Macro Stability: Budget Priority

Introduction

Economic growth has averaged around 4.7 per cent for the past two years.  Gross fixed investment is at a standstill, barely increasing by 0.2 per cent in 2013-14 after a dismal growth of 0.8 per cent in 2012-13.   Manufacturing output is now lower than it was a year  ago, with no indications yet about.  Despite collapsing growth, inflation has averaged 7.1 per cent per annum, suggestive of stagflation.  The high inflation is driven by agricultural prices which have increase at an average 11.5 per cent despite a relatively high growth average of 3.1 per cent. The Current Account deficit shot up to 4.8 per cent of GDP but has come done to 1.8% in 2013-14, partly due to restrictions on gold imports.  This backdrop defines the immediate priorities of the incoming priorities.

Budget: Macro Sustainability

The first priority of the new government must be to restore Macro-economic balance.   The second priority is to accelerate investment and growth.  The third priority is to address the structural factors driving agricultural prices.   The budget that will have to be presented by the new government within 6 weeks of taking oath of office will provide the first opportunity to address these issues. Given the shortage of time, the budget can and must focus on those issues coming within the purview of the finance ministry.  Two major objectives would therefore be, to  put the fiscal situation on a firm improving trend and to address the problem of NPAs and Capital adequacy of Public Sector Banks 

    The BJP manifesto has promised a clear accounting of fiscal deficit.  Based on this, the should aim to reach the FRBM targets of 3% for the fiscal deficit and 0% for the revenue deficit within two years with the objective of halving the difference from 2013-14 in each year. This requires a corresponding reduction in consumption expenditures and subsides, particularly petroleum product related subsidies. It is quite clear to everyone that the damage done to corporate confidence by the retroactive changes in tax laws and harassment of corporate tax payers (what the BJP manifesto calls “Tax terrorism”), must be corrected. In addition some progress must be shown with respect to implementation of GST and simplification of income taxes.  Given that several of the holdouts were BJP States, this should not be too difficult.

    Another mistake made by the outgoing government was to force Public Sector Banks to provide credit to infrastructure projects with less than adequate long term financing.  Given the high risks associated with bad policy and regulatory environment, several of these projects would not have got off the ground. Forcing PSBs to provide credit merely postponed the day of reckoning in the form of Non-performing assets.  Re-capitalization of these Banks is therefore urgently required to revive their ability to lend to new borrowers. A policy change allowing Government holding to go below 50% will allow sale of government equity to finance re-capitalization, without worsening the (real) fiscal deficit.

Inflation: Agriculture 

 Finally the disastrous management of the agriculture sector, that has resulted in almost 10 years of high agriculture price inflation.  The minimum support pries must be restrained for the next few years, the huge buildup of stocks that has resulted in double digit price increases in wheat & cereal prices corrected.  Steps can also be taken to reform the Food Corporation of India. The likelihood of a below normal monsoon also makes it imperative to move quickly from the Ad Hoc changes in QRs and expot controls to a stable system of import tariffs and export duties.  This will help moderate price inflation and provide an incentive to farmers to investment in productivity improvement.  Greater efforts must also be made to convince States to abolish the APM or remove vegetables and fruits from its purview.

Separately and independent review must be carried out of policy and regulations in the  infrastructure and energy sectors under the purview of the Central government and the governance of Public Sector and Departmental enterprises.   Hopefully some action can be taken on these within 3 months after the budget has been passed.

A version of this article appeared in The Hindu, on 17 May 2014 under the banner, “Restore Balance in The Macro Economy,” http://www.thehindu.com/todays-paper/tp-miscellaneous/tp-others/restore-balance-in-macroeconomy/article6018606.ece