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Shankar Acharya: Some pre-Budget musings

What are the five or six major challenges facing the Indian economy on which some serious policy action could be taken in the Budget?

Shankar Acharya 

Budgets just aren’t what they used to be. Where are the major tax reforms and important economic reform announcements that used to drive the budgets of the 1990s? These days they are notable by their rarity. Even when such announcements are made (and repeated in several successive Budget speeches) heralding the Goods and Services Tax (GST) and the Direct Tax Code (DTC), the promises are not borne out by performance. Postponement is the order of the day. Perhaps governance, in general, has got harder over time and economic policy (including budgets) simply reflects that broader reality.

It certainly doesn’t help when there is entropy in the official structures charged with budget-making. Thus the venerable institution of the “budget group” (BG) in the finance ministry seems to have greatly weakened since 2003, if it has not been disbanded. The BG consisted of the three departmental secretaries of economic affairs, revenue and expenditure (with the senior-most designated as finance secretary) and the chief economic adviser. In the old days, the BG would begin meeting in late November, both by itself and with the finance minister (FM). The frequency of meetings (coordinated by the additional secretary, budget, in the department of economic affairs) would gradually increase and rise to a crescendo in January and February, with many meetings on tax issues held in the inner sanctums of the two revenue boards rather than in FM’s chambers.

The competence and cohesion of the BG was deemed to be a significant element in successful budget-making. Its continuity between November and next April was taken for granted. Not so in the last two years. Last year the revenue secretary was allowed to superannuate in the middle of the process. This year, ten days ago, it was the turn of the finance secretary (also head of the economic affairs department). I do not recall any comparable case in the twenty-five years prior to 2010. Of course, if the BG’s role has been diminished any way, the disruption from the exit of individual members may be less.

Turning to substance, what are the five or six major challenges facing the Indian economy on which some serious policy action could be taken in the Budget?

First is the continued stubbornness of inflation, especially in food articles. It has been many years since food inflation has been in double digits for two successive years. Thus far, the government has mainly left it to the RBI to battle inflation through a series of small increases in policy rates. The government has not explicitly tightened fiscal policy, although its failure to spend authorised amounts has contributed to a short-run liquidity squeeze. Thanks to this, high inflation (which boosts the GDP dominator) and the massive bonanza from spectrum auctions, the Centre’s fiscal deficit in 2010-11 is likely to be well within the 5.5 per cent of GDP target.

The deficit is slated to drop to 4.8 per cent in 2011-12. Given the stickiness of inflation, the forthcoming Budget should target a lower fiscal deficit in the range of 4 to 4.5 per cent of GDP. This would make for a more balanced monetary-fiscal mix and lighten the pressure on RBI to undertake further investment-discouraging increases in policy rates. The Budget should also announce a set of measures to strengthen the supply chain in agriculture and reduce restrictions on trade and marketing, including on foreign direct investment in retail.

Second, India’s current account deficit in the balance of payments has widened substantially in the last three years (to 3.7 per cent of GDP in the first half of 2010-11), while its financing has relied increasingly on more volatile components of capital inflows. Aside from more active currency management by RBI (which is necessary), the recommended reduction in the fiscal deficit should help reduce the current account deficit. In addition, significant reforms/improvements in policies relating to natural resource management (notably, mining and hydrocarbons) could spur more stable, direct investment inflows.

Third, India faces a huge challenge of a “youth bulge”, also referred to as the “demographic dividend”. Government estimates suggest that the annual increment in the labour force is about 12-13 million a year, of which only 10 per cent or so is finding jobs in various organised sectors. The remaining 90 per cent is condemned to eking out a precarious living in various forms of casual/informal activities. The single-most important antidote to this growing problem would be to reform our currently anti-employment labour laws. This reform would also provide a powerful stimulus to labour-intensive manufacturing (for both exports and the domestic market), which has been languishing in recent years, dragging down both employment and overall manufacturing growth. Successive governments have ducked this issue. It would be a huge and long overdue step if this Budget were to confound expectations and announce reforms.

Fourth, in his Budget speech a year ago, the finance minister had stated “if there is one factor that can hold us back in realising our potential as a modern nation, it is the bottleneck of our public delivery mechanisms”. The plethora of scams and scandals during the past year have certainly amplified concerns about India’s rickety and corrupt public delivery systems. Oddly, this does not seem to slow the burgeoning of government entitlement programmes, where hundreds of thousands of crores are spent to ostensibly help the poor and the weak, but most of the money (Rajiv Gandhi used to say 85 per cent) winds up with various intermediaries who have become adept at milking the vulnerable delivery systems. This Budget could announce serious moves towards targeted cash transfer systems based on the Unique Identification programme that has been gaining critical mass in recent times. Simultaneously, the Budget could formalise forward movement on the recent announcements by the Congress party president to improve governance and reduce corruption, including through initiation of state funding of elections.

Finally, with each passing year that reforms in agriculture remain stalled, rural distress mounts and the disparities between the rural poor and the urban rich become increasingly glaring. The broad thrust of necessary reforms has been outlined by successive high-powered committees. The challenge is to find the political will for implementing changes.

Will this Budget announce serious measures to meet the five challenges outlined above? If the past is any guide, it might be prudent to harbour low expectations, while nurturing hopes for pleasant surprises.

The author is honorary professor at ICRIER and former chief economic adviser to the Government of India. The views expressed are personal

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First Published: Thu, February 10 2011. 00:45 IST