Donít look, leap

Fuel price hike is the first of many big steps govt must take to rescue the economy

In the midst of a sharp depreciation of the rupee, the government announced a hike in petrol prices. This is perhaps the first of many steps the government must take to keep the economy from deteriorating further. Rescuing the economy requires a focus on macroeconomic policy that includes fiscal deficits and inflation. And better governance requires leadership in high ethical standards, the rule of law and a well-articulated and -implemented supportive environment for private and foreign investment.

The crash in the rupee and in stock prices has served as a vote of no confidence in economic policies. The recent movement of the rupee and stock prices are mere barometers of the economy and reflect deeper problems of macroeconomic mismanagement. We must stop looking for quick fixes ó for one micro tweak after another ó which we hope will solve the problems. Macroeconomic problems cannot be solved by any number of microeconomic interventions. If we ban currency futures trading, the rupee will still depreciate. Forcing exporters to bring half their proceeds home quickly will trigger off a new wave of capital flight.

Indeed, every time distortionary micro measures are used, it further damages the credibility of policymakers. The world at large understands that the government has a weak understanding of macroeconomics, when they see the procession of microeconomic distortions that have been rolled out in recent months. This loss of trust in Indian policymaking is a central problem that needs to be addressed.

The biggest credibility gap of the Congress is on the fiscal deficit. The budget focused on raising taxes more than on expenditure reduction. This is a bad sign; sustained fiscal consolidations are led by expenditure reductions. For many years, India was in a slow process of reforming tax policy and tax administration, which would transform the tax-GDP ratio. That policy continuity has been lost in recent years. The thirst for revenues seems to have triggered off elements of an inspector raj, which will not deliver tax revenues, and will damage confidence in India.

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