Will the budget be sufficient to cushion the economy against shocks and deliver higher growth next year? The answer is a cautious yes.
The task facing the Finance Minister in this Budget was to take steps to offset the effect of some of the uncertainties facing the economy. These include the Iraq war and the shock due to higher oil prices, the sluggish global recovery, and uncertainties on domestic industrial growth because of the lagged effect of the poor monsoons and a lower rabi crop.
Jaswant Singh has tried to address these issues by trying to raise domestic demand. He has, accordingly, reduced income taxes for most tax-payers, reduced prices on plenty of goods, planned for a boost to infrastructure spending, and tried to improve sentiments in capital markets. The key question is-will these measures be sufficient to cushion the economy against shocks and deliver higher growth next year?
Consider first the government's numbers. The Budget assumes a nominal GDP growth rate of 11.3 per cent, as against 6.7 per cent in 2002-03. Implicit in the high nominal rate is the assumption that inflation in 2003-04 will be much higher than in the preceding year, possibly as high as five per cent, which will mean a real GDP growth rate of 6.3 per cent. That's much higher than the 4.4 per cent growth this fiscal, but could be achievable because agriculture will rebound from a lower base next year. The critical factor is whether industrial growth will remain robust.
In view of the higher deficit level and the rise in borrowings by the states as a consequence of the debt swap scheme mooted by the Centre, it's imperative to keep interest rates low. Hence the decision to reduce interest rates further, in spite of a spurt in inflation in recent weeks.
Bond Markets
What consequences will the finance minister's strategy have on the markets? Much of the liquidity in the bond markets this year has been on account of foreign inflows. These remain robust, as can be seen by the upward pressure on the rupee. Unless the US current account deficit is reduced, the downward pressure on the dollar will continue.
Next, the immediate decision to reduce repo rates and the exhortations to lower credit rates further are signals that the government wants the easy liquidity scenario to continue. That will imply that the RBI should be ready to supply liquidity to markets whenever needed. The question is whether this will result in higher inflation-the government's calculation seems to be that the hike in inflation is largely a consequence of higher oil prices, which is a temporary phenomenon related to the Iraq situation. Once that uncertainty goes, oil prices should fall.
Lower interest rates are also critical not only for the government's borrowing programme but also for its strategy of propping up demand. Low interest rates for housing, automobiles and consumer durables have played a crucial role in stimulating consumer demand, and interest rates must remain low in order for this demand growth to continue. But the bullishness on account of these positive factors will be constrained by a wary eye on the inflation figures, and on oil prices in particular.
The hike in road cess, in particular, will raise petrol and diesel prices.
Stock Markets
So far as the stock markets are concerned, the duty cuts will be passed on and that should improve the demand outlook. The sops to specific industries such as textiles and automobiles will also help. More important is the big push to be given to infrastructure. True, most of this money is supposed to come from private sources. But that's true for the current road building programme as well, and it has played a critical role in stimulating demand.
Will the duty cuts and new infrastructure projects buoy demand? The hike in fertiliser prices is a dampener, but that's likely to be rolled back. Balancing pluses and minuses, projects such as rural roads will at best serve as a safety net for the rural population, and they are unlikely to create new demand.
In contrast, lower prices on a variety of luxury goods and reduction in direct taxes will help the urban consumer. A further fall in borrowing costs too will be a positive. In other words, the nature of the budgetary sops and the lower borrowing costs are likely to benefit the well-heeled urban consumer with access to credit. While that is a positive for many companies, there will be few immediate benefits.
Perhaps it's time to realise that the Indian economy is now a global one, the state no longer plays a crucial role in the economy, and companies here are affected by many factors besides the Budget. The uncertainty over higher oil prices, or the recent rise in global commodity prices are more important than marginal duty reductions.
But if current trends in industrial production and credit offtake hold, the sops announced for the capital markets should see an inflow into equity. All that the finance minister has done is to increase the probability of that happening.
