It has been almost two years since I started writing the “Looking for Logic” column. The theme was dictated by the observation that there were several policies in India whose logic was not obvious e.g. why was there no privatization taking place, why were interest rates on small savings so high, why did we have such high transaction costs for brokerage, or why badla was so favored by stock market operators. Today, second generation reforms have gathered enough pace (though several fault-lines remain) that one can begin to think about third-generation reforms. And what might they be? For starters, the removal of policies that defy logic, that are “Beyond Logic”. Hence, the new name for this column.

How sensible is it to have the government making, or more accurately attempting to make, macro-policy (i.e. the budget) in secret? Surely, this is a hangover from the days when industrialists used to buy favours from politicians by dictating distortionary policies e.g. increase excise taxes on my competitor, increase tariffs on imports, or provide subsidies to me. Today, hopefully, such behaviour on the part of the industrialists would be laughed out of the Finance Ministry. So, the next item on the reform agenda should be the preparation of the budget in a completely transparent manner. The policies under consideration can be announced, research financed, open parliamentary hearings held, and intelligent policy made.

If such a procedure had been adopted, then Budget 2002-03 would have been made on realistic assumptions. This tax and spend budget appears partly "sensible" and partly "balanced" only because of its assumption of nominal GDP growth of 10.6 percent for the next fiscal year. How realistic is this assumption?

Nominal GDP growth is composed of two factors - real growth and inflation, and both should be in an approximate ballpark. While reasonable women should -- and do -- debate the determinants and expectations of growth, policy planners can only hope for the best. Granted that the world economy is improving, but how many economies increase their growth rate with an increase in real cost of capital and an increase in tax rates? Not many, and if the budget had been an open one, the planners would have been told that a growth rate of only around 5.4 percent for 2002-03 was possible. (Last four years' average is 5.4 percent; this year, 2001/02, is expected to register 5.3 percent).

Which means that the planners have budgeted for an inflation rate of 5.2 percent for 2002-03. How realistic is this estimate? Beyond logic. The price deflator for the last three years has averaged 3.4 percent; this year, because of fuel-price increase of 20 percent, approximately 4 percent. There is no reasonable basis for expecting the inflation rate to increase by a third in 2002-03. However, there is a price index which can warrant such "optimism" on inflation - the consumer price index, more affectionately known as the "communist price index". This index shows an average three year inflation rate of 3.7 percent. However, an alternative consumer price index - one for the rural areas - shows an average 3 year increase in prices of only 1.4 percent, with the average for the last two years at zero percent!

The CPI has long been discredited by our policy makers, which is why the cardinals of inflation - the RBI - concentrate on the wholesale price indicator. Inflation according to the WPI - last three years average of 4.6 percent; year-on-year today, close to 1 percent. Why is the "official" CPI is so far out of sync? Because it is used by the government to grant hefty salary increases to its under-worked and over-paid staff, and by the unions to obtain unfair cost-of-living increases for its members. These interest groups have prevented any (third-generation) reform of the consumer price index; both outdated weights, and possible manipulation of the index, allow this holy cow to roam unabated.

The chart shows the explosive nature of this roaming. The Communist price index shows a 79 percent inflation between 1993 and 2001; the CPI for agricultural workers registers 57 percent; the WPI for manufacturing only 45 percent. Obviously, union workers and babus prefer the wrong index to be used for their wage negotiations and cost of living clauses in their contracts (and therefore it stays wrong); and the babus use this in their periodic Pay Commission awards. No awards for guessing why the official CPI does not get reformed. Compared to their brethren in the rural sector (CPI - rural sector), the union workers/babus are about 22 percent unfairly richer today than in 1993; compared to manufacturers (WPI in manufacturing), some 34 percent, unfairly, wealthier. And this is only over the last eight years.

The distortion has been present for a considerable period of time, and as often happens before the day of reckoning, there is a blow off when the interest groups go for broke. Indeed, it is likely that the CPI has gone through a second transformation in recent years - it should now be called the "cheating price index". There is no set of calculations, or assumptions, which warrant an extra 1.2 percent a year increase for the last eight years - and an extra eight percent increase in just the last three. When every price index has registered declining inflation in 2001, the CPI shows increasing inflation! Even the globalization and WTO induced prices of the three R's of communist consumption - red shirts, red caviar and red wine - have registered a decline; so upon what mooli does the communist price index feed that it has grown so fat?

We are not unique among governments raising taxes to gorge themselves, and manipulating price indices to keep their appetites keen. In the seventies, Sri Lanka also faced increasing deficits, increasing inflation, and increasing cost of living allowances for its union workers and the babus. What action did it take? It cheated by publishing CPI data which showed lower inflation than that which occurred. Thus, it saved itself some money, and enjoyed a lower fiscal deficit. The reported inflation rate was lower than the actual by about 1 percent a year for close to 10 years (1973 to 1982). That was twenty years ago - today, not only do we cheat, but like our corruption, we do so in an inefficient manner. We incur higher wage payments, and higher fiscal deficits.

To get back to the budget - an assumption of over 5 percent inflation is not only a pipe dream, it is nonsensical. Inflation of even 3 percent next year will be extra-ordinary. But our policy makers know this, so why did they indulge in this miscalculation? Because they did not want to show a higher budget deficit than they were forced to? But what were they "forced" into doing? Adopting old style planning methods of tax and spend e.g. real plan expenditure increases of over 10 percent for the fourth straight year, necessitating tax increases this year, and next, and…Alternatively, maybe our budget makers knew better and assumed a realistic inflation level of 2.6 percent, and a real GDP growth (achieved on paper) of 8 percent! For details on such hair-raising experiments, tune in next fortnight to the "Tales Beyond Logic", and the fortnight after that, and...