Q: Is there as much buzz and anxiousness around a federal budget in other Asian countries as in India?
A: India stands out in the Asian region with the nature and magnitude of the tamasha in the run-up to the Union budget. This is understandable for three reasons.
First, it highlights the extent of government’s interference via its tax policies in the Indian economy. Second, it underscores the uncertainty around the government’s approach with respect to specific fiscal measures, over and above the broader macro mess created by this government’s fiscal policies. Tax changes have positive and negative impact on different sectors and companies, hence the high level of interest and anxiety from stock market investors. Third, the hype is also fed by the plethora of print and electronic media covering the event, and the multitude of opinions that are expressed.
The level of tamasha in the run-up to the budget in India is itself a bad sign of a still-shackled economy. Indeed, India has a long way to go before the budget-related cacophony softens to the level in other Asian countries.
Lax fiscal policy has often been cited as a key factor behind India’s distressed macro which has also crippled growth. How quickly can this be reversed?
High fiscal deficits are like obesity: it is easier to put on weight than to shed the extra kilos. Similarly, fiscal correction is a slow process, unless forced by the exigencies of a crisis. Additionally, there could be adverse fallout on the growth momentum from fiscal correction which should not be ignored. Thus, fiscal correction is generally not painless.
A self-inflicted tragedy with India’s macro policymaking since the 2008 global financial crisis (GFC) has been the misdiagnosis of several economic ills which were worsened by wrong prescriptions. India’s speed, magnitude and coordination of fiscal and monetary policy mix to deal with the GFC were remarkable. In fact, revised estimates show that real GDP growth in 2008-09, the year which captured the full impact of the GFC, was 6.7 percent. Non-agriculture GDP grew 8.1 percent in that year. This was lower than the 10.1 percent in the prior year but the near-8 percent growth outcome when the world was on its knees is hardly anything to cry about.
The problems began with the delay in the much-needed timely and adequate withdrawal of the fiscal stimulus following the post-GFC recovery, which was aided by fiscal steroids. The rebound in aggregate demand in the chronically supply-challenged Indian economy along with the recovery in global commodity prices pushed up inflation, which already had some local structural drivers behind it.
This “money grows on trees” approach led to record-high market borrowings by the government, which in turn adversely affected private investment. The corruption scandals were the final straw that broke the back of investment by spreading risk aversion across the private sector and delaying timely decision-making by the bureaucracy.
India is now a low growth/high inflation economy, thanks to the gross economic mismanagement by UPA-2 headed by a trained economist. The macro healing will be protracted. Growth will improve slightly, possibly to around 6 percent in FY14 (2013-14) but a growth takeoff similar to 2003-07 in the next few years remains wishful thinking. It is often ignored that lasting low inflation and qualitative fiscal adjustment are prerequisites for India’s sustained growth acceleration.
How can the forthcoming budget play a constructive role in India’s economic healing?
India needs three related macro adjustments: (1), the twin deficits need to be brought under control; (2) fiscal policy should be tighter, which in turn will create room for monetary policy to be loosened; and (3) investment needs to become a more important driver of economic growth than consumption.
Frankly, the budget is not the forum for fixing all these issues. Still, a practical and sensible macro framework can be presented with some meaningful fiscal action and credible guidance. The latter is crucial because this government has an exceptionally poor fiscal track record. To be fair, the process of fiscal correction has already started following the recent emergency-like spending cuts. The key is the sustainability of fiscal healing – and does not mean improvement for just one or two years.
The political pressure to compromise the spending discipline will be high, especially in the second-half of FY14. Thus, Finance Minister P Chidambaram will probably deliver a “responsible” budget that cuts the fiscal deficit. But whether he will stick to it in the run-up to the next general election is the key issue. Most likely, a slight slippage from his fiscal roadmap will occur even if the broad direction is maintained. Just because the government got into an overdrive to cut spending this year to gain credibility by finally delivering on its revised fiscal deficit target is no reason to expect an encore.
