The union budget of India announced today seemed to be way too optimistic. Agreed there were some positive announcements, but the budget fails to address the concerns plaguing the economy for long.
While black money is supposedly one of our biggest concerns, the agriculture sector continues to be untaxed. As a result it has become an avenue for the high and mighty to evade tax. With they being well connected and a large number of politician themselves being beneficiaries of these largesse (directly or indirectly), this is not an issue that is even thought fit for discussion
Both the Economic Survey and the Budget has been very explicit about the threat that inflation poses. However, during the entire budget speech, there were only nine references to inflation, mostly passing and the only explicit measure (if I may call so) was dependence of hope. Hope that inflation will come off due to the lag effect on tight monetary policy and the base effect. There has been some mention of improving supply response of agriculture to the expanding domestic demand and expecting the states to do something agricultural marketing policy but no definitive announcement were made to underline real intent
The budget also talked about implementation gaps, leakages from various public programmes and the fact that quality of outcomes pose serious challenge. But, as has been the case of all the earlier budgets, no serious intent have come forth which shows that the government is serious about administrative and bureaucratic reforms that can help plug the loopholes. Way too much hope, it seems, is pinned on the UID programme, which is not supposed to be mandatory in any case
To me, however, the biggest disappointment is the way deficits are being treated. it is important to note here that during the previous budget, the government expected to garner about Rs.350 billion from auction of 3G spectrum. In reality, they garnered close to Rs.1,000 bn. With such a cushion, it was widely expected that the actual deficit numbers for FY11 would be much lower than that of the budgeted. While the budget estimate for FY11 was for a fiscal deficit of 5.5% of the GDP, in effect it came at around 5.1%. Despite the one-time windfall gain through spectrum auction and some positive tax buoyancy, the fiscal deficit was as high was 5.1% of GDP. In fact, the extra revenue from the auction (than what was budgeted) was about 0.8% of the GDP. In effect, the government clearly slipped on the fiscal deficit front. In fact, the actual deficit at Rs.4.01 tn was higher than previously budgeted at Rs.3.81 tn. On the other hand, the revenue deficit, was turned out to be lower than what was budgeted (at Rs.2.7 tn as against Rs.2.77 tn).
Even, at first glance, some of the assumptions seem to be questionable. During FY12, the subsidy burden is pegged at Rs.1.44 tn as compared to Rs.1.64 tn during FY11. This, at a time when oil prices are expected to remain on boil. The government’s best bet is the so called move toward market related pricing. And there is a big if. When diesel is not market related and continues to be subsidized as inflation fear holds grip, how can mere adherence to market related petrol prices serve the purpose? Also, even though the petrol prices are market related, these do not rise immediately, thereby adding to the subsidy burden. The greater fear, of course, is the international price level itself. The uprising that started in Tunisia has spread to Libya with a much more destructive connotation. As the turmoil spreads from North Africa to Middle East, oil prices are expected to remain at elevated levels going forward. This can and will add further fuel to the subsidy fire. Add to that the subsidy implication of the food security bill, and there is very little chance of the subsidy bill remaining under check. With subsidy being the holy grail of Indian politics and with five states scheduled to go for polls during FY12, not much hope can be pinned on the government being able to control subsidy, let alone reduce it.
Even the expected growth in nominal GDP is a bit suspect. The budget document assumes a 14% growth in nominal GDP during Fy12. Given that the government expects the inflation to be at 5%, the targeted real GDP growth rate is a pretty optimistic 9%. This will be a real tall order, especially given that rising interest rates are expected to slowdown domestic demand, Europe expected to just muddle through or even experience contraction in some economies reeling under steep budget cuts and US unlikely to hold onto the stimulus driven rebound in growth for long.
One thing is sure though. Fiscal deficit for FY12 is most likely to be on the other side of 5%, irrespective of what the so called roadmap might want us to believe.
With the Union budget of India slated to be released next Monday, India's Finance Minister Pranab Mukherjee would be in a much happier frame of mind than he was during the presentation of the previous budget. This has mostly to do with the current state of government finances. The following table indicates why:
India’s fiscal deficit for the first nine months is only 44.9% of the budget estimates, while it was 77.3% in the previous year. Similar is the situation with Revenue Deficit and Primary Deficit, both of which are substantially lower than what it was in the previous year. And, this despite the total expenditure being relatively higher at this point in time.
