Right approach, but falls apart in the details

Right approach, but falls apart in the details

The budget speech he delivered on Friday had a different flavour. Mukherjee outlined five strategic goals, but the difference was not just in the number of strategic objectives mentioned. The finance minister spoke about nurturing a growth recovery rather than maintaining high growth rates; the additional objective of depending on domestic demand for the recovery makes me wonder whether old-style export pessimism is making a comeback in the Indian policy framework, thanks to the global economic turmoil and the excess capacity in China.

Mukherjee also specifically mentioned the need to rekindle private investment activity. He spoke about the necessity of removing supply bottlenecks in important sectors such as agriculture, energy, national highways, railways and civil aviation. He avoided any sweeping statements about inclusive growth but focused on the need to intervene decisively to reduce malnutrition in 200 high-burden districts.

And, while he reiterated the importance of better delivery of social services, he also spoke about the problems of black money and corruption soon after the movement led by Anna Hazare took the ruling alliance by surprise.

How important is this subtle yet important change in approach? The political economy of the UPA government has revolved around entitlements, subsidies, consumption spending and reforms inertia. The strategy worked as long as strong economic growth yielded ample tax revenue, but it unravelled after 2008 to result in a toxic combination of growth trending down and inflation trending up. One indication: the national investment rate has been slipping, and is now lower by some three percentage points of gross domestic product (GDP), compared with its pre-crisis highs. The Reserve Bank of India has already hinted at structural problems when it said that the growth rate India can sustain without fanning high inflation is 7%, about 1.5 percentage points lower than in 2008.

I had argued in an article published on Thursday that what India needs right now is a dose of supply-side economics, especially initiatives to get private sector investment back on track soon, as well as coherent policies to overcome significant medium-term constraints such as food, energy, water, logistics and infrastructure. Fiscal consolidation to raise the national savings rate and economic reforms to improve business confidence are central to these policy challenges at this juncture when India seems to be in the midst of a structural rather than cyclical slowdown.

Finance Minister Pranab Mukherjee.

Most importantly in this context, public finances continue to be in a mess despite the widely-expected increase in excise duties and the spread of the service tax net. To be sure, the finance minister made the mandatory noises about the importance of fiscal consolidation. Not too many seem to be impressed. The government has missed its fiscal deficit target for the current year by a wide margin, but Mukherjee has bravely promised that he will reduce the fiscal deficit from the current 5.9% of GDP to 5.1%.

How credible is that target? There are three important issues to be considered here.

First, the success of the budget arithmetic depends, among other things, on a 31.96% increase in non-tax revenue (think 2G spectrum auctions and disinvestments) and a 12% drop in the subsidy bill in a year when the Food Security Bill could add an estimated Rs30,000 crore to subsidies. Remember how the subsidy bill went out of control in the current year.

Second, the fiscal deficit target for FY13 should not be compared with what was achieved this year but with the trajectory provided by the Thirteenth Finance Commission headed by Vijay Kelkar; the fiscal deficit should have been 4.2% of GDP next year, nearly a percentage point less than the budget estimate. So what we actually have is not a modest fiscal correction but a significant fiscal slippage, according to the medium-term goals that were accepted by the government.

Third, the revenue deficit is still too high, which means that the government is borrowing to finance current expenditure on items such as wages, interest payments and subsidies. India should have a zero revenue deficit by now, with the government borrowing only to finance capital spending. Further, a persistent primary deficit (or the fiscal deficit net of interest on past debt) shows that the fiscal consolidation is on shaky ground.

The government will have to borrow at least Rs5.6 trillion next year to cover the hole in its budget. Such a large borrowing programme will ensure that interest rates do not fall rapidly enough, a dampener on corporate investments.

That effect could have been partly neutralized by bold reforms that would raise business confidence and help the economy in the coming years. Nothing of the sort has happened. There was not enough credible commitment on issues such as land acquisition for industry, financial sector reform, coal availability, rural supply chains, tax reforms and much more.

Though it is possible that the UPA backs up its intentions with forceful policy support in the coming months, its record on economic reforms in recent years does not inspire confidence.

The Manmohan Singh government has a narrow window of opportunity before the system goes into election mode ahead of the 2014 national polls. Budget 2012 is an indication that the opportunity will not be grabbed. That is a pity.