Thursday, February 28, 2013

Setting The Stage for Macro-Pivot: The 2012-13 Budget


Many different words have been used to describe this budget. ‘Reasonable’, ‘Responsible’, ‘Sound’, ‘did no harm.’  The words that have not been used are ‘reformist’ or ‘big bang’. Those who were dis-appointed fall largely in the latter camp.  I would call it a “conventional budget,” where, by conventional I mean what one had begun to expect once the reforms of the 1990s were over.  Its main distinguishing feature is the determination to hold to fiscal deficit fixed in the budget and outlined in the long term policy stance.  This was a welcome and necessary departure from the budgets since 2009-10. For the rest it was the usual socio-political document, with a number of expenditure allocations to different groups to reassure them of its inclusive nature and incremental measure to correct small anomalies in infrastructure sectors, presumed to be the central propeller of government planned development programs.

Popular Expectations

 Some expected growth oriented budget and others feared a populist budget.  Neither the expectations nor the fears came true. Though the Finance Minister opened with a statement on the importance of economic growth for generating jobs, inclusive growth and revenues which could be used to help the poor, there was no headline making reform that could enthuse the stock markets or the domestic industrial community.  Measures to incentivize investment, savings, infrastructure, bond markets were neither much better nor much worse than those seen in earlier budgets.  Similarly there were a number of expenditures and increases in the same, directed at the Welfare of various groups, at food security and malnutrition, education and skill development, agriculture, textile workers and small industry.

Benchmark: Macro-Pivot

  Personally, the budget achieved the professed objective of the Finance minister to contain the fiscal deficit to 5.3% of GDP in 2012-13 and to reduce it to 4.8% of GDP in 2013-14.  Though the growth assumption on which this was based were optimistic, my view is that this finance minister is very serious about this objective and will therefore ensure that it is achieved.  This is an important step in restoring the fiscal sustainability and macro-economic balance, some of the most disturbing symbols of which are the current account deficit of 4.2% of GDP during the last two years and the high rate of consumer price inflation.
Why is this so important?  In a paper in 2012 I showed how many growth stars became shooting stars because they were not able to deal with macro-economic shocks emanating inside and outside their country. Thus it is essential to deal with this issue if we want to restore growth to a reasonable level and sustain it for the next few decades. Further, my analysis of the macro-economic situation in India, suggests that the best way to remove the cyclical down turn in the Indian economy is a “Macro-pivot,” which rebalances the fiscal and monetary policy, by tightening the former and loosening the latter.  Again this is based on research which showed that economies showing similar symptoms of macro imbalance as us, such a pivot led to an increase in the average growth rate in one to three succeeding years.  Further the evidence very clear when the fiscal tightening was the result of expenditure reduction but mixed or non-existent when it was the outcome of a tax increase

Fiscal Tightening

The finance minister has accomplished this reduction in the fiscal deficit by correctly focusing on the reduction of subsidies, which were the cause of the unsustainable rise in the fiscal deficit.  Further he has achieved it without cutting capital expenditure (government investment).  In fact capital expenditures are budgeted to increase by 27% in 2013-14.  There is however, one trend that has not been reversed, which needs to be, to put the fiscal deficit on a sustainable trend.  Revenue expenditures net of subsidies, are projected to increase at an even faster rate that the increase in GDP.  Thus the ratio of these expenditures to GDP is likely to increase significantly.

Further Reforms

 The finance minister has also mentioned a number of pending bills, such as the DTA, GST, Pensions and Insurance, that will help improve the investment climate.  If his expectation-hope of these bills in the budget of subsequent session of Parliament fructify, then enough momentum will be generated to return to a growth rate of over 6% in 2012-13.  If these and other administrative and procedural reforms, such as the setting up of an effective ‘Road Regulatory Authority,”  that have been talked about do not come through, then growth is likely to be around 6% (+/- 0.5%). 

A version of this note appeared in the Op Ed page of The Hindu on March 1, 2013 under the banner, “The path to Fiscal Sustainability,” at

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