Making a mini-budget while the sun shines

Soon after he became finance minister in July 2002 Mr Jaswant Singh said that he wanted to put money in people's pockets. A few weeks later he told a TV station that his first Budget would provide a major fiscal stimulus to the economy.

I had written at the time that this was the right idea, but that there was a danger that by postponing decisions until the Budget, which was still several months away, the boost Mr Singh was aiming at would get implemented far too late "" if at all.

I was wrong because although there have been several other factors, the Budget did provide a boost and played no mean part in inducing the current buoyancy in the economy. Waiting, therefore, did no harm.

Judged by that token, Mr Singh could have waited a bit to announce the duty cuts that came into effect yesterday. By doing it now, he has lain himself open to the charge of doing it for electoral reasons "" as if that matters to anyone except other politicians.

In fact, Mr Singh has powerful intellectual support for doing what he has done. No less an economist than Martin Feldstein, Professor of Economics at Harvard University and President of the National Bureau of Economic Research, USA, had recommended exactly the same thing to George Bush. Mr Feldstein will be here next week to attend the NBER-NCAER annual Neemrana conference. Mr Singh should meet him. They can have a nice pow-wow.

Feldstein's paper was called "The Role for Discretionary Fiscal Policy in a Low Interest Rate Environment"(NBER Working Paper 9203) and it advocated tax cuts to increase domestic demand. To quote, "a stimulus can be achieved without increasing budget deficits if the fiscal policy acts by providing an incentive for increased private spending."

There, I believe, lies the answer. If private spending increases, the revenue loss will be much lower than is being feared. Much depends on the relevant elasticities, of course, and admittedly there is a little bit of a wing-and-prayer element in the cuts. Overall, however, I am certain that import demand will increase, and even at the lower duty rates, the increases in import volume will make up for the revenue losses.

But let's just quickly look at what is happening in the economy. Start with public finances, which were looking very dodgy until recently owing to the tax refunds. But now things are looking much better. Net tax revenue in the first eight months has grown by 12.03 per cent and stands at almost half the budgeted amount With the third instalment of advance tax, this share is likely to go up.

Non-tax revenue has increased by 8.76 per cent compared to a decline of 1.52 per cent last year. Recoveries of loans have also increased by 230.96 per cent due to the debt swap scheme but disinvestment proceeds have declined by 50.7 per cent compared to same period last year. But now if the GAIL and ONGC disinvestment gets off, it will fetch around Rs 12,500 crore.

There is also the much larger question "" elections are not "" of the timing of fiscal interventions by governments. A sudden kick in the economy's pants can be destabilising at times. That is why it calls for a lot of good luck to get the timing right, especially when the going is bad.

That is also why governments prefer monetary policy, in general, when they want to alter the structure of incentives. But what do you do when monetary policy has shot its bolt, as it clearly has? There is no way that interest rates are going to be lowered any more for some time. The banking system's rigidities, not to mention the higher rate of inflation now, will not allow it.

Mr Singh could have waited, of course, for a few weeks till the elections were out of the way and a proper Budget had been presented. But when the going is as good as it appears to be now, waiting would have made no sense. You have to make hay when the sun is shining, if only to eliminate or reduce one important element of uncertainty, namely, of getting the timing right.

Feldstein again: "If the net effect of the lower inflation rate is to reduce the overall incentive for business investment, the depressing effect on aggregate demand can be offset by a suitable investment tax credit." Read duty cuts and you get the same result. Why wait?

Three months ago, when the idea of cutting import duties was first mooted (to deal with, as it happens, the appreciating rupee and the accumulation of foreign exchange reserves and not to put money in businessmen's pockets) it was not possible to do so for political and bureaucratic reasons. In short there were serious doubts about the timing. But those doubts have greatly reduced now, and Mr Singh has done absolutely the right thing.

In any case, it is difficult to see what else Mr Singh could have done if he were to deal with the rapid accretion to the reserves. These have already crossed $100 billion and are increasing.

Economist after economist, and even this newspaper, has been saying that if the RBI is to keep the exchange rate at around Rs 45, which would be necessary to keep exports going, the only way to soak up the dollar inflow was to reduce tariffs. Even otherwise, it has been widely recommended that India should cut tariffs down to around 20 per cent. This has been done. Let us wait and see what happens.

To say that the government has an eye cocked at the election is probably true. But woe betide a prime minister and finance minister who think that customs and excise duty cuts are going to fetch votes. That is not how it works in India, or anywhere else for that matter. Income taxes, yes, but customs duties and excise duties? That would be the day.

The big question "" although not to my mind because I think the fiscal deficit issue is blown out of all proportion "" is whether Thursday's cuts will increase the deficit or leave it as it is. The answer is that we don't know yet but the chances are that the year will end with a deficit that is not very much larger than the one that was projected when the Budget was presented. It might even be smaller. If it isn't, the numbers can always be cooked!

You can be sure of one thing, though, then. No economist will question them.