Abheek Barua: In defence of the Budget

The finance minister could have highlighted some of the key risks that stem from the bottlenecks in areas like labour markets.

Most people I have spoken to or seen on television seem to be somewhat disappointed with the Budget. Some have used words like "insipid", "timid", and "lacklustre" to describe it, although they have been quick to point out that the efforts at fiscal consolidation have been commendable. Much of their disappointment apparently stems from the fact that the Budget ran short of reform initiatives. For instance, it carried nothing on agriculture or labour reform, was remarkably parsimonious both in rhetoric and allocation to the infrastructure sectors, gave the issue of raising FDI limits in key sectors the short shrift, and so on and so forth. I think this is being is somewhat unfair to Mr Chidamabaram.

Budget 2006-07 reflects the evolution of the reform process in our country. The key feature of this evolution has been the decentralisation of the responsibility for reform within government. Let me try and explain this and place it in some sort of a historical context. In the first flush of liberalisation in the nineties, many of the key initiatives related to macroeconomic policy""import tariff reform, an overhaul of the tax structure, exchange rate liberalisation, and so on. These, by their very nature, lay in the domain of the economic line ministries""finance and commerce, particularly finance. This led to the centralisation of the reform process""the reform agenda began to be viewed as the finance ministry's baby. Simultaneously, the Budget, the finance minister's annual policy announcement, began to be seen as the omnibus statement for all the reform plans that the government had for the ensuing year.

Quite a bit has changed since then. Over the last few years, the government has done a reasonably good job of macro-economic policy but left "micro-economic" sector policy in a bit of mess. Reforms going forward (the so-called second-generation reforms) have much more to do with the nitty-gritty of policy within sectors like agriculture, labour, electricity, and so on, and less with conventional macroeconomic policy.

There are a couple of things that I would like to point out about these second-generation sector reforms. First, they require intense and specialised attention and the best way to give them some traction is to empower the sector ministries concerned more. In short, decentralise the reform process. This devolution of the reform agenda within the government seems to have happened to a degree over the last couple of years. The onus has shifted from the finance ministry or the Prime Minister's Office to ministries like civil aviation, agriculture, and power. They have their own pace and style of functioning and it would be unrealistic to expect them to dovetail their schedules to the Budget so that all policy initiatives can be announced on the last day of February.

Coming to think of it, the finance minister's degrees of freedom are limited when it comes to sector policy initiatives. It is ultimately limited to allocating more or less money to a sector for the fiscal year. However, "second-generation" reforms are much more about institutional change than about simply allocating more money. Agriculture, for instance, still suffers from the problem of the draconian Agriculture Produce Marketing Committee Act (APMC), which represses private trade and stifles the growth of competitive markets. To take another example, the unhealthy bias towards food-grain production (instead of higher value-adding activities such as horticulture) continues because of the skewed incentives that the procurement price mechanism fosters. The procurement price regime also bloats the food subsidy bill and the exchequer suffers as a result. However, subsidy reduction is possible only if the agriculture minister is able to convince the farm lobby that agricultural support price changes are good for them in the long term. It is simply unviable for the finance minister to slash food subsidies unilaterally.

The most critical problems of the electricity sector lie in the domain of distribution. Unless power tariffs are made commercially viable and are able to pay for upstream investments, the chronic problems of India's electricity sector will remain. Much of the increased investment in other sectors such as roads and ports will have to come from the private sector. For this, the structure of concessions, and the enforcement of mechanisms to charge profitable tariffs become enabling factors for higher investments. Labour reform is so contentious in our country that it requires the might of the entire government put together to push even the most minor of changes through.

These institutional problems need institutional responses and not looser purse strings. To make matters worse, a lot of these reforms require the active participation and co-operation of the state governments. Both the APMC and electricity distribution reform, for instance, fall in the state's domain. There is precious little the finance minister can do about these things""the fact that he was loquacious on things like power sector or labour reform underscores this basic fact.

My disappointment with the Budget, particularly the Budget speech, was that it was a little too upbeat on future prospects. Instead of reassuring the Lok Sabha that the current growth momentum would continue untrammelled, the finance minister could have highlighted some of the key risks that stem from the bottlenecks in areas like the labour markets, where reforms are long overdue. I, for one, don't believe it is always incumbent on the finance minister to talk up the economy. The Budget speech could have been used to stress the urgency of second-generation reforms and try to build a consensus around it. That would perhaps have been a more sensible political strategy.

The author is chief economist, ABN Amro. The views here are personal

abheek.barua@in.abnamro.com