What explains this healthy situation? Two important developments. One positive – greater tax buoyancy and, the other fortuitous - windfall revenue generated through the auction of the 3G (Third Generation) spectrum and broadband. It is important to note here that the revenue generated through the auction was more than Rs. 1,000 bn.
The bigger problem, however, is the deficit itself. Rather, the constituents. In the report, “The Future of Public Debt: Prospects and Implications,” by Stephen G. Cecchetti, M. S. Mohanty, and Fabrizio Zampolli, published by the Bank of International Settlements (or BIS Working Paper No. 300), there is discussion two types of deficit viz. cyclical deficit and structural deficit. A cyclical deficit refers to the deficit that increases at the lower end of the business cycle and decreases when the cycle turns around. Structural deficit, on the other hand, refers to the deficit that shows stickiness across the business cycle.
In case of India, most of the deficit components are structural in nature. And during high growth period, India has demonstrated the uncanny ability to find expenditures to meet rising income rather than conserve the same for the rainy season. The best example that comes to my mind is the debt waiver scheme that was announced during Feb’08 that was estimated to cost Rs.600 bn. Did this scheme led to lower indebtedness? Highly doubtful. Has this scheme reduced incidences of farmer suicides? NO. Could this amount been better utilised? Anyday.
First, there’s the holy grail of Indian politics – subsidy. Oil subsidy remains high. So does fertilizer and food subsidy. And, once Food Security Bill comes into force, the impact could be debilitating. As per the estimates of the expert committee headed by Dr Rangarajan, Chairman of the PM’s Economic Advisory Council, food subsidy will rise to Rs. 920.60 bn, which is about 65% higher than the estimated subsidy bill for the current financial year. As this will call for increased procurement of foodgrains, one can only expect a rise in MSP (Minimum Support Price) to achieve this objective and also additional cost of storage of foodgrains.
Currently, oil subsidy itself is estimated to be close to Rs. 750 bn. Additionally, as the turmoil in the African nation spreads to Middle East, the situation can worse. And, with inflation remaining high the government will, per force, prefer not to align domestic oil prices with international prices, for fear of further backlash. Thus prices of petroleum products and fertilizers are likely to remain the same, thereby inflicting further damage to the fiscal position.
With regard to the comfortable fiscal situation this year, let us not be under any illusion of successful fiscal management by the government. There’s no indication whatsoever about the governments intent to bring a check to its profligate ways – be it through reduction of wasteful expenditure or through administrative reforms to check the huge leakage in the system or more prudent subsidy schemes. With unchecked rise in expenditure, the only way the deficit can be under control would be through increase in receipts. And, that’s a big if.
With the 3G auction behind us, only other source of some one-off revenue would be disinvestment in government entities. Success would depend on improvement in overall investment climate. If the climate does not improve the government will be hamstrung. Thus the hope of the government would pin on rising tax revenue. Whether the tax revenue will continue to be as buoyant, remains the moot question. With GDP growth expected to be lower next financial year, things do not definitely look as good. More so with the government facing a crisis of confidence, in terms of high inflation and corruption at higher levels. I believe that the forthcoming budget would see the government adopting more populist schemes to deflect the recent spate of criticism. This will mean, good bye to fiscal prudence.
The IIP number released today merely confirms what I have been saying for a long time. India's Index of Industrial Production or IIP plunged to a low of 1.6% in December 2010 as compared to 18% recorded during the same period in the previous year. In November, 2010, the Index of Industrial Production had expanded by a meager 2.7%.
Clearly the process of the slowdown that started as early as March'10, continues. A look at the three month moving average data (3-MMA) confirmed the slowdown from March and now, with Monetary tightening starting to take effect, slowdown is but a natural consequence. Add to that negative signals emanating from the capital goods sector and things indeed look less than sound, atleast in the short to medium term.
With inflation likely to remain at elevated levels as is the interest rate, 2011 will be quite a difficult year for India. This also exposes the basic frailty of the Indian economy. A supply constrained economy like ours is expected to face inflationary pressures if the economy starts to grow fast over a period of time.
All actually boils down to the basic problems that continues to haunt the economy:
1) Inadequate physical infrastructure
2) Continuous under-investment in agriculture
3) Clear lack of accountability in governance
4) Policy decisions with political overtones that result in wrong policy choices etc
An economy that flatters to deceive, I expect the FY 2012 GDP growth to hover between 8 to 8.2%, with a downside risk. Its a shame really, given the potential that is there.
I will conclude with my favouraite phrase - India is growing despite the politicians and not because of them