The Budget is timid on economic reforms and imprudent on fiscal management
Shankar Acharya / New Delhi Jul 09, 2009, 00:45 IST
Finance Minister Pranab Mukherjee’s maiden Budget for the freshly reelected UPA government disappoints in two major dimensions: it is timid on economic reforms and imprudent on fiscal management. Taken together these features weaken the likelihood of an early resumption of high economic growth, which, in turn, weakens the long-term sustainability of inclusive development.
On the first point, the Budget speech is unexpectedly shy of projecting a “reform stimulus” to investment and growth. There is no mention of the insurance amendment bill in Parliament, which would raise the foreign investment cap from 26 to 49 per cent. Unlike Budgets of previous governments (Congress, United Front and NDA), there is no significant estimate of disinvestment proceeds, though the finance secretary volunteered on television that the Economic Survey’s number of Rs 25,000 crore could be taken as a guide. There is no echoing of the reforms in the coal sector, or foreign investment or open access to electric power indicated in the President’s address to Parliament last month. Or, for that matter, of the reforms in education, administration and the judiciary also mentioned in the same address. The need for reform of petroleum pricing is mentioned but only to indicate the formation of another expert group (the third in two years!) on the subject. More predictably, no fresh initiatives are envisaged in difficult areas such as labour laws.
For a government no longer dependent on Left support, such a high degree of reticence on reforms is both puzzling and, perhaps, damaging. All said and done, the Union Budget is the key economic policy document of the government in power, which can transmit powerful signals to investors at home and abroad. And I am referring to those who invest in real economic activities, not stock market players. A muted signal on economic reforms can damp investor sentiment across the country to the detriment of investment and growth. That’s a pity, especially when such reticence doesn’t, on the face of it, seem to be an obvious political necessity.
FISCAL INDICATORS
(Rs Crores)
2007/8
Actuals
2009/10
B.E.
1
Revenue Receipts
541,864
614,497
(a)Taxes (net to Centre)
439,547
474,218
(b)Non-Tax Revenue
102,317
140,279
2
Revenue Expenditure
594,433
897,232
3
Revenue Deficit (2-1)
52,569
282,735
4
Revenue Deficit (% of GDP)
1.10
4.80
5
Fiscal Deficit (% of GDP)
2.70
6.80
Source: Budget at a Glance, 2009/10, July 2009
More tangible and worrying is the “calculated risk” the finance minister has taken in opting for a huge fiscal deficit of 6.8 per cent of GDP. Together with states’ fiscal deficit of 4 per cent of GDP, a combined government deficit of 10.8 per cent of GDP is envisaged, pretty much unchanged from the exceptionally high level of 2008/9 (inclusive of off-budget bonds for oil and fertiliser). “Fiscal deficit” is an abstract phrase which masks the core of the problem. A cruder but more compelling phrase would be “government’s net borrowing need”. The Centre’s 6.8 per cent fiscal deficit translates into Rs 400,000 crore of borrowing from the market. The states might require another Rs 150,000 crore or so. To put the enormity of the challenge into better perspective, the Centre’s market borrowing need in 2009/10 is about four times higher than the amount envisaged in the 2008/9 Budget.
There are only three sources from which government can borrow: the domestic market (mainly banks and other financial institutions), the RBI and foreigners. Too much borrowing from the market leads to the crowding out of private investment, either directly or via higher interest rates (the yield on benchmark government bonds rose markedly within hours of Budget presentation). Too much borrowing from the RBI fuels monetary growth and risks rekindling of the inflation scourge. Too much borrowing from foreigners runs the risk of an external debt and payments crisis.
The finance minister (and his officials) are, of course, well aware of these risks. That is why he intends to “return to the FRBM target for the fiscal deficit at the earliest and as soon as the negative effects of the global crisis on the Indian economy have been overcome”. In the mean time, he presumably believes that the demand stimulus imparted by the high fiscal deficit is necessary to sustain the economy’s growth momentum in a still recessionary global environment. Indeed, as part of the Budget papers laid in Parliament, the minister’s “Medium Term Fiscal Policy Statement” (MTFPS) envisages a reduction of the Centre’s fiscal deficit to 5.5 per cent of GDP in 2010/11 and 4.0 per cent in 2011/12. About half of the projected fiscal correction of 2.8 per cent of GDP is expected to come from higher tax revenues.
