The central goal of the Budget that Finance Minister Pranab Mukherjee will present in March must be to restore confidence in the prospects for rapid growth in India. He has to convince not just prospective foreign investors, but also domestic corporations and financial institutions, as well as the stock market. This will involve some fiscal measures; but much of the impact will have to come from the announcements of new policies, which have become so important a part of the Budget speech.
The finance minister will receive a lot of advice on the importance of fiscal prudence, including exhortations to contain the deficit. The main motivation for this is a very monetarist view of inflation. I have yet to see a serious piece of research that demonstrates this alleged connection convincingly for the Indian economy. Another reason for this exhortation to fiscal rectitude could be to restore the confidence of foreign bankers who are great votaries of sound finance.
He should ignore this advice. Foreign bankers are running scared and will not venture out from their safe havens right now. The deficit in India is not that large by international standards, and the food and fuel inflation that has troubled us is not amenable to demand-side measures. The economy needs a demand-side stimulus — and an excessively prudent Budget would be counterproductive, worsening matters by further eroding investor sentiment. The risk we run today is not of hyperinflation, but of a premature end to the India growth story. The finance minister must focus on the measures that can restore confidence in this story.
He must administer a strong aphrodisiac to the stock market’s bulls, who are lying low right now. Economists who believe that stock markets are efficient in anticipating the future will be scornful of this piece of advice; socialists will be appalled by this sop for rich rentiers. But this is the quickest way of shifting the climate of opinion about economic prospects — and, if it stimulates the response to new issues, also a genuine boost to the real economy. An unexpectedly large interest rate cut or a significant relaxation of rules on pension funds investing directly in equity should be among the options the finance minister considers for this purpose.
A bull market in stocks is only the start. Much more needs to be done to reanimate the entrepreneurial spirit that led to the high growth phase that began in 2003-04.
In terms of scale of impact, the big issue is that of connecting the lower-income, slower-growing regions in the north and the east with the richer, faster-growing regions in the west and the south. Long-term demographics require this. The north is where the demographic dividend will accrue, and connecting it with the engines of growth in the other parts of India is vital not just for the India growth story but for the democracy and inclusion narrative.
The main measures required for this integration of markets are long term and slow acting. But the Budget can do a few things to signal the priority the government attaches to this. The goods and services tax (GST), for starters. This is the most important immediate move to establish an effective national market. Some progress has been made recently with the states agreeing on a negative list for taxation of services. But GST is much more than that. The finance minister can signal seriousness of purpose by appointing a high-level special envoy to talk to the states and move the process forward.
In order to promote market integration and support small industries, the finance minister can also do something to address the problem of assured payments for transactions, particularly between large and small firms. Logistical improvements to reduce internal trade and transport costs may take longer to take effect. All of these are essentially measures to reduce transaction costs, and this will help lower barriers to internal trade — so that a buyer in Mumbai would no longer prefer to get his supplies from China, if a unit in Patna or Gorakhpur can meet his needs.
Expenditures on social inclusion are a necessary part of the Budget in India’s political context. But a decisive shift from NREGA-type handouts to training and skill development for entry-level jobs in the non-agricultural economy would be a positive signal. It will help particularly in promoting growth using the demographic dividend in the northern states. Making corporate contributions for skill development eligible for weighted deductions, as is the case for research investments, is a potential tax-side measure that can reinforce this. I emphasise this because the government is not fully in sync with industry concerns about skill availability.
Restoring confidence in the India growth story also requires that the government remove some of the hurdles in the steeplechase that precedes any business decision requiring official clearance or approval. India ranks very low in the World Bank “ease of doing business” indicators: its rank in the latest listing is 132 out of 183. The finance minister can at least make a start by addressing the indicator that is directly under his charge, the ease in paying taxes, where India ranks 147 out of 183. The issue here is not personal taxation, but the hoops that businesses have to jump through in the tax system. But this is a small part of the regulatory woes of business. The finance minister must also persuade colleagues in Company Affairs, Environment and elsewhere to announce some big-ticket reforms that will reduce the corruption and delays that bedevil all interactions with the government.
The finance minister will surely do something to boost infrastructure spending. The main area needing attention is the power sector, where losses of the state electricity boards have risen to Rs 82,000 crore. The Shunglu Committee has made some suggestions for funding these losses, as well as a few other pious recommendations. The sector needs stronger medicine than that, and the rescue must be packaged with strong conditionalities on tariff revision and management reform. Perhaps the issue can be taken forward by setting up an inter-state ministerial group under the National Development Council.
It is possible that a Budget drawn up on these lines will be described as inflationary in the next day’s headlines. If that happens, the finance minister can rest assured that he has done the right thing.
