Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

Budget 2014: Reduce revenue deficit, increase savings

The budget should provide direction for sustainable growth recovery

The first budget of the new government would be unveiled on the back of huge expectations of reviving investor sentiment by addressing growth-inflation concerns. While it not clear what would be its shape, in my view, the government should address few key concerns that are crucial for growth recovery in the medium term.

Apart from the standard views that are highlighted on the need for sticking to fiscal consolidation targets, one key issue to keep in mind is the sub-targets as well. Unfortunately, in the whole debate the issue of achieving revenue deficit target, which is the critical element of fiscal consolidation, is completely ignored and undermined. But this may be largely due to lack of clarity on the size of fiscal multipliers that various public expenditures have on growth. The best example is of 2013-14 when India achieved a fiscal deficit of 4.6%, slightly better than the target. However, the positive impact of such achievement on either reviving investments or reducing inflation is not visible until now. Fiscal deficit target was achieved through compression of capital expenditure while allowing revenue deficits higher than targeted. Such strategy would hold back growth. Too much focus on fiscal deficit—perhaps due to pressure from rating agencies—for a developing country like ours with huge infrastructure deficit is not prudent. Hence, the strategy should be to switch the expenditures from revenue to capital in order to revive growth. This is the crux of fiscal consolidation. In the absence of such a strategy, focusing only on headline fiscal deficit is inadequate. Indeed, little slippage in fiscal deficit target while sticking to the revenue deficit target could still be a credit-positive for a slowing economy that has higher public capital expenditure multiplier.

Another issue that may need to be given importance is increasing savings. Measures to increase financial savings and channelling them to investments will be crucial. The importance of financial savings can be gauged from its trends in the pre-crisis period where savings-investments had peaked despite higher interest rates. Some of us argued that high stable growth and contractionary fiscal policy in pre-crisis period were largely savings-led. Higher savings can also help the banking sector recovery, which in turn can eventually help in higher credit availability.

This is more so with the latest reports suggesting that public sector banks are piling up large non-performing assets (NPAs) compared to private sector banks (of course, this is very surprising!) In the absence of this, banks would be constrained to increase credit even if there is a reduction in the policy interest rates—credit channel is stronger than interest rate channel. Or else, banks may need more recapitalization than what was suggested in the vote-on-account. There are talks of consolidation among public sector banks. However, my own assessment on the extent of financial access suggests that India needs more banks—specifically more local area banks—in order to expand the reach as well as to reduce the transaction costs and risks.

Expanding financial access also helps in improving the public delivery mechanism. This is another crucial part of public expenditure management that the budget needs to focus. In the absence of a robust mechanism, one would end up in larger allocations in order to achieve development goals. Here, some reports suggesting discontinuation of Aadhaar-based direct benefit transfer system are disturbing.

The government, which is giving priority to larger use of information technology in governance, should not be tempted to do so when such systems has shown success in reducing leakages. Another crucial policy in this area that may be addressed in the budget is providing resources to make India Post a core banking solution (CBS) system. Given its role in implementing social sector programmes at the rural level, one would have expected India Post to get the banking license. In the absence of a license, making them CBS consistent could enhance financial inclusion significantly and also reduce leakages in the public delivery mechanism.

Overall, while the budget by itself would have limited space to address all the medium- to long-term issues, it can at least provide direction for sustainable growth recovery.

N.R. Bhanumurthy is a professor at National Institute of Public Finance and Policy, New Delhi.

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