New Delhi: In the trade-off between growth and inflation, finance minister Pranab Mukherjee had last year plunked for the former and delivered a budget that was growth-oriented but potentially inflationary. Looking back, he would have reason to be pleased that not only did he manage to protect the growth trajectory but was also on course to achieve unprecedented fiscal consolidation—at the end of December, about 45% of the fiscal deficit target for 2010-11 had been used up, compared with an average of around 60% at this time of the year.
But it has come at a cost. A year later, the risk underlying the finance minister’s macroeconomic bet eventually came true and the country is once again nudging double-digit inflation (Mint had dubbed the effort as “Up in the air”). As a result, Mukherjee will have to face up to the same vexing question: push for growth or work to dampen inflationary pressures?
With elections due in four states, in all of which the Congress is potentially looking to regain power or to retain it, the answer is obvious. So the big test of this budget is what it can do to fight inflationary pressures, both in the short run and long run. In fact, it would be safe to say that managing inflation is not only the key priority but is also rapidly emerging as a binding constraint. Strong signals in the Union budget due on 28 February would dampen inflationary expectations and bring some relief in the short run.
It won’t be easy though. International crude oil prices, driven by the nascent recovery in the US as well as the turmoil in West Asia, have already begun to harden; generally, commodity prices, driven by crop failures, too have begun to touch the peaks of 2008, generating a fresh wave of food inflation. India has been saddled with double-digit food inflation for the last two years, and will, therefore, only face a worsening of inflationary pressures and also be subject to frequent price spikes in the case of individual commodities such as onions—the worst recipe for incumbents in the poll-bound states of Kerala, Tamil Nadu, West Bengal and Assam.
Politically, the government has been on the back foot, reduced to fire-fighting growing charges of corruption even as its numbers have dwindled in Parliament—though still not precarious enough to threaten survival. Intra-government feuds, both among senior Congress ministers as well as those involving other coalition members of the United Progressive Alliance (UPA), have only further weakened the political resolve.
Taking the two together would preclude tough decisions or at least enhance the political cost of such moves. Already, Mamata Banerjee, the Trinamool Congress chief and railway minister, who is expected to end the three-decade-long Left Front rule in West Bengal, has sought to distance herself from any policy decision of the UPA that she perceives to be a threat to her electoral prospects. Mukherjee, an old-school politician groomed by former prime minister Indira Gandhi, is acutely aware of his key priority.
In any case, the Reserve Bank of India (RBI) served up a reminder in its latest credit policy review. Its modest action in raising the bank rate by 25 basis points signalled that monetary policy had reached the limits of its ability to tackle inflation. Anything beyond this would be counterproductive, forcing up the cost of the capital and choking off growth.
The unstated message from RBI is obvious. By suggesting that monetary policy can do no more, the onus is on the finance ministry to curb inflation. North Block could do so in several ways such as by tinkering with import tariffs and excise levies. Simultaneously, Mukherjee, keeping in mind the upcoming poll test, would definitely offer some populist servings such as income-tax breaks for the middle class. But these would be short-term and interim in nature. Worse, they come at a fiscal cost—forgone revenues.
A short-term fix to manage the political fallout of inflation flies in the face of the more durable solution (and something desired by RBI) by putting the brakes on runaway government spending. The fiscal numbers in 2010-11, which will be disclosed in a few weeks from now, will not reflect this. Go behind the numbers, by netting out the one-off gains to the exchequer through non-tax receipts such as 3G (third-generation telecom) licence fees and some big-ticket public sector disinvestments, and the fiscal situation would be less comfortable.
It is obvious that the correction has to come from the side of expenditure. The big question is whether the minister would be able to follow the example of the US, which has capped expenditure for the next five years—a drastic measure, which reinforces the uncomfortable reality. The 13th Finance Commission had suggested a new road map for fiscal rebalancing, but this was presaged on moves to a unified goods and service tax (GST) that would have, according to their calculations, led to a revenue boost of over 1% of gross domestic product. The minister will most certainly announce a new road map—an important signal to the foreign institutional investors who dominate investments in the stock market.
In the final analysis, it is apparent that Mukherjee’s third budget in the second phase of the UPA is an exercise in juggling difficult macroeconomic questions, some of which require equally tough responses, with electoral compulsions and rapidly weakening political resolve. Not surprising, therefore, that expectations ahead of the budget are at the bare minimum. It will be interesting to see whether Mukherjee will surprise his critics and reclaim the Congress party’s mojo through a budget as, if not more, radical as the 1991 Budget presented by his present boss, Manmohan Singh.