Up in the air

Up in the air
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First Published: Sat, Feb 27 2010. 01 50 AM IST

Road to reforms: Rameshwarji takes his daughter to school in Chhir village, Jaipur, after his wife has left for work at an NREGS site. Madhu Kapparath/Mint
Road to reforms: Rameshwarji takes his daughter to school in Chhir village, Jaipur, after his wife has left for work at an NREGS site. Madhu Kapparath/Mint
Updated: Sat, Feb 27 2010. 01 50 AM IST
New Delhi: Finance minister Pranab Mukherjee’s second effort in less than nine months is an honest attempt at consolidation and correcting the fiscal abuse of the past, but it may yet fall under the burden of scepticism emerging from the underlying macroeconomic risks and what’s been left unsaid in Budget 2010.
Road to reforms: Rameshwarji takes his daughter to school in Chhir village, Jaipur, after his wife has left for work at an NREGS site. Madhu Kapparath/Mint
In the trade-off between inflation and growth the minister, risking personal political damage, has opted for the latter and at the same time, to ensure the desired fiscal discipline, targeted subsidies in a manner that could, in the short term, imply an adjustment cost for consumers.
Together with an across-the-board increase in indirect taxes, which signalled the rollback of the fiscal stimulus, and bringing new services in the tax net, the Budget creates the basis for inflationary pressures.
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Given the politics, especially with the opposition parties staging a walkout, the first in the history of Parliament during the presentation of a budget, it is understandable that the minister stayed away from stating the bare facts about the adjustment (consumers will end up having to pay more for a variety of offerings, though Mukherjee has tried to lessen the impact of the blow). The downside is that because he hasn’t done this, interpretations are open to exaggeration. This could mean trouble when the message sinks in. This is evident in the reaction of the markets—buoyant at first, muted later.
Politically this can make the Congress-led United Progressive Alliance (UPA) unpopular and give the Opposition a rallying point, besides stirring disquiet among allies. It could also make individuals and companies hold off investments and defer consumption—threatening growth and the core of the government’s strategy.
A reforms legacy
Still, the UPA has to be complimented for seizing the political space provided by the 13th Finance Commission (TFC) to press ahead with some honest and much-needed (and politically difficult) fiscal reform even as it continues the stock-market friendly disinvestment programme. If it does not lose its nerve and effect a retreat, the UPA may well find itself in a position to add to its already enviable legacy as the political coalition that helped put in place the building blocks for a modern economy. Mukherjee has, with this Budget, already joined the pantheon of politicians such as P.V. Narasimha Rao, Manmohan Singh, P. Chidambaram and Yashwant Sinha, who pushed difficult but very critical economic reforms.
Budget 2010 also marks a departure from finance bills of the UPA’s first tenure (2004-09) when the government failed to take advantage of a booming economy to undertake structural measures to cut back expenditure. This is important because the action taken report (ATR) on the recommendations of TFC submitted to Parliament on Thursday seemed to suggest that the government had deferred any response to the proposals on expenditure reform.
It emerges that relying on the recommendations of TFC, a constitutional body, the government has actually moved ahead with a reordering of expenditure and committed itself to a transparent and binding medium-term fiscal reforms programme. Not only is the UPA going to reduce its borrowing by about Rs1 trillion from 2009-10, it has decided to embark on a new strategy: the government will cap its stock of internal debt at 68% of the gross domestic product and derive the fiscal deficit, gross borrowings, as a residual, instead of deriving the fiscal deficit from spending excesses as it used to do previously; since the government also plans to eliminate the revenue deficit, the gap between the government’s income through taxes and other revenues and its spending, this means that it will progressively reduce its borrowings. Not only will this guarantee a non-inflationary financing of development programmes, it will also ensure that such financing does not crowd out private investment and create an upward pressure on interest rates.
It is apparent that a lot of thought has gone into this Budget.
It is not, despite the Rs26,000 crore giveaways in direct tax concessions and the sustained spending on social sector programmes, by any measure a populist budget. A tax concession of about Rs60,000 for anyone earning above Rs9 lakh, a key demographic category among the middle class, would in normal circumstances be construed a sop. Instead, it is, as are the other direct tax changes, designed to ready the tax infrastructure for the introduction of the game-changing direct tax code (DTC) in April next year. Similarly, the minister has gone in for several measures—such as preferring to retain the service tax rate at 10%—in the area of indirect tax to prepare ground for the introduction of a single goods and services tax (GST).
Mukherjee has also taken an initiative to usher in the much-needed institutional reform. Key among these is the move to create the information technology infrastructure that can make a success of efforts such as the implementation of GST and DTC. Another is the implementation of TFC’s recommendation to create a national mission for delivery of judicial and legal reforms.
Equally significant is the UPA’s decision to press ahead on green initiatives. Accordingly, it has effected a 61% increase in the outlay to the ministry of new and renewable energy, funded new programmes for river-cleaning and give a big push to use of non-fossil fuels such as solar energy.
Threat of inflation
Since previous governments shied away from action on the vexing issue of expenditure reform, Mukherjee inherited a dubious legacy; matters were worsened because some of his predecessors resorted to creative accounting to mask the fiscal impact of subsidizing consumption, especially when there was a runaway rise in international fuel prices. Any effort to undo this would inevitably imply adjusting prices. Unfortunately, since this has coincided with the rollback of the fiscal stimuli that the UPA had injected over the last two years, it is likely to lend a price shock to the system—indeed, if not contained, it could spiral out of control.
Inflation, as measured by the Wholesale Price Index, was already high at 8.5% in January; more worrying is the fact that food inflation continues to remain in the high double digits.
Some of the inflationary effects of the Budget have already resulted in price rises in some offerings; rises in several others could follow. The list of such offerings includes fuel, cars, air tickets, cement, coal, cigarettes, consumer products, and air conditioners.
The challenge
Going green: The UPA has pressed ahead with environmental initiatives in its 2010 Budget. Ramesh Pathania/Mint
The Opposition has, by seizing on the weak link in the Budget, signalled its intent to throw down the gauntlet on inflation. The UPA has no choice but to take up the challenge; it will find the going difficult since some of its allies have very publicly differed with it on politically sensitive reforms. So far, the Congress has demonstrated leadership qualities by refusing to bow to such pressures, even as it has, occasionally, passed on the responsibility to politically weakened allies such as the Nationalist Congress Party led by Sharad Pawar. It has been helped, no doubt, by its firm commitment to inclusive growth, something that Mukherjee referred to as “an article of faith”.
The Congress’ spin doctors will have to back Mukherjee and wear down the political criticism to the Budget. To its advantage, the Congress still enjoys credibility with people; but in politics, like in cricket, situations can alter dramatically and often without warning. What would also help is the fact that Mukherjee, as a CVoter survey reported in Mint on 25 February, showed enjoys personal credibility. Troubleshooters of the government have already indicated that they are prepared to take on the political opposition. The Congress has 208 seats in the Lok Sabha, needs 273 for a simple majority in the House, and it still has the backing of 276 members of Parliament—even after the withdrawal of outside support from the Samajwadi Party and the Bahujan Samaj Party.
The real test for Budget 2010, however, will be the ability of the UPA to ensure strong policy response to prevent inflationary pressures from spiralling out of control. So far, it has been found wanting on that front. But now the stakes, both political and economic, are very high. Any misstep in policy would not only set back the Congress as well as the UPA, it could plunge the country into an economic crisis—that could mean missing out on a once-in-a-lifetime opportunity to break the economic shackles and deliver inclusive growth.
anil.p@livemint.com
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First Published: Sat, Feb 27 2010. 01 50 AM IST