher in bold reforms, push up investment, revive India's engines of growth and create an environment in which domestic and foreign capital felt confident of investing. The budget speech was expected to outline a roadmap for liberalising the economy. It was hoped to be more reformist than the budget speech of 1991.

Budget 2016 was presented under completely different expectations. Fingers were crossed that Jaitley would not deviate again from the path of fiscal consolidation. It was hoped that the strategy of borrowing more for public investment would not be tried again. Markets prayed that an impending rejig of the long-term capital gains tax was just a rumour.

When the budget was announced, most heaved a sigh of relief. Many bad ideas had been kept out. A few good ideas had crept in. Jaitley decided that it was more important to stick to deficit numbers. There was no mention of the long-term capital gains tax. Public spending was more or less budgeted to be under control. Whether this was done to persuade RBI Governor Raghuram Rajan to cut rates, to protect India's credit rating, or out of genuine concern about the debt-to-GDP ratio, it was a relief.

Some worry that the budget numbers are based on unrealistic assumptions, that these numbers can never be achieved. Others feel that there has been a shifting of budgetary allocation from mundane-sounding heads to more politically correct heads. Still others find that investment in roads and railways will now be done by off-balance sheet borrowing. Yet, on the whole, there is cheer.

The need of the hour is a rate cut. And for that, we needed an announcement of sticking to the path of fiscal consolidation.

It is now hoped that Rajan will cut interest rates, will cut them soon and will cut them by a significant amount. Further, it is hoped that he will ease liquidity in the banking system so that the policy rate cut is transmitted to other interest rates. Lower rates would ease the interest burden on industry and prevent further damage to balance sheets. Hopefully, it will also eventually help spur investment.

Given the poor transmission mechanism of monetary policy and the weak balance sheets of banks, hopefully Rajan will also allow the rupee to weaken. A depreciated rupee would help make imports more expensive and exports cheaper, thus giving a boost to demand for industry.

Other than the impact of the budget on boosting growth through the easing of monetary policy and a more competitive currency, there is little else in the budget that will help push investment. For example, the retrospective tax was not repealed. Only assurances about the good behaviour of the income tax department were given. Similar assurances have been made in the past. The reduction in the corporate tax rate did not take place as promised. There was little progress on disinvestment or privatisation. There was no serious cut in food or fertiliser subsidy. Rural distress and low income growth in the farm sector received significant attention in the budget speech, though, fortunately, not that much in terms of budgeted expenditure.

One explanation for why the economy does not need more reforms could lie in the GDP numbers. The logic seems to be as follows: We've already achieved high growth. GDP growth has now accelerated to 7.6 per cent. The increase in Central government capital expenditure has revived investment. The government converted the difficulties and challenges it faced when it came to power into opportunities. Make in India, Skill India, Digital India and a host of other initiatives have yielded results. We are growing faster than China or anyone else.

Mission accomplished! Now we can turn our focus away from growth to redistribution. The redistribution should be done better, with lower leakages and improved targeting. Money should go to the poor and to farmers. More taxes and more transfers can reduce distress. That is why the focus of the budget is not on reviving investment and growth.

While it is all very good if the GDP numbers could be relied upon to tell us the state of the economy, few today have faith in these numbers. Most of us, including macroeconomists like me who have spent most of their lives studying GDP numbers, no longer understand what GDP in India means. This is not to doubt the CSO's methodology in correctly measuring value-added or its sincerity in deflating it with what it believes is the correct deflator; this is more a case of complete bewilderment.

In the past, when production, profits, wages and jobs grew, GDP growth would be healthy. If production was falling, the GDP would fall. Perhaps it was all a play of a healthy inflation rate in which simple calculations made in our heads would make sense. Today, when the volume index for manufacturing is showing tepid growth, we learn that manufacturing GDP is growing very fast. When the net sales of companies are flat, we learn that wages and profits are growing. When bank credit growth is slow and banks are not lending, we are told we need to deflate them correctly and that will turn bank credit growth upside down.

Regardless of what the GDP numbers say, however much they point upwards, almost everything tells us that the economy is looking down. Focusing on GDP numbers hides the danger that we may be living in la-la land. Unless we acknowledge that there is a problem of slow growth and low investment, we do not worry about how to solve it. Perhaps that is why the budget did not focus on investment revival.

There are a few good initiatives in the budget but none that reflects the urgency of the situation. In other words, official GDP data is embedded in Jaitley's vision and strategy. If the GDP does not reflect the true state of the Indian economy today, these may need a reassessment.

Wednesday, 3 February 2016

Let the rupee slide

Indian Express, 3rd February 2016

The economy is best served by lowering interest rates and blocking protectionism.

