A heady brew from conflicting ingredients

A heady brew from conflicting ingredients
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First Published: Fri, Feb 29 2008. 11 10 PM IST

Expert View | Haseeb Drabu
Expert View | Haseeb Drabu
Updated: Fri, Feb 29 2008. 11 10 PM IST
Expert View | Haseeb Drabu
Underlying the 2008 Budget are the economics of the 1960s, the politics of the 1970s, and the language of the 1990s. Only P. Chidambaram could have cooked up a heady brew from such conflicting ingredients. Indeed, even in its method of budgeting, it is pretty much a budget from the 1950s rather than from the post-reform period. It is a compendium of programmes—more specifically expenditure programmes. There is hardly, if any, policy measure that has been announced in this Budget. Compare this with any other post-reform budget and you realize the striking difference—no policies, no projects, only programmes.
It is not surprising that there is not much it has to say on revenues, largely because these, by all accounts, have done rather well. So it is over and over an expenditure budget.
The centrepiece of the Budget is the debt waiver and relief to farmers that will cost the Union government Rs60,000 crore. With no pressure on revenues, deficits or even the FRBM (Fiscal Responsibility and Budgetary Management) Act, this bonanza may not disrupt the fiscal balance of the economy, but it will have a wide-reaching impact on the financial sector of the country. Without getting into issues of moral hazard, the real problem with debt waiver schemes is that they benefit none, including the intended beneficiary.
As for their macroeconomic impact, in operational terms the loans are non-performing assets of the banking sector, especially the public sector. Mostly there is no servicing and the effort is to recover at least the principal and applied interest. There is hardly any mortgage, so recovery is difficult.
To write off this loan and provide the settlement amount to the banks through some form of subvention or the other ends up with monetary benefits to them and psychological relief to borrowers, who now don’t have to pay the amount they weren’t going to pay as they were not able to do so!
This will surely alleviate distress in the farmer community, but cannot ensure non-recurrence of the situation.
In the last decade or so, there have been two types of budget—one, the pre-1990 one and the other, post-1990. The latter was full of policy announcements, even though it violated the essence of the budget. With this Budget, Chidambaram has gone back to the pre-reform budgeting style. It’s more on expenditures this year, largely because this will be the last one before an election year.
Given this, it is obvious that in terms of the overall position, this Budget decisively reflects an expansionary fiscal policy. It is here that the real problems may emerge in the macroeconomy. This Budget should have been placed in the context of the contractionary monetary policy that is being pursued by the Reserve Bank of India with good reason. Instead, it appears that having failed to convince RBI to drop rates, the finance minister has gone out of his way to stimulate the economy through the fiscal policy interventions.
The result is very simple: schizophrenia in economic policy making. The system will now have a contractionary monetary policy along with an expansionary fiscal policy. Not only will it reduce the efficacy of monetary measures that have been taken so far, it will make it even more difficult to rein in the errant numbers.
What will be the net impact of this? It will depend on the composition of expenditure, both sectorally and functionally. If capacity is increased as a result of increased public expenditure, it will pay the way for a rate cut without threatening to raise inflation. If, however, there is more transfer payment-oriented expenditure, it will raise income with no increase in capacity, constraining monetary policy authorities from cutting rates. At first sight, it seems it is the latter.
The Economic Survey and the Budget seem to be based on the premise and understanding that the turmoil in financial markets in the last few weeks has been due to a liquidity crunch. The fact is that it is more importantly related to serious credit problems, especially in some sectors, including those of over-leveraging. In this context, the debt bailout, even if not quite the same, is providing a fiscal solution to credit problems, with adverse implications for some time.
The larger point is that there is now a new and increasing recognition that monetary policy alone cannot resolve severe credit and financial distress problems. Thus, if a political consensus were to emerge that some financial support of distressed borrowers is fair and necessary then fiscal—as opposed to monetary alone—solutions may have to be discussed and implemented in a more institutionalized setting rather than an ad hoc package that has been done.
Haseeb Drabu is chairman and chief executive of Jammu & Kashmir Bank Ltd
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First Published: Fri, Feb 29 2008. 11 10 PM IST