All eyes are on the maiden Union Budget from Prime Minister Narendra Modi’s one-month-old government. It is widely – and justifiably – expected to initiate the anticipated retooling of the sick economy. Expectations from the government are already in the stratosphere and the forthcoming Budget is no exception. Consequently, it will probably be difficult for the Budget announcements to significantly exceed expectations — though the details and the fiscal and economic road map should reinforce the post-election boost to confidence.
India is a high-decibel democracy, and there is copious evidence of that every year at Budget time. To be sure, few emerging economies can match the tamasha in India around the federal Budget. This isn’t because fiscal policy is unimportant in other countries. Rather, it is because successive Budgets in other countries generally stick to a stable, consistent and clear fiscal agenda. This doesn’t mean that there is no change in priorities in other countries when a new government comes to power. But the level of uncertainty is still far lower than it is in India, even when it’s the same government presenting a new Budget!
Two additional factors make the forthcoming Budget attract more-than-usual interest. First, it will be the first Budget from Finance Minister Arun Jaitley. How he deals with his unfortunate economic inheritance and designs his way forward will offer some clues about how he plans to earn his spurs. Second, Union Budgets are normally presented at the end of February; but this one was delayed because of the general election. Consequently, it can be designed with a high probability of a below-normal/deficit monsoon in mind rather than being completely blindsided by it.
Fiscal laxity and high consumer price index (CPI)-based inflation were among the root causes of India’s macro-distress. Both were misunderstood and ignored by the previous Congress-led government until it was too late. The party paid a heavy price at the polls. The big picture is that the 2014-15 Budget should offer a credible road map for a good-quality fiscal correction — even as it has to rework the arithmetic of the interim Budget announced in February.
Mr Jaitley would do well to appreciate, and hopefully initiate the reversal of, an important impression about India’s fiscal policy: Indian Budgets are typically designed under the best-case scenario, and score poorly on fiscal transparency. The assumptions leave little scope for fiscal flexibility, and ultimately result in unrealistic revenue and expenditure (and, hence, fiscal deficit) forecasts. It would be better to be conservative and credible in fiscal calculations, leaving some scope for potential positive surprises. Essentially, it is important to reverse the destructive and embarrassing cycle of promising too much and delivering too little.
There will likely be several valuable signals, including on the reform agenda, in the Budget — though it is apparent that “wishes” and “expectations” are being confused. The corrective fiscal agenda’s key focus should be to shift the drivers of growth from consumption to investment while shrinking the fiscal deficit; as well as to encourage households’ financial savings.
An important aspect will be whether Mr Jaitley uses the fuzzy fiscal arithmetic of the interim Budget for 2014-15 as an excuse to announce a higher revised fiscal deficit. Or will he positively surprise everyone by adopting a new higher bar and sticking to – or staying very close to – the 4.1 per cent of gross domestic product (GDP) deficit target announced in February. (A slippage in the fiscal deficit of around half a percentage point of GDP doesn’t constitute as “close” by any stretch of the imagination.)
Fiscal red lines cannot be self-serving and temperamental, as is often the case in India. Public finances in India shouldn’t be designed with the magnitude of any slippage decided by expectations of an adverse reaction from credit rating agencies. That would reflect an unwelcome attitude — “doing what we can get away with” rather than “doing the right thing we’re supposed to do”. It is the latter that is much needed.
The main argument for exceeding the 2014-15 fiscal deficit target of 4.1 per cent of GDP is that the economy can do with a stimulus to boost growth. Well, the excise duty concession has already been extended by six months. Surely, that counts as a stimulus?
It is worth emphasising that India’s annual fiscal deficit ratio has to be progressively lower as credible and sustained good-quality fiscal healing will ultimately favour growth. Even when the fiscal deficit is narrowing, it doesn’t necessarily mean that the quality of the underlying spending cannot be favourable to growth. In fact, the idiosyncratic economic mess that India finds itself in is not because the previous government spent too little; it is because it spent inefficiently and on the wrong things.
It is a myth that all of what is labelled as capital expenditure, or capex, necessarily enhances the productive capacity of the economy; there is significant wastage that can be trimmed. This, along with some rationalisation and reorientation of the schemes left behind by the previous government, will be effective in checking the slippage. Further, unless implementation improves, higher capex allocation will have low impact. Indeed, if implementation improves, the current backlog of spending doesn’t require additional allocations. For that, one can wait until the next Budget in February.
Divestment is always seen as an easy option to raise revenue intake. It is one thing for the divestment target to be raised, but another for the government to stick to the fiscal deficit target of 4.1 per cent of GDP. Even here, one could argue that, in line with good fiscal practice, divestment should be treated as a financing item; this will give a more accurate picture of the fiscal deficit. India’s current practice of treating divestment as a revenue line item understates the actual fiscal deficit.
However, to show a wider fiscal deficit despite higher divestment will be regressive and disappointing. In the past, all kinds of governments have used the carrot of improving growth for justifying slippage on the fiscal deficit. That ploy rarely resulted in sustained improvement in growth. In fact, it often created a new mess.
The Budget cannot fix all of India’s economic ills. Still, it is best to shun the politically self-serving but sub-optimal route of a wider fiscal deficit. Of course, that won’t be easy. It will require political capital to push through tough and unpopular decisions, such as cutting back subsidies and limiting goodies, to strengthen the evolving India story. But what else is the strong mandate for?
The writer is senior economist at CLSA, Singapore.
These views personal
These views personal