If indeed the Centre’s high fiscal deficit could be corrected so promptly, the “calculated risk” of the very high deficit for 2009/10 might be justifiable. Unfortunately, recent history does not support much optimism on this count. First, it took the previous UPA government a full four years to reduce the Centre’s fiscal deficit from 4.5 per cent of GDP in 2003/4 to 3.3 per cent (including 0.6 per cent of off-budget items) in 2007/8. And this was during a period when economic growth was averaging close to 9 per cent a year and powering an unprecedented rise in the Centre’s tax ratio (net of states’ share) from 6.8 per cent of GDP in 2003/4 to 9.3 per cent in 2007/8. This pattern is unlikely to be replicated. A fiscal correction of about 1.5 per cent of GDP in each of two successive years (as projected in the MTFPS) has never been achieved in India. Thus, the MTFPS targets lack some credibility.
One’s doubts are greatly amplified when one digs a little deeper into the fiscal trends of the last two years. The table shows that in the two years since 2007/8, the Centre’s revenue deficit has more than quintupled in absolute terms and increased 4.5 times as a ratio to GDP. This has happened essentially because revenue expenditures have increased more than Rs 300,000 crore, while tax revenues have risen only Rs 35,000 crore, that is, expenditures have risen almost nine times more than taxes. (Incidentally, the revenue deficit in 2009/10 would be that much higher if one excluded the one-off credit of Rs 35,000 crore attributed to the telecom 3G auction.) The rise in the fiscal deficit essentially mirrors the increase in the revenue deficit. The bulk of the massive expenditure increase is due to interest payments, defence, subsidies, salaries and pensions, and major social programmes such as NREGA and Bharat Nirman. The notion of a temporary fiscal stimulus assumes that it can be readily reversed when the need for the stimulus goes. None of the expenditure categories mentioned above looks very reversible to me. Indeed, the significance of non-compressible “entitlement schemes” such as NREGA, social security for unorganised workers and the promised National Food Security Act is on the increase in the Union Budget.
The poor recent performance of tax revenues (despite near 7 per cent growth) and the explosive increase in expenditures both suggest that rapid future correction of the currently high fiscal deficit (as per the MTFPS) is likely to be impossible. Ergo, the Indian economy is likely to pay a significant price in terms of foregone growth, inclusive development and, perhaps, rekindled inflation because of continuing high deficits. The “calculated risk” of the present fiscal stance looks unduly high.
The author is Honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. Views expressed are personal
The article puts the budget short comings in the right perspective. The worst part that whatever borrowing the government plans, against the spending, meager sum is allocated to productive and much required infrastructure which is considered to be back bone of any economy which would indeed also create job there by replacing the schemes such as NREGA..etc.
Its interesting to see how long this Government is able to provide the freebies in terms of subsidies, NREGA, ..etc.
However the present form of Government in its previous tenure has been successful in pulling down the road construction growth from 32km to 9km and many other infrastructure projects vital for the growth of INIDA.
The crux of the budget seems to be more of a "Political statement than Political will".
We all must have known the shape of things to come when we were told that the Governnment would give 'one last chance' to Air India and in the same breadth also add that nobody will loose jobs in Air India !!
The bloated and incomptent workforce of the national carrier is in fact a national shame and it has already been given umpteen number of chances.
If people do not read the signs and develop unreasonable expectations about reforms, who is to blame.
Congress is rightly the B-team of the left and hundreds of millions in this country are doomed to poverty as the Governments keep wasting money.
I totally disagree with your personal views.Why should the PM disinvest in a recession.India must get max value for its stock sale of PSU's.We must not follow the model adopted by Russia in 1991 wherein stocks were sold at very cheap prices resulting in private cartels being formed.Prudence is required in the next 8 months&in a full fiscal year ie 2010-11 we should go in for large reforms.India growing at 6%this year is very good as doom&gloom is there in the world economies&even OPEC is forecasting a 17%drop in energy requirements worldwide.That means oil prices at$50/barrel and gas at $3/Btu!RIL&RNRL should drop all cases&get to work& set up the Dadri power plant in quick time.India needs power TODAY.That should be a single point agenda for the next 5 years. SEE WHAT LENIN achieved by his focus on electricity.All other good things like education,healthcare,agriculture,entertainment etc. will boom when power is available.Mr FM go for it.
What do you mean by "the" insurance amendment bill? It will be done if and when politically expedient. You are talking as if such a bill was already passed and awaiting implementation.
The article has the budget in the right perspective. This budget is all about freebies as the always has been the case expect for the period 200-2004. Hardly any productive investment being chalked of the total borrowing that Government has planned.
The crux of budget is seemingly "A political statememt than Political will".
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