I have remarked on previous occasions that the first test of an Indian Budget is whether it passes the Hippocratic test: first, do no harm. Given the populist sentiments abroad in the land, I feel that the finance minister did reasonably well on this score. There were comparatively few sins of commission. The Budget also signalled a continued strong commitment to further integration of India into the global economy, with attendant benefits for the investment climate. The main omissions, for obvious political reasons, are in modernising the role of the state in the economy. It now seems clear that such administrative and political reform cannot take place with any seriousness under the present coalition, despite their vital importance for the poorest and most vulnerable in the society. Instead, more money has been thrown at areas with deep-seated governance problems.
As a macroeconomist, I start with the numbers. The finance minister (FM) is rightly proud of meeting his goals under the Fiscal Responsibility and Budget Management Act 2003 (FRBMA). Yet, as was pointed out by AK Bhattacharya in this paper a few days ago, the underlying reality is much less impressive. The government has been saved by an unanticipated boom in revenue of Rs 19,000 crore, largely from direct taxes. All of this has gone to increased revenue expenditure (including a substantial increase in interest expenditures). As always, capital expenditure is absent from the party. Another important measure of fiscal strength is the difference between non-interest expenditure and revenue, the so-called primary deficit. At 0.1 per cent of GDP this is slightly better than the Budget estimates, but still way below the 4-6 per cent of GDP that is routinely being achieved in countries like Brazil and Turkey. It means that we are still borrowing to pay interest.
The Economic Survey is frank in admitting that, in contrast with the fiscal adjustment profile of many other countries, in India the convergence to the FRBMA targets has been primarily on the revenue side rather than on expenditure. Given the still relatively low (though rising) share of tax revenue to GDP of 11.4 per cent this is not inappropriate, although goodness knows the structure of spending remains extremely inefficient. But this is a golden moment for India in terms of fast growth and a relatively protected market for government debt. While we all expect and hope that such fast growth will continue into the future the time to generate a larger primary surplus is now, even if it means over-achieving on the formal goals of the FRBMA. Another reason for doing so is to create space in our debt burden for the counter-cyclical use of fiscal policy rather than using up all our seed corn now.
As noted earlier, a positive feature of the Budget is its continuing commitment to integration with the global economy. While widely anticipated, the reduction in the peak rate of non-agricultural tariffs to 10 per cent is a step in the right direction, and will give increased room for manoeuvre in both our bilateral and multilateral trade negotiations. At the same time, the much bruited elimination of exemptions, very important to improve trade facilitation, was nowhere in sight. Nor were any steps taken to increase the international competitiveness of our flourishing automobile sector by beginning a phased reduction in the external tariff on new cars, or, even more importantly, on second-hand cars. However, giving credit where it is due, the continued commitment to a national GST will be an enormous boost to integrating the domestic market and to our international competitiveness.
Helpful for our continued financial integration is the apparent simplification of investment by Indian residents in overseas equities through local mutual funds. While the devil will be in the detail, it is high time this was granted given the wide freedom now available to Indian companies to diversify both their assets and liabilities. The proposed capital market reforms in short selling and securities lending will also aid price discovery for both debt and equity issues. But as much academic work has noted, one of the likely consequences of greater international investment freedom for resident entities is likely to be an effective increase in the real cost of borrowing for government. Thus, a consistent, coherent strategy for financial integration really does require more aggressive fiscal adjustment to make sure that additional revenue is not swallowed up by increase interest payments, but are actually available for improved public services.
Since one of the ongoing parlour games in Delhi over the past few months has been the tug-of-war between the finance ministry and the Planning Commission, it is interesting to keep score on how all that seems to be coming out. On the issue of gross budgetary support (GBS) to the Plan the Budget speech conceded a range of alternatives designed to accommodate the demands of the Planning Commission without appearing to give in; the larger tussle on the FRBMA lies ahead. The scheme to tap reserves for infrastructure has once again resurfaced, this time with the apparent endorsement of the finance ministry. One can only shake one’s head sadly about a policy framework which first has the Central Bank buy reserves, then has government pay the cost of sterilisation, then have government offer a guarantee to the private sector to borrow the same funds! There is an easier way, and it is called a flexible exchange rate with inflation targeting. But that would be too simple for the subtle Indian mind.
I started though by talking of some sins of commission. The itch to use tax policy to achieve micro goals, evident in the relief to small cars last time, was evident once again in the cute (and unwise) scheme to curb cement prices through tax rather than competition policy. The continuation of the interest rate subsidy on agricultural credit also flies in the face of what we know about credit rationing in rural credit. Similarly, the increase in the education cess smacked of lazy tax policy. Overall, this was a budget devoid of new ideas and initiatives. Just holding the line seems to have been taxing enough.
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