In its monetary policy announcement on Tuesday, the Reserve Bank of India (RBI) decided to keep the policy interest rate unchanged. One of the implications of this decision is for the rupee. High interest rates have helped in keeping the rupee strong in recent years. It appears policymakers wish this to continue.

But the recent slowdown in China and the depreciation of the yuan means India's external environment has changed significantly. While two years ago it might have seemed like a good idea to prevent the rupee from weakening, a rethink is now warranted.

In recent months, Indian industry has been facing sharp competition from falling international prices. As the budget-making process starts, demands for tariff hikes will get stronger. Accepting protectionist demands could impact downstream industries and have implications for India's international treaty obligations. Favouring certain sectors, especially those with a few large companies, can make the protection politically difficult.

One example of this is the steel industry where the world's largest producer of steel, China' has seen a slump in demand and has an industry suffering from overcapacity. The Indian steel industry is faced with an onslaught of cheap imports. It has, in response, been pressing for hikes in import duty on steel, imposition of a minimum import price and anti-dumping duties.

It can be argued that the government should do nothing, and allow the Indian consumer to benefit from lower Chinese steel prices. However, it is difficult for the government to ignore the state of the steel industry and job losses. The consequent higher probability of defaults on bank loans by steel companies may also push banks into further trouble.

Already, India is ranked No 1 in imposing the most protectionist measures since 2008. In 2015, India imposed the second highest number of protectionist measures, after Russia. For the fastest growing economy in the world, the policy of greater protectionism is becoming untenable.

We expect that in 2016 the pressure for protectionist measures may increase. Global trade has slowed down to nearly zero per cent growth. As the Chinese economy and Chinese exports slow down, Chinese authorities may to try to help push exports.

For one, the Chinese renminbi was devalued. For years, the Chinese currency had seen pressure to appreciate. The slowdown, the pressure on exports and China's decision to depreciate seem to have set off an outflow of dollars from China. Today, the pressure is for greater depreciation. The pace of depreciation has been slowed by foreign exchange intervention. China has been selling dollars. We have seen a decline in its foreign exchange reserves by $513 billion in 2015. In the month of December 2015 alone, China's reserves fell by $108bn. With higher pressure to increase exports, China may allow the yuan to depreciate more.

The most likely direction of the yuan is downwards. In response, other emerging economies are also weakening their currencies. It is not difficult for an emerging market (EM) to do a currency depreciation in today's environment. It does not require cutting interest rates, out of line with macroeconomic conditions. Global growth has slowed down and commodity deflation is putting downward pressure on prices. Following the increase in US interest rates by the Federal Reserve, emerging economies have been witnessing outflows of capital. This is putting pressure on EM currencies to weaken. Indeed, today it is harder for an EM central bank to prevent a depreciation than to allow it.

If other currencies depreciate, it will further make India's imports cheaper and increase the demand for trade protection. However, tariffs are not the only way to protect domestic industry. As is being seen globally, an alternative approach to raising tariffs to tackle the loss of competitiveness of domestic industry is currency depreciation. In the above example, the impact of a 10 per cent depreciation is equivalent to a 10 per cent tariff on all steel imports. Depreciation increases the price of imported goods.

Last week, when Japan adopted a negative interest rate strategy, currency considerations are understood to have played a significant role. While deflation has been around in Japan for a while, the challenge from the yuan and the decline in commodity prices is new. The cut in Japanese policy rates will, it is hoped, depreciate the Japanese yen and increase import prices.

Today, when other countries are protecting themselves by allowing currency depreciation, should India lean against the wind? Should we combine a strong rupee policy with protectionism?

Allowing the rupee to depreciate has further benefits: It makes all imports more expensive. The government does not have the politically difficult job of increasing tariffs case by case. A weaker rupee would also help push Indian exports.

From 2009 to 2013, in the period of high volatility in the global economy, India had a largely flexible exchange rate policy. Since May 2013, India's exchange rate policy has been to prevent significant appreciation or depreciation. Since the taper talk and expectation of rupee depreciation in May 2013, an increase in interest rates and liquidity tightening have prevented any significant weakening of the rupee. Debt flows have been large as the differential between domestic and international interest rates remains high.

Everyone does not want a weak rupee. Foreign investors applaud the strong rupee policy as it protects their returns. Rich Indians like cheap foreign holidays and imported goods. For some people, a strong rupee is a matter of pride. However, the policy of keeping the rupee strong and combining it with protectionist trade measures is unsustainable. Exchange rate policy and strategy for 2016 cannot be the same as it was before the Chinese story started unfolding. The RBI and the commerce ministry need to be on the same page. The government must take a holistic view of the policy strategy on protectionism, the exchange rate and interest rates. The Indian economy would be better served by lower interest rates, blocking protectionism and letting the market determine the price of the rupee.


