Show me the money
The industry felt badly let down when it turned out that the reform agenda articulated in the budget was a far cry from the hopes raised in the Economic Survey
Noor Mohammad Delhi
The Union budget for the financial year 2009-10 has proposed hefty hikes in public spending on infrastructure and social sector projects in a bid to revive the sagging domestic demand in a time of falling exports. Though a welcome move from the perspective of long-term economic growth, it has given rise to serious fiscal concerns. Enhanced public spending will raise the Central government's fiscal deficit to 6.8 per cent of the country's Gross Domestic Product (GDP) in the current financial year. The budget has not outlined any strategy on how the fiscal deficit will be brought back to an acceptable level once the economy on the track. This has left financial markets wondering if the government is really serious about containing fiscal deficit. However, the budget seems to have gone down well with the aam aadmi.
Significantly, this is the second consecutive year of high fiscal deficit. The spending by the Central government went up by a massive 33 per cent in 2008-09 whereas its revenue receipts rose by 3.7 per cent only. This was due to additional revenue outflows from the government exchequer owing to factors like the hefty rise in government salaries, large debt waiver for farmers, substantial rise in expenditure under the National Rural Employment Guarantee Scheme (NREGS), reduction in excise duties and petroleum taxes. This pushed up fiscal deficit to 6.1 per cent in 2008-09 from the level of 2.7 per cent in the preceding fiscal.
"The budget has failed in restoring confidence the lack of which is a reason for the current economic slowdown. The policy of continued demand stimulus without tackling the huge supply side problems through a 'reform stimulus' is likely to fail in stimulating the economy," said Mathew Joseph of Indian Council for Research on International Economic Relations (ICRIER).
The budget has targeted mobilisation of just Rs 1,120 crore in the current fiscal as against the projection of Rs 25,000 crore drawn up in the Economic Survey. Meanwhile, growth in the government's revenue receipts is expected to remain sluggish due to the economic downturn. In such a situation, the Central government has projected its borrowing needs for the current financial year in the range of four lakh crore rupee. This has fueled concern that the private investment might be crowded out.
Additionally, the state governments have been permitted to incur a fiscal deficit of up to 4 per cent of their gross state domestic product (GSDP) in 2009-10, higher than both the initial target of 3 per cent set under the Debt Consolidation and Relief Facility and the relaxed target of 3.5 per cent announced previously. The borrowing programmes of the Central and state governments are likely to put an upward pressure on bond yields and negatively impact the banking sector.
"India's high fiscal deficits are not sustainable in the medium term and if fiscal consolidation is delayed, there is a risk that the sovereign credit ratings on India (BBB-/Negative/A-3) may be lowered," international credit ratings agency Standard & Poor's reckoned.
The high estimate of fiscal deficit in the budget has led many to paint a doomsday scenario similar to the 1991 when Indian rupee came under speculative attack in the wake of sudden flight of foreign capital. However, Suman K. Berry, a senior economist, does not think that situation is so bad. According to him, India's comfortable position in foreign currency reserves negates any such possibility.
The real risks to India's fiscal position emanates from the external sector, that is, commodity price shocks and surge in liquidity, which could complicate monetary management. Berry argued that there is an urgent need to outline a 'fiscal exit' strategy. This should be done sometime between the Thirteenth Finance Commission and the mid-term review of the Planning Commission.
Economists might be justified in their criticism of what they call government's fiscal profligacy. But it should be noted that due to the exigency of enhanced public spending to counter the impact of the global recession, the budget had little room for fiscal consolidation. Finance Minister Pranab Mukherjee had to walk a tightrope between increasing public expenditure and managing fiscal situation. As a result, the budget is a trade-off between fiscal deficit and economic growth.
The budget was not prepared with an eye to please the financial markets. Rather, it was meant to keep the economy on the long-term growth trajectory while pre-empting the possibility of massive job losses in the medium term. To that extent, the finance minister seems to have hit the nail's head.
In any case, India is not the only country to use fiscal stimulus to boost domestic demand in the aftermath of the global economic recession. Countries across the globe have done the same thing. This Keynesian theory had lost its sheen in the days of economic stability. But, when the financial crisis struck in September 2008, the world suddenly woke up to its usefulness.
Indian has maintained a positive growth even as major economies like the US, the European Union and Japan contracted in the wake of the global economic recession. Since the global economy was still in the grip of recession, the first budget by the Congress-led United Progressive Alliance (UPA) government in its second term was expected to continue the policy of fiscal stimulus. This is because public spending is expected to remain the key driver of economic growth in the current fiscal year.
The high fiscal deficit aside, the government has articulated bold taxation reform measures like introduction of the Good and Services Tax (GST) by April, 2010. It has also abolished Fringe Benefit Tax (FBT) and Commodities Transaction Tax (CTT). The budget also shows resolve to rationalise fuel and fertiliser subsidy, which threw the government's fiscal calculations off balance in the financial year 2008-09. For example, the government has proposed to move from cost-based pricing to nutrient-based pricing for the fertiliser subsidy. It has also mooted to provide fertiliser subsidy to farmers directly instead of routing the same through manufacturers and traders. The budget also proposes setting up an expert group to suggest modalities for decontrol of petroleum product pricing.
If the financial markets thumbed down the budget despite all these reform measures, it was not the fault of the finance minister. In his budget speech, the finance minister had clearly said that budget was not the only instrument to address economic issues. Sadly, the stock markets failed to interpret the finance minister's budget speech properly.
Following the resounding victory of the UPA in the general elections, industry went into a state of exuberance. With the Left out of the picture, industry started betting big on the government kick-starting big-ticket reforms like disinvestment of its stakes in profit-making Central public sector enterprises and hike in foreign direct investment (FDI) ceiling for the insurance sector and pension funds. This saw a significant rise in Sensex in the run-up to the budget presentation.
But the industry felt badly let down when it turned out that the reform agenda articulated in the budget was a far cry from the hopes raised in the Economic Survey. Apparently, the bears at the stock markets better understood the nuances of Mukherjee's budget speech than the bulls.