India’s new finance minister enters with high expectations.
Living up to these is not easy at the best of times. It’s even harder when economic growth is in a nine-year trough and macroeconomic indicators are flashing red. Still, he began with a statement of intent extending to taxation, inflation, investment and savings, interest rates and fiscal consolidation. The vast array makes one wonder how much action can be packed into one movie.
Fortunately, he need not act beyond public finances. Pulling up the fiscal boot laces will improve matters everywhere else. But when tax revenues are sliding and the year happens to be the last but one before a general election, that’s easier said than done. Political consensus on subsidy adjustments may prove elusive, forcing him to focus on the revenue side of his balance sheet.
For that, the best short-term course is to maximize non-tax revenue; in other words, disinvestment, which is projected to yield Rs 30,000 crore in the 2012-13 budget. It helps that his presence reassures markets and investors; their sentiments are crucial to sustain the recent revival of interest in Indian stocks as global risk shifts to equities; portfolio capital inflows in July rose to $2.6 billion. Other factors also impart an upward bias: Market valuations are perceived fair; uncertainty on tax issues is receding. So a return to the January-March scale of inflow is not unimaginable; in the year-to-date, India has managed to attract the highest capital inflow in Asia. So a ready-state with disinvestment issues should cash in on the pulse of this momentum.
The denominator, or GDP, needs work too. With the economy now expected to grow slower than budgeted, deficit targets will overshoot. Here, switching budgeted expenditure toward investment and away from consumption, fulfills an important real and signaling role. Between private and public capital expenditure, the government directly influences the latter, so speeding up on some key projects will raise infrastructure investments. Growth and private investments will respond to multiplier effects in the next few quarters. Productive spending will also help bring down inflation, and importantly, the high-cost environment, which isn’t exactly due to tight monetary policy alone. Without these supplements, calibrated risks like a reduction in policy rates will be an ineffective quick-fix.
All this improves matters cyclically, although that matters for pesky credit rating agencies. India’s public finances remain structurally weak and the singular cause of its non-investment grade status. In P. Chidambaram’s earlier stint, unprecedented high growth rates helped improve public finances to even post a primary surplus in 2007-08. This created the illusion of a structural improvement that profligate spending and hard times have since rudely dispelled. On Monday, experts were also appointed to draw a fiscal consolidation path. This should be formalized into a second round of fiscal rules, now well overdue. A Fiscal Responsibility and Budgetary Management Act II, coincident with the 14th Finance Commission the tenure of which commences soon, would contribute to strengthening afresh the country’s fiscal position. Chidambaram should live up to his reputation by elevating India to an investment-grade country in his third stint.
Renu Kohli is a New Delhi-based macroeconomist; she is a former staff member of the International Monetary Fund and Reserve Bank of India.