Thursday, February 28, 2013

Budget Expectations, Benchmarks and Reality


The question I as an economist, have been asked many times in the past and will after this one is, “what do you think about this budget?”  To make sense of the diverse and contradictory answers from supposedly neutral experts (that the average person will receive), one has to know the benchmark the person was using.  What were the expectations against which the budget was assessed? These related primarily to stabilizing the macro-economic situation and secondarily to boosting investment.


Let me therefore start by defining my benchmark.  The rate of growth of the Indian economy has been on a downtrend during the last three years to reach a projected  5% in the current year.  Over the same period, the current account deficit reached 2.8% and then jumped to an unprecedented 4.2% of GDP and investment growth halved and then halved again.  At the same time inflation measured by different indicators remained stubbornly high.  Consequently the rating agencies threatened to reduce India’s global rating to Junk status.  The political system including the government took serious note of this potential crisis in the last quarter of 2012 and started taking policy action to free the administered prices of petroleum products and increase FDI limits in Aviation and Retail.  This was good start, and helped to reverse the extreme pessimism that had gripped domestic and international investors.  Phase I of an operation to retrieve the situation and reverse the trends in investment and growth. 

Phase II of a Reform Process 

  I saw the Budget as Phase II of the process, whose focus was on reversing the fiscal trends as a critical input into overall macro-economic stabilization.  The critical test, as I pointed out in a media discussion about a month ago, would be to see if the Finance minister is able to deliver on his long term fiscal deficit strategy and the targets of 5.3% and 4.8% for the years 2012-13 and 2013-14 respectively and reverse the trend of rising subsidies and government current expenditures and transfers.  Tested against this benchmark the 2012-13 budget has done well (5.2% and 4.8%) with a few caveats. Much of the increase of the fiscal deficit in 2009-10 (the high point) was due to a jump in subsidies.  Returning subsidies to the 2% of GDP that they had stabilized at in 2007-8 was therefore an essential element of Fiscal stabilization.  A projected 10% decline in the subsidy bill is reassuring even if this decline is exaggerated.   However total current expenditures are projected to increase by about 14% next year, above the projected growth of GDP of 13.5%, which in my view is based on an optimistic growth projection.  Thus current expenditures net of subsidies will increase as a proportion of GDP.  This up trend is a little worrying as the revenue deficit (RD) will only decline by about 0.5% of GDP even under the optimistic growth projection.   As the RD is approximately equal to the Governments Investment – saving gap, the impact on the current account deficit (0.5%) is not sufficient to bring it down below 3.6% or so.  On the other hand, capital expenditures have increased by 27%, thus this reduction has been achieved while raising government investment, which should have a positive effect on overall investment.

Mesures & Reform Hints

There are also some measures in the budget to increase private investment and savings.  The introduction of an investment allowance for large investors has however, been accompanied by rise in surcharges on corporate profits.  This fiscal twist (positive and negative) could in principle bring forward and accelerate private investment expenditures.  This will however, only happen if the promise that the rise in surcharge is temporary is believed by investors?  Credibility is the key to its success.  There was also some expectation that clear explicit administrative and procedural measures would be taken to reverse what has been perceived as creeping return to permit-inspector raj in the revenue (tax) department (CBDT, CBEC).  The budget did not, unfortunately, give a convincing demonstration of this reversal.

Phase III Vital

There is an underlying concern that many in the UPA and in other parties do not realize the seriousness of the situation, in which the rate of growth of GDPMP is likely to be an abysmal 3.5% in 2012-13 and are again becoming complacent that the measures already taken will propel us back to 6.5% and then to 8%.  In my view this will not happen without further policy, regulatory and institutional reforms.  I look forward to phase III of the reform process that can make this return to sustained high growth likely. 

A version of this note appeared on the Op ed page of the Indian Express on March 1, 2013 under the banner, “Reform Phase II,”

No comments: