On the back of general expectations of measures to address the inflation issue, Budget 2011 tries to do a balancing act of maintaining higher growth, controlling inflationary expectations (if not inflation) and address the issue of the current account deficit.

This it tries to do through sticking to its fiscal consolidation targets and through some sectoral policies. In other words, the budget believes in the argument that containing fiscal deficit could address two pertaining issues: reduction in fiscal deficit would crowd in private investments; and fiscal deficit is also the cause for current high inflation. Hence, it targets a fiscal deficit of 4.6% with “effective revenue deficit" of 1.8% in 2011-12, which is lower than the 13th Finance Commission’s estimates.

While controlling the fiscal deficit could result in higher private investments and, hence, higher growth in nominal output, real growth would largely depend on inflation. On the other hand, although this strategy can contain demand side inflation expectations through reduction in the government borrowing programme, supply-side pressure on inflation might still remain. As the recent inflation episode is largely attributed to supply side reasons, with demand side pressures, if any, contained by the regular tightening of monetary policy, the Budget was supposed to temper this through supply side measures.

The budget indeed tries to address these supply-side issues through various interventions,b particularly in the agriculture and infrastructure sectors. But these measures are at the most expected to have an impact on the inflationary expectations in the medium to long term, while the short-term inflationary pressure might still remain.

To contain food inflation, increase productivity and promote the supply response from agriculture, the budget has taken several measures such as increasing allocation under its Rashtriya Krishi Vikas Yojana, promoting pulses, promotion of oil palm, initiating vegetable clusters, promotion of higher production of nutri-cereals etc.

It has also increased the allocation of credit to the agriculture sector and infrastructure such as improving storage, cold chains and revamping the APM Act. There are also some measures that would bring down the cost of inputs such as fertilizer, credit, power, micro-irrigation, machinery, feedstock etc. All these measures are expected to reduce costs and improve productivity in the agriculture sector, thus bringing down food inflation.

A recent rise in world oil prices and the firming up of other commodities in the international markets are expected to put pressure on domestic prices as well. But the Budget is silent on this issue. By not addressing this, the government seems to indicate that any further rise in fuel prices might be passed on to consumers. This itself could push inflation through both direct and indirect channels.

As the focus was on making a “transparent and result-oriented Budget" that relies heavily on the technology, one would expect that many of the social security programmes may see less leakage and ensure a effective delivery mechanism. This could itself create inflationary pressure in the short term as it may improve rural incomes.

Something that the budget missed is strengthening the early warning systems. Although it is easier said than done, tracking supply disturbances (short-term supply shocks) and integrating climate change in food inflation models could help in the government’s risk-mitigation policies and also help in reducing volatility in food prices.

The other thing that was completely kept aside is the issue of land acquisition. Lack of clarity on this subject appears to have had a substantial adverse impact on agricultural land use and pushed up opportunity costs, which in turn create uncertainty in both agriculture and industrial sector production activity and pricing.

Overall, the measures that have been taken in the budget, no doubt, help in addressing the structural inflation, particularly food inflation. But these measures would at most help in the medium term. As a long-term strategy, it is imperative to treat agriculture as an “industry" that sees improvement in investments, productivity, price discovery mechanism, reducing volatility and risk.