Believe it or not, but India is numero uno on one yardstick among the Asian economies: the annual tamasha over the Union Budget. In other countries, government budgets come and go with little song and dance. India's Budget is also an annual grim reminder of the still-high extent of the government's shackling of the economy through tax policies.
With the Budget out of the way and the Reserve Bank of India (RBI) policy meeting ahead of us, it is a good time to take stock of India's much-needed macro recalibration. It is also worth assessing to what extent the latest Budget acts as a catalyst for this adjustment.
India's economy needs to make two transitions. First, the fiscal-monetary mix needs to be recalibrated towards fiscal tightening, which in turn should make room for monetary easing. A credible and sustained reduction in the fiscal deficit is crucial to help ease inflationary pressures. Supply-side initiatives are also a must for returning to lasting low inflation. It is often overlooked that fiscal policy in India has a much greater impact on aggregate demand than monetary policy, even though the latter has risen in importance. Consequently, pulling back the fiscal lever will have bigger adverse fallout on growth, which will warrant a super-aggressive monetary easing to offset it. The RBI is widely expected to ease further, but the magnitude is unlikely to be dramatic.
Second, economic growth needs to be driven more by investment than consumption. This will come partly from a lasting fiscal correction and partly from proactive measures to sort out the dead weight of stalled projects. For an enduring investment upturn, corporate profitability and policy setting will need to improve as well. So far, the on-the-ground reality of delayed projects on the move again has not been encouraging. Given the idiosyncratic factors responsible for crippling investment, fiscal correction is a necessary but not sufficient condition for investment revival in India.
The above-mentioned economic transition has to occur subject to three constraints, which make the adjustment more challenging. First, India has become a low growth-high inflation economy (officials remain in denial), and the macro healing will be protracted and uneven. Second, we are in a pre-election year - amply confirmed by the Union Budget, even if it wasn't shamelessly populist. Frankly, it couldn't have been heavy on populist giveaways as adverse reactions from investors and credit rating agencies would have precipitated economic fallout that would be akin to political suicide. Third, the ballooning current account deficit - and its worryingly increasing dependence on risk-driven capital inflows - is a ticking time bomb.
Finance Minister P Chidambaram deserves credit for having delivered on his guidance on the headline fiscal deficit of 4.8 per cent of GDP for 2013-14. Frankly, there was little scope for disappointment given what was at stake, how he had raised expectations in his meetings with investors, and the recent spending cuts. Also, he had the important political blessing for spending cuts, which were not available to his predecessor. Frankly, he will earn his spurs only on delivery this year.
The 2013-14 Budget suffered from three tactical mistakes, in my opinion. One, after all the good that Mr Chidambaram did in the last six months, there should not have been zero scope for poking holes in his arithmetic. The real issue is not that slippage will occur, but that there is an unnecessary risk, over and above the sleight-of-hand of cash accounting. This risk should have been avoided. I have yet to come across a finance minister who was not confident of his Budget projections. Despite that confidence, India has a poor fiscal track record.
How can anyone talk about spending restraint when total spending is forecast to increase over 16 per cent - higher than the optimistic nominal GDP growth forecast of 13.4 per cent - and will push up the expenditure-GDP ratio to a three-year high? The spending cuts of 2012-13 will essentially come back in 2013-14, conveniently well timed for the election calendar.
Two, few have bothered about the poor quality of fiscal correction. The government plans to raise 0.8 percentage points of GDP in revenue from the sale of telecom spectrum and divestment, but the fiscal deficit is budgeted to shrink by only 0.4 percentage points. The government should have used the room offered by this one-off flexibility to limit the announced tax increases by showing a smaller increase in spending. Adjusted for these two items - which the government self-servingly shows as revenue rather than financing items, as is standard practice for the International Monetary Fund - the 2013-14 fiscal deficit remains unchanged at 5.6 per cent of GDP. Strip away the veil and there is no fiscal correction in the Budget.
Three, there was no ironclad commitment to cut the subsidy bill. Cutting non-subsidy spending to offset a higher subsidy bill in order to meet the fiscal deficit target is not a sustainable strategy. An open-ended subsidy bill, even for food, is a threat that can create bigger economic stress. As it is, the National Food Security Bill is underfunded in the Budget. More importantly, few have as yet woken up to the fiscal inflexibility this Bill will breed, especially in years of poor monsoon rainfall.
How will the RBI react to the Budget? We perhaps got an appetiser in the form of some official comments immediately after the Budget. These were surprisingly glowing in their endorsement of the Budget and the anticipated outcomes. In fact, so one-sided was the assessment that I thought I was reading comments from the finance ministry. The comments shed no light - not even reiterating what has been already officially stated - on its implications for monetary policy.
Given the combination of below-trend GDP growth of 4.5 per cent in the fourth quarter of 2012 and some corrective effort on the fiscal front, the RBI will find it very difficult not to cut the repo rate on March 19. The crucial issue will be its guidance, based on how much it believes the Budget's arithmetic and how forgiving it is on the poor quality of fiscal correction. Most likely, it'll offer scope for some limited easing, but subject it to delivery on the fiscal front and the worrying strains on the balance of payments.
It is ironic that the arithmetic of the 2013-14 Budget, like the earlier one, is based on optimistic GDP growth and revenue forecasts, a jump in Plan spending and poor quality of fiscal correction. Hopefully, the RBI will remain objective and avoid its last year's misguided adventure of swallowing the Budget's questionable maths with eyes wide shut.
The writer is senior economist at CLSA, Singapore.
These views are his own
These views are his own
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
