Grounded in reality, paves way for a responsible Budget: Shubhada Rao

Prudent policy support from fiscal side and in turn monetary policy could leading to a virtuous cycle of recovery

Ahead of unveiling of the Union Budget, the finance ministry tabled the customary Economic Survey for FY13, a flagship annual document considered a precursor in shaping the Budget expectations. While the tone of the Survey was marked by caution for the current financial year, it sounded more optimistic on the 2013-14 outlook.

The survey acknowledged the current economic slowdown, an overhang of 2011-12, being rooted primarily in domestic factors, though global factors have played their due share. A sharp slowdown in investments and private consumption ensued during the course of the financial year, owing to a confluence of factors such as tighter monetary policy, elevated inflation, lack of administrative and policy impetus. The survey, however, welcomed the government's recent reform measures, such as deregulation of diesel prices, opening up of foreign direct investment in retail and liberalising investment norms for various sectors, including insurance. As such, the survey predicts a turnaround in FY14, riding on an improved investment climate on the back of reforms, lower inflation and consequent easing in interest rates, accompanied by government continuing with its fiscal consolidation efforts. It anticipates economic growth to rebound in the range of 6.1-6.7 per cent in 2013-14, compared to a decadal low of 5 per cent pegged by the Central Statistics Office for 2012-13.

Focus on subsidy managed fiscal consolidation
Reeling under the threat of a credit downgrade from global rating agencies, the government unveiled a revised fiscal consolidation road map late last year. We have witnessed the finance minister's persistent commitment to the revised target turning into a reality, owing to a massive compression in expenditure.

The FM is expected to announce fiscal deficit target of 4.8 per cent of GDP for 2013-14, implying an effective fiscal consolidation of 50 bps over 2012-13 and 100 bps of 2011-12. That would be a significant achievement amid a deteriorating growth environment. To be able to achieve the fiscal deficit target, while options to increase revenues remain limited in a slowing economy, the focus of the government will, and should be on expenditure management by controlling subsidy outgoes. The Union Budget must be utilised as a platform to showcase the drive of a�'�'economic reality', and possesses the grit and determination to deliver what is economically right for the economy, while eschewing the need to be populist on the eve of general elections scheduled in 2014.

Total subsidies as a percentage of gross domestic production (GDP) have risen from 0.7 per cent in 2004-05 to 2.2 per cent in 2008-09, and have remained consistently above 2.0 per cent since then. The Budget last year had outlined the intent to restrict expenditure on central subsidies to under 2 per cent of GDP in 2012-13, and to lower it further to 1.75 per cent of GDP over the next three years. The FM is expected to uphold this commitment this year as well. Towards this end, while the government has initiated subsidy reforms by allowing oil-marketing companies to adjust diesel prices by small quantities and adjusting fertiliser prices, it is critical that these measures are implemented in entirety.

The recently rolled out direct cash transfer scheme, while expected to reduce transaction costs and leakages along with better targeting of subsidies; has kept major subsidies of food and fuel outside its purview. Extending the cash transfer scheme to major subsidy items, where the scope of plugging the leakages is largest, is bound to improve expenditure efficiency over the medium term. In addition, reprioritization of expenditure mix away from untargeted subsidies, will create the much-needed fillip to crowd in private investments and free resources for strengthening the social safety net. A subsidy-reform led fiscal consolidation has positive implications for the current account deficit and inflation, by normalising demand in conjunction with market determined price. As fiscal consolidation gets back on track, savings and capital formation should also begin to rise. According to the economic survey, the year 2012-13 could possibly act as a point of inflexion. The vicious circle of last two years is expected to end, with prudent policy support from fiscal side and in turn monetary policy, leading to a virtuous cycle of recovery.

Shubhada Rao
Chief Economist, YES Bank