Why did the Budget make the markets plunge nearly 900 points? Was it poor communication on the finance minister’s part or did the markets genuinely tank over the fiscal deficit? Whatever it was, there was surely a disconnect—the only question is whether it’s between Bharat and the markets or the minister and the markets. For, the Budget signifies a structural shift in the way macro policy is likely to be framed in the future—well, at least during the tenure of this government; others to follow might just mimic this model. Increasingly, the focus in coming years will be where 60% of the population resides. We could call it populist or electorate-driven; the point is that it is here to stay. The markets had gotten used to being spoken to by budgets—this government is speaking to 1.2 billion people. And time will tell if this is only populism or if it actually raises the productive potential of the economy.
Illustration: Jayachandran / Mint
The Budget signifies a shift by aiming at infrastructure in a big way, especially in the rural sector, to boost economic growth. Increasing capital expenditure, Plan and non-Plan, by 36% in the current year over 2008-09 (revised estimates) and intending to raise investment in infrastructure to exceed 9% of gross domestic product (GDP) by 2014 is a massive effort in that direction. The 87% jump in allocation for the Jawaharlal Nehru National Urban Renewal Mission, refinancing for banks up to 60% by India Infrastructure Finance Co. Ltd along with investment targets, a 160% increase in the Accelerated Power Development and Reform Programme allocation, a 23% increase in the share of the National Highways Development Programme and housing initiatives for the urban poor, etc., all fit into this design.
In doing so, there is a conscious policy shift to direct a significant portion to where future private investment and consumption demand is going to come from—rural India. Key public investment initiatives announced in the Budget—a 45% increase in allocation for the Bharat Nirman programme, a 30% rise in the share of the Rashtriya Krishi Vikas Yojana, slated to create close to 12 million jobs, a 75% increase in allocation for the Accelerated Irrigation Benefit Programme to realize the 4% agricultural growth objective, tax incentives for investments in establishing and operating “cold chains” and storage warehousing facilities for agricultural produce—are all efforts in this direction. These hefty investments are complemented with short-term, consumption-boosting initiatives: a 144% jump in allocation under the National Rural Employment Guarantee Act, a demand-driven programme, extension of debt waiver and interest subventions as well as increased targets for agriculture credit.
Even standard textbook policy prescriptions—a fiscal stimulus to lead the economy out of a downturn must aim at enhancing the economy’s long-term productive potential, as consumption-based stimuli are temporary in nature and, hence, have short-term validity— cannot squabble with this. If one were to take a longer, broader, view of post-crisis, macro policies since last year—the immediate, short-term, consumption-based boosters are now being supplemented with a long-term, productivity-enhancing fiscal effort—have been laying the basis, as it were, for enhanced productive capacity when the economy picks up.
Next, the Budget places social security firmly on the political agenda by initiating provision of social security to unorganized sector workers and introducing a National Food Security scheme. These will be difficult to reverse until economic conditions improve with the economic cycle or structurally, as income levels rise in the future.
But the markets discounted all these measures. Perhaps they were looking for reforms and, maybe, a road map for fiscal consolidation. So why is it that key structural reforms—release of the new direct taxes code within 45 days and to expedite the process for introduction of the goods and services tax (GST) with effect from 1 April 2010—did not generate any positive sentiment? Nearly every analyst had written off the GST introduction by this date before the Budget, so maybe it wasn’t expected at all. But that does not detract from the fact that these reforms have enormous potential for increasing revenues and stimulating economic growth, as recently spelt out by Vijay Kelkar, chairman of the 13th Finance Commission.
Combined with the reorientation of the current fertilizer subsidy regime, the Budget can be called reformist. But not exactly in the way the markets wanted or expected.
Financial sector reforms and disinvestment, the reaffirmation that banking and insurance will remain in the public sector and a measly Rs1,120 crore budgeted revenue from divestment caused the mayhem. How the markets could expect a big-bang announcement on both these issues defies political economy logic. At the best of times, lowering stakes in banking and insurance has been a thorny issue; with the massive private bank failures in the West, which make India’s public sector banks shine in contrast, it was a bit unrealistic to expect any moves on this count. And a quick look into the past history of disinvestment, privatization, or whatever we might call it, shows how politically contentious these reforms are, and will continue to be. Announcing divestment upfront would surely be sounding its death knell even before it has begun. It will happen, no doubt, but gradually and in a politically non-controversial style; as the finance minister put it, “with people’s participation”. In fact, it’s very much his style of politics—he always looks for consensus and is very effective at achieving it; for five years, he was the single Congress point man, building bridges on contentious issues.
So not only were the markets expecting much too much, but they also misjudged the “gradualism” that characterizes India’s reform process, a feature noted by Planning Commission deputy chairman Montek Singh Ahluwalia in his analysis of India’s reforms.
Renu Kohli was until recently with the International Monetary Fund. Comments are welcome at firstname.lastname@example.org