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India’s finance minister Arun Jaitley. Photo: Sonu Mehta/Hindustan Times
India’s finance minister Arun Jaitley. Photo: Sonu Mehta/Hindustan Times

Brewing a budget

The budget should concentrate on getting the structure and composition of public expenditure in order

An important aspect of, and the reason for, the success of the economic policies after 1990 was the broad political consensus underlying it. Not much has been made of it, but the fact remains that despite opposition of a few political parties, successive governments followed the same kind of economic reforms.

In the last four years, not only has the consensus been decisively disrupted, the manner in which the debates have been conducted—be it on the allocation of resources or on foreign direct investment—indicates the consensus is over.

This calls for an articulation of the economic position and policy agenda of the Bharatiya Janata Party (BJP), which is far from clear. There are well-know positions on specific matters. But these don’t add up to make an economic policy.

As such, in his first budget, finance minister Arun Jaitley will do well to outline the overall contours of BJP’s economic policy. This may entail technically overstepping the strict fiscal mandate that a budget has. But then, there has to be some clarity on the enabling initiatives that the new government will take.

To this extent, the context—political as well as economic—in which the budget is being presented must inform the content of the budget. But, it should not get overwhelmed by it. For a routine budget is driven by the economy; a good budget drives the economy.

The focus and fulcrum of this budget should be public expenditure policy and not fiscal policy. While public expenditure policy is a subset of fiscal policy, it will help that the operative part of the budget has a narrower and sharper focus.

The idea should be to recalibrate and restore the expenditure balance that has got skewed since 2010. It is time to pull back from a transfer payment, revenue expenditure-led budget to a capacity creating, capital expenditure-led budget.

What this means is that the budget should concentrate on getting the structure and composition of public expenditure in order.

The challenge is not so much to secure a level of spending consistent with macroeconomic stability. It is to restructure expenditure as part of a systemic reform package aimed at raising the sustainable growth rate by promoting domestic saving and productive investment.

It may not be a bad idea, for instance, to keep the real rate of total expenditure (as a percentage of the gross domestic product) constant and but changing the mix substantially.

In budgetary parlance, this means a reduction in revenue deficit as a percentage of the fiscal deficit, and allowing for an increase in the contribution of capital expenditure to overall fiscal deficit. Even if the fiscal deficit is a bit higher, its quality will be much better both for growth as well as inflation.

The new structure of public expenditure should be such that it recognizes the severity and seriousness of supply-side constraints that are holding growth. So even with a lower level in real terms, the structure and composition of the budgetary expenditure will generate growth.

This type of an expenditure composition can then be complemented by fiscal and monetary policies to provide greater liquidity to the infrastructure sector that has become a binding constraint for growth.

Be it through encouraging infrastructure debt funds (IDF), or credit enhancement mechanism for infrastructure financing institutions such as the India Infrastructure Finance Co. Ltd or reducing the cash reserve ratio and statutory liquidity ratio on infrastructure bonds that banks could raise.

This budget can address the stagflationary situation by a combination of two measures. One, propelling autonomous investment demand through a change in the composition of public expenditure. Two, providing liquidity for financing infrastructure and thereby reducing the capacity constraints.

A focus on public expenditure policy will go a long way in addressing another structural constraint: the decline in the savings and investment rate that was earlier driving high growth. If these are restored through public expenditure policy, growth will revive on its own.

More worrying than the government saving which has come down due to a rise in the fiscal deficit, is the aggregate household savings and especially saving in financial assets.

The economy is currently being driven by consumption rather than investment demand. This makes raising domestic household savings a critical challenge for a future. This is also a systemic issue that needs to be addressed.

Finally, there is no need to get bogged down by the inflation-growth trade-off. As relevant as it may be analytically, it is not as constraining in policy formulation as it is being made out to be.

There cannot be a Reserve Bank of India prescription for reviving growth that is at variance with the finance ministry policy for it. The same is true for inflation. The perspective of the central bank and that of the finance ministry, to the extent that these are at variance, only change the nuances and the emphasis of the policy.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice.

Comments are welcome at views@livemint.com.

Also Read | Drabu’s earlier columns

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