Inflated expectations

INTERIM BUDGET & OPINION

At the end of the day, one has to accept that the finance minister was operating under a number of rather serious constraints as he worked on his proposals for the interim Budget.

One, he was dealing with a convention, and a very legitimate one at that, which frowned on any significant tax or expenditure announcements on such occasions.

Although many people expected him to break ranks with his predecessors on this issue, there were equally strong views that he would adhere to it.

Two, he had to be working on the assumption that there was a strong probability that he would be back in North Block after the elections; if not him, then someone from his party at least.

If he were to take a completely opportunistic view of the situation and use whatever leeway he had with the procedural constraints to commit resources to a whole range of programmes, he or his successor would have to deal with the consequences when they came into office after the elections. You don't want to completely scorch the earth that you anticipate returning to.

Three, there is a clear trade-off between initiatives that take effect immediately and have an impact quickly but benefit only a small group of people and those, which are grand in scope and potentially benefit a large number of people, but whose impact is felt, if at all, after years.

In his first Budget speech last year, the finance minister had shown a proclivity towards dealing with a whole range of relatively small and focused sectoral objectives.

In this speech, he took this to an extreme, for example, in describing the increase in house rent allowance for government employees posted in a few places.

This approach suggests a pragmatic orientation towards what works quickly, even if the impact is narrowly spread and combining many such small initiatives in the hope that some of them will pay off in the short run.

The combination of these three constraints gave the finance minister relatively little room to work with. Many initiatives were announced, in keeping with his approach to simultaneously address the concerns of many small groups.

However, very little, if any, mention was made of any financial commitments to these schemes by the central government.

In this sense, the convention of not committing government resources was adhered to; however, if the minister is to return to office after the elections, he is certainly accountable for the promises he made in this speech and would have to look for resources to implement them with.

Setting up six institutions along the lines of the All India Institute for Medical Sciences, assuming that this is a good model to follow, is going to take large amounts of money and, presumably, a significant share of this must come from government.

One glaringly negative tendency that the minister has displayed in both the announcements made prior to the interim Budget and in it is the reliance on interest rate distortions to deliver benefits to various groups of people.

It must be borne in mind that the entire thrust and direction of financial sector reforms so far has been to move towards market-determined rates of interest.

In fact, I would argue that one of the most significant economic achievements of the current government is the reduction of the administered rate on small savings schemes from 12 per cent to 8 per cent over a three-year period.

This had an enormous impact on interest rates across the board and as they came down, they stimulated demand for housing, automobiles and durable goods.

However, the market orientation of interest rates that represented such a positive development is now apparently vulnerable to a new round of distortions.

Senior citizens, exporters, farmers "" the groups of people who are apparently going to be the beneficiaries of distorted interest rates is growing larger and larger and the potential impact on the banking system correspondingly more alarming.

If these schemes are implemented to the letter, they could make banks more fragile and a government bailout down the road that much more likely.

Also, they make banks that much more vulnerable to intervention in the process of meeting targets for lending to these defined interest groups.

This is an unwelcome return to a scenario from which the system has been trying very hard to escape. There is little question that, left to themselves, banks would probably not cater to the groups whose welfare the government is concerned about.

But, it is time for the government to think of more efficient redistributive mechanisms and explicitly provision for the subsidies involved. Continuing to rely on banks to meet welfare objectives is simply going to weaken the financial system some more.

The announcements apart, the key information contained in the Budget was about the government's financial performance in the current year.

The fiscal deficit was estimated to be 4.8 per cent of the GDP, a significant reduction from the Budget estimate of 5.6 per cent. Three factors have contributed to this: lower than budgeted expenditures, which is not necessarily a good thing; higher than expected revenues, particularly on the direct tax front, which, will not persist; and higher than expected GDP growth, which may or may not persist.

Under the circumstances, the projected deficit/GDP ratio for 2004-05 of 4.4 per cent is a red herring; it is based on simple projections of expenditure and revenue based on a rather optimistic assumption of GDP growth.

Getting from 5.6 per cent to 4.8 per cent is certainly an achievement, whatever the reasons may have been.

However, next year's deficit will only become visible when the new government backs up its good intentions with resource allocations.

At least on this count, the give-away to government employees by merging their basic pay with 50 per cent of their dearness allowance needlessly locks the successor government into one more escalation in committed expenditure.

(The writer is Chief Economist, Credit Rating Information Services of India Ltd. The views expressed are personal)