Monday, 18 January 2016

Be tight-fisted

Indian Express, 18th January 2016

The 'tight fiscal, easy monetary' policy mix can better address problems that plague private investment.

The finance ministry has stressed that it will stick to the path of fiscal consolidation. This is good news. While a move away from the announced targets to give the economy a stimulus may have seemed attractive in light of the signs of slower growth, the policy would not have been the most suitable for reviving investment, the biggest challenge facing the economy.

After the mid-year review suggested that fiscal targets may need to be revised, many economists emphasised the benefits of staying put on the announced path of fiscal consolidation. First, the debt to GDP ratio would remain under control. Equally important, the finance minister would maintain his credibility, particularly since he has already deviated once from the path. The decision of the government to stick to the path of the announced fiscal targets is good not just in the long run. It is also more likely to help in the short term.

One immediate gain of sticking to the path of consolidation will be to create space for monetary policy easing. The sharp decline in global commodity prices and the slowdown in demand in the domestic economy have reduced inflationary pressures. The policy interest rate - that is, the repo rate - stands at 6.75 per cent. Unlike, say, in Europe, where there is no scope for cutting the policy rate that is near zero, in India, there is ample scope to cut it. But while in principle the policy rate can be reduced significantly, the question is how to give monetary policy the space to do so.

A fiscal stimulus would increase the likelihood of demand rising and pushing up the inflation forecast. While deciding the policy interest rate, monetary policymakers target the forecast of inflation and analyse the pressures of demand on core inflation. With a slowdown in global demand, investment and domestic deman, a greater easing of the stance of monetary policy may be more possible today than perhaps even a year ago. This opportunity could be lost if the government had chosen to pursue a policy of fiscal expansion.

Monetary easing in the last one year has been cautious. A number of factors were responsible for this. One, the United States Federal Reserve was expected to raise interest rates in 2015, which could impact volatility in financial markets, especially currency markets. Two, there was a sharp increase in the prices of food items like onions and pulses, feeding into higher food inflation. Three, right at the beginning of the year, the government moved away from the path of fiscal consolidation. The fact that the policy rate was eased by only 125 basis points over the year, though inflation fell by about 500 basis points, can partly be explained by fears of rising inflationary pressures later. Today, when the Fed has finally raised rates and food inflation is expected to remain within control, deviating from the path of fiscal consolidation could keep fears of inflationary pressure alive and keep monetary easing cautious.

A loose fiscal policy would, therefore, have effectively meant that policymakers would be choosing the "loose fiscal, tight money" policy mix. This is sometimes justified by arguing that, given the poor transmission of monetary policy in India, its impact is limited compared to that of public investment, which involves direct spending by the government and raises demand instantly. While, in theory, this may hold, there are two reasons this may not be true in India today.

First, the capacity of the government to spend is limited. A large share of the capital expenditure allocated in Budget 2015 is yet to be spent. Many good plans have been approved and money allocated, but the shovel is yet to hit the ground. While, in theory, public investment can spur private investment' limited state capacity may be one reason why the magnitude and lags involved may make this strategy less optimal than theory suggests.

Second, private companies are unable to repay the interest on their debt. Banks are increasingly seeing loans get in trouble. High interest rates hurt not just the companies whose revenue growth has fallen sharply but also banks whose stressed assets have been on the rise. For private investment to pick up, companies need to have the ability to borrow, and banks the ability to lend. Raising demand through a fiscal stimulus does not address the balance-sheet stress of companies and banks, while a reduction in interest rates would.

Early in 2015, the government and the RBI adopted inflation targeting as an objective of monetary policy. Inflation targeting is adopted by governments and central banks to tie down their own hands. The benefit of low inflation goes to the elected government that gains by way of providing a low-inflation environment to citizens. While endless arguments can be made about the effectiveness of monetary policy in India, the efficiency of the transmission mechanism, the role of food inflation, and so on, there is little doubt that the objective of low inflation is consistent with the preferences of the bulk of the population. The suggestion made by some economists that the government should rethink and review its commitment to inflation targeting, instead of finding ways to meet it, is unwise.

The best strategy for the government, therefore, lies not in giving up the inflation target, or in changing the measure of inflation adopted, the consumer price index, because it is higher than the wholesale price index, or in changing the glide path towards the target, but in creating the conditions that would keep inflationary pressures down.

In the present context, adhering to the announced path of fiscal consolidation would allow the "tight fiscal, easy monetary" policy mix that is more suited to addressing the troubles that plague private investment. The RBI should respond to this commitment by cutting interest rates. There is clearly no magic bullet for reviving investment. However, a reduction in the interest burden could possibly prevent more companies from going towards bankruptcy. This is a greater need of the hour than higher demand.