Shankar Acharya: Year of the Carp

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Shankar Acharya: Year of the Carp

A PIECE OF MY MIND

Shankar Acharya / New Delhi March 13, 2008

A fortnight has passed since the Union budget was presented. As usual, it has provoked reams of commentary from serried ranks of financial journalists, tax consultants, investment analysts, general columnists and, of course, my own tribe …economists. Reviewing the flood of material that has been published, I am struck by the apparent disconnect between the views of the general run of commentators (GC, for short), who have broadly welcomed the budget, versus the economists tribe, who have been mainly critical (see, for example, the views of six economists in the latest India Today). Why this disconnect between carping economists (CE) and the other professional commentators? The following Platonic dialogue between a fictional representative of each group tries to shed some light.

GC: Hey, man, that was a really good budget, wasn’t it? FM has made all the big vote banks happy: farmers, urban middle class, aam admi and the poor. And he has done it without sacrificing fiscal prudence. He has even thrown in some reform stuff for you reform-wallahs. You have got to hand it him. He has pulled off the impossible: a sound budget with enormous political appeal. What more could you have asked from him? A Bharat Ratna for sure!

CE: Well…I concede it’s a clever, political budget. But it’s not that good when you look at it carefully. Let’s take a look at the four major dimensions of the budget: reform announcements; overall fiscal stance; expenditure priorities and tax measures. Take reforms first. There’s no forward movement on the big ticket reform needs of the country such as power sector overhaul, privatization of banking and energy companies, major subsidies, labour laws, agricultural policy, education, retail trade and so forth…

GC: Come on, yaar! Be reasonable. You know perfectly well that the Lefties and the Congress old guard have blocked all these reforms for the last four years. What do you expect FM to do about it? Besides, he has given you some tax reform and something about “bond, currency and derivative markets”. Boy, you economists are really mean! Any way, let’s move on to your “fiscal stance” yardstick. He has really hit a sixer there. Even bigger than Yuvi’s in the 20-20. In spite of his generous tax moves and expenditure increases he has managed a fiscal deficit of only 2.5 percent of GDP for next year, well below the 3 percent mandated by the FRBM law. And while he is bringing down your favourite fiscal deficit, he is still successfully boosting overall demand through his expenditure hikes, excise cuts and income tax slab concessions. Quite a rope trick.

CE: You could say that. It’s too good to be true. First off, if he really succeeds in bringing the fiscal deficit down from 3.1 percent of GDP to 2.5 percent, then he would have reduced the fiscal stimulus in the economy. It’s the net position that counts, not every individual tax break or expenditure increase. But I don’t think he will achieve the target because of four big items. The Sixth Pay Commission award is almost certain to increase expenditures by at least half a percent of GDP. The farmer loan waiver costs are unfunded, whether in cash or bonds. The projected subsidies for food and fertilizer look under-budgeted, not to mention the strong likelihood of higher off-budget accommodation to the oil companies. And the 17 percent income tax revenue increase looks way too optimistic after the big bonanza through tax slab changes. So expect additional government borrowing and some upward pressure on interest rates later in the year. But, oddly enough, the higher fiscal stimulus may not be all bad in a year when the foreign trade gap may widen and domestic consumption soften because of negative wealth effects.

GC: That’s quite a concession from a fiscal fundamentalist like you. Sure you are feeling ok? Now I suppose you want to talk about the expenditure side. And I bet you only want to talk about the farm loan waiver. You guys don’t care when overdues from rich industrialists are written off by banks. But you yell and scream about “moral hazard” and “credit culture” when poor farmers are given a break. Hey, did you see that Surjit Bhalla and Sunil Jain (BS, 11 March) have estimated the waiver to be less than half FM’s figure of Rs. 50,000 crore. So what’s your problem?

CE: The loan waiver does bother me. It’s not so much the fiscal burden, whatever that turns out to be. The real problem is that it conveys a powerful signal, which will undercut the initiatives for financial inclusion. Just think what this move does for the future climate for sound credit systems and subsidy containment when famous reformers like Manmohan Singh and Chidambaram are seen to be blessing government-sponsored loan waivers (that’s very different from an individual bank writing off a particular industrialist’s non-performing loan). We live in a populist democracy in populist times. This move will encourage more competitive populism and undermine sound economic policies. As for all the other expenditure increases, they are not much different from previous budgets. The disappointment is that FM’s earlier clarion call for more focus on “outcomes than on outlays” seems to ring a bit hollow after five UPA budgets.

GC: At least, you will admit that his revision of the income tax slabs after ten years is both good politics and good economics? And the reduction in the CST to 2 percent and the CENVAT rate to 14 percent are moves in the right direction towards an integrated GST. Or are you going to carp about the tax proposals too?

CE: Well, you expect me to carp…so here goes. The tax slab revisions are good, though it would have been better if these were revised approximately in line with inflation every three years or so. I would have welcomed the CENVAT reduction more if the government had shown the courage to raise the general service tax rate closer to 14 percent from the present 12. (By the way, how come legal services continue to escape inclusion under this tax?). And was it really necessary to continue tinkering with excise and customs duty rates on particular commodities? But my real unhappiness is with FM’s continued proclivity to introduce odd new taxes. This time we have the CTT on futures trading in commodities and the effective hike in the rate of STT for stock traders. Both show an unfortunate affection for turnover taxes when the thrust of tax reform is towards taxing value added. The CTT could seriously hurt the nascent activity of commodity futures trading on organized exchanges. And the revision of the STT will hurt the brokerage business at a time when it’s already reeling from massive declines in stock trading volume. But then neither group has political clout.

GC: You economists are complete bores, yaar. You are always looking for dark clouds when the sun is shining. Luckily, nobody cares what you think or write. Hey, how come you are titling this ‘Year of the Carp’ when everybody knows it’s the Year of the Rat?

CE: Now look who’s carping….

The author is honorary Professor at ICRIER and former Chief Economic Adviser to the Government of India. Views expressed are personal

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