Economic Thinking Takes Precedence Over Cynicism

The finance minister, Mr P Chidambaram, has finally delivered what was expected of him for a long time. The Budget this year has certainly put to rest much of the growing suspicion about the continuity of the reform process and the ability of the finance minister to formulate a good Budget.The Budget is good because it takes the most direct route to economic growth "� boosting investment and encouraging producers to produce more.

A proposed fiscal deficit to GDP ratio of 4.5 per cent, and the absolute fiscal deficit figure of Rs 65,504 crore, indicate that the finance minister has estimated a nominal growth rate of GDP equal to around 15 per cent for 1997-98. If the minister is also expecting an inflation rate next year of no more than 7 per cent, then he is actually expecting an 8 per cent growth rate of real GDP. This is not to say that if the inflation rate is higher, the growth rate will be lower! This is just to set the framework in which one must analyse whether this Budget will increase, or decrease, the inflation rate which has been hovering around 8 per cent this year.

 

People are worried that with the implementation of the Pay Commission report, increasing subsidies, etc. and a recent slowdown in some sections of the industry, there are strong inflationary pressures building up in the economy. The Budget tackles this issue head-on. An inflationary pressure is essentially too much money chasing too few goods. The finance minister has less control on subsidies and the implementation of the Pay Commission report. He, however, has more control on production. Thus, he has concentrated his efforts there. If output grows, then more money will be chasing more goods. Why will output increase in the next year?

First, import duties have been brought down, especially on some important capital goods and raw materials affecting the infrastructure sector. This will increase activity in these sectors, which slowed down considerably this year. Important export industries, like textiles and chemicals will also benefit from similar measures. The reduction in excise duties, and their rationalisation, will also boost production. Both of these will have a direct effect on prices. Insofar as taxes are passed on to consumers, lower taxes should bring the prices down.

Second, incentives have been offered to increase the savings of both households and corporates. A revival of the capital market has become necessary to allow firms to raise cheap capital for investment. The only solution is to encourage the small investors back into the stock markets and the direct tax proposals will help in this regard.

While these are obvious implications of the Budget proposals, there is a third, and not so obvious reason why there should be less pressure on price increases next year. That has to do with the personal tax measures. It is incorrect to think that lower taxes will encourage people to spend more and, hence, fuel price rises. With high taxes, people avoid paying them, and the consequent black income has a higher consumption ratio than white income. With more white money, there will be more white assets which are usually more productive than assets created with black money like, gold, real estate, etc. Also, this increase in disposable income in the hands of consumers, encourage them to vie for productive assets which, at lower post-tax incomes they could not hope to get.

The icing on the cake has been provided by the abolition of ad hoc Treasury bills. The government is the biggest contributor to inflation, with its wasteful expenditure and very little actual production to show for it. This measure alone should reign in the government's unnecessary expenses.

In short, Mr Chidambaram has decided to finally let economic thinking take precedence over the cynical pessimism about the economic discipline shown by our politicians. In that sense alone, the proposed Budget marks a watershed, just as much as (and I would say more than) that of 1991.