BackMuch more needs to be done
Chidambaram had to ensure short-term risks are taken care of while the long-term health of the economy is restored
Premium(Pradeep Gaur/Mint)
While the budget pays significant attention to the long-term health of the economy, it does not adequately address some of the key risk factors the country confronts in the short term. Recall that the budget has been presented against the backdrop of a possible sovereign ratings downgrade to junk status, on the one hand, and a significant economic slowdown, on the other, with growth forecast to slump to 5% in the current year—the slowest pace in a decade. Given this background, the finance minister had to perform a difficult balancing act between ensuring that the short-term risks are taken care of while the long-term health of the economy is restored. Since the short term provides the bridge to the long term, addressing short-term risks was paramount. My initial impression—remember that the devil lies in the details, which require more time for one to assimilate—is that the finance minister has been unable to strike the appropriate balance.
In the short run, the risk of the economy not being able to achieve its fiscal deficit target of 4.8% remains significant. Honestly and transparently achieving the fiscal deficit target requires that the projections do not under-provision expenditure, over-provision revenue and/or overestimate gross domestic product (GDP) growth. Of the three possible methods of sleight-of-hand, possible overestimation of GDP growth rate is a worry. The economic survey assumes a minimum growth rate of 6.1%. In the first half of fiscal 2012-13, the economy grew by 5.4%. If the estimate provided by the Central Statistics Office, which is what the Economic Survey as well as the budget have relied on, is accurate, the economy would grow by an average rate of 4.6% in the second half of this year. To achieve the projected minimum growth rate of 6.1%, the economy needs to expand by at least 1.5 percentage points more in the next fiscal.
I am concerned that the steps announced in the budget may not help the economy achieve that additional growth. While the budget has announced several steps to incentivize investments in soft and hard infrastructure, we have to recognize that the effect of infrastructure investments on economic growth does not manifest itself contemporaneously. In fact, typically we can expect a two-year lag at least. Therefore, investments made this year are unlikely to provide the additional fillip to growth this year. If the target is not achieved, the revenue estimates based on the growth rate assumption will suffer. For example, last year’s budget had projected revenues assuming a growth rate of 7.6%. When the realized growth rate is about 5%, is it surprising then that revenues have been significantly lower? A similar risk remains for the coming year as well. If the revenue estimates are not achieved, we would have to repeat this year’s practice of cutting down on expenditure to achieve the fiscal deficit targets. Since a significant part of the non-Plan expenditure is inflexible and cannot be cut, the axe usually falls on the Plan expenditure, which can dampen growth because of the reductions in capital expenditures. Moreover, to argue that cutting Plan expenditure is fine because the efficiency of expenditures can be enhanced assumes that a sticky factor such as the efficiency of expenditures can be altered within a short period of time.
That said, the broad emphasis on the creation of hard and soft infrastructure is a welcome step and in fact one that is quite courageous. Because of the lagged effect of infrastructure spending on economic growth, its benefits are unlikely to be reaped by the current government. This preceding an election year—the move is, therefore, quite courageous and farsighted. Unlike in the previous years, where the Economic Survey remained a wishlist put down by the chief economic adviser and was ignored by the finance minister, the measures to create hard and soft infrastructure have taken the cue from the recommendations made in chapter 2 of the Economic Survey. The three-year window for small and medium enterprises during which they can continue to avail the benefits they enjoyed as small firms is a good example. It addresses the concerns laid out in chapter 2 that current regulations serve to disincentivize such firms from growing into large ones. The increase in the limit for interest payments on home loans can have a positive spillover effect on sectors such as cement and steel, and create jobs not only in construction but also in these sectors. Similarly, the ₹ 1,000 crore outlay for skills development for about 1 million youth represents a small but significant beginning that responds to the clarion call in the Economic Survey to seize the demographic dividend. While a beginning has been made, much more needs to be done to create the soft and hard infrastructure that can deliver sustained, inclusive economic growth. The way the short-term risks are handled, however, need to be watched.
Overall, this budget can be described as courageous and statesmanlike, on the one hand, and embedded with short-run risks that need to be carefully monitored, on the other.
Krishnamurthy Subramanian is assistant professor of finance at the Indian School of Business, Hyderabad.
Comments are welcome at views@livemint.com
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