Sustained fiscal correction will ease the aggregate demand pressure, which will be favourable for the inflation outlook. In turn, this will facilitate more interest rate cuts. Importantly, such an outcome in no way eliminates the urgent need for reforms and supply-side initiatives for a long-lasting decline in inflation.
What are your expectations from the forthcoming budget?
Finance Minister P Chidambaram has reiterated his guidance of cutting the fiscal deficit to around 5.3 percent of GDP in FY13 and to 4.8 percent in FY14. I expect him to come through on these. Expenditure control will be of prime importance. Direct and indirect taxes are unlikely to be raised but there is a strong possibility of a temporary surcharge on the income of the very rich and an inheritance tax. Both are essentially political posturing as the government can collect more revenue by merely improving the tax compliance. Some tweaking of exemptions in excise duty and service tax is likely.
The actual fiscal deficit in FY14 could be slightly higher, say, around 5 percent, but let us wait for the actual details of the FY14 budget. The real test for the FY14 budget won’t be what is shown on paper; that is the easy bit. Instead, it will be the commitment to stick to the fiscal deficit target as the year progresses.
The Direct Tax Code (DTC) will be delayed, again. This time because Chidambaram might want to take a fresh look at it. He’ll likely indicate the broad contours of the anticipated goods and services (GST) tax and also include the outlines of the amendments to Constitution on the GST. However, it’ll be disappointing if, after the repeated delays in recent years, there is no airtight deadline.
Most investors have lost sight of the fact that in its rush to show progress on the GST, the government has compromised the effectiveness of the GST. Multiple rates and varying timelines for states to adopt the GST will limit the potential benefit from creating a national common market and also give birth to complications. Don’t forget that the GST is meant to get rid of complications, not create new ones from a sub-optimal design. Half-baked reforms are not the way to go.
There could be some measures to encourage retail participation in the equity market. While these could be positive for the equity market, the underlying impact on fixing the economic ills will be practically zero. The real economy is screaming for more pertinent action, not merely changes that push up equity prices. If economic structural problems could be solved by just pushing up stock prices, equity brokers would be manning policymaking (there are good reasons why this doesn’t happen in any country).
Finally, expect more song and dance about the cash transfer scheme even as the government goes ahead with the National Food Security Bill (NFSB). The potential net fiscal savings from the cash transfer scheme is being played up. For the record, there will be fiscal savings because of better targeting of subsidies and cutting leakages, both of which will be the result of the pace of implementation of Aadhaar, not cash transfers per se. More likely than not, politicians will find ways for spending the initial savings, which will partly be a function of how quickly bank penetration can be increased.
How worried are you about the National Food Security Bill (NFSB)?
Weak fiscal dynamics have always been India’s Achilles’ heel. Coalition politics and uncertainty about how long a party will be in power often breeds economic short-sightedness. Also, the ruling UPA government has been in favour of using fiscal policy under the guise of an “inclusive” or “redistributive” agenda for its political goals.
Sonia Gandhi, the populism-favouring President of the Congress party, reportedly directed the government recently to widen the coverage of the NFSB. Ironically, while Chidambaram is attempting to fix what was broken, Sonia Gandhi’s populist initiative is sowing the seeds of another problem.
Following the proposed changes, the NFSB’s coverage will probably increase to nearly 70 percent from the initial estimate of around 67 percent of total population. The implementation of NFSB will be spread over two or three years, and the forthcoming budget will reportedly initially allocate around Rs 50 billion (Rs 5,000 crore, which will be over and above the usual allocation for food subsidy). Officials reportedly indicate that the overall food subsidy will increase to around Rs 1.2 trillion (Rs 1,20,000 crore, or 1.1 percent of FY14 GDP on our estimate). There will also be implementation cost.
The recent reduction in fuel subsidy is welcome, but its positive impact on the headline fiscal deficit will be meaningfully offset by higher food subsidy. Few are opposed to helping the poor but the problem with the NFSB is more serious. It will make the government’s discretionary spending more inflexible, shrink room for counter-cyclical measures in down years, and add to inflationary pressures, especially during poor monsoon years.
Indeed, the fiscal slippage in drought years could be more pronounced due to the legal entitlement of food subsidy. There will also be serious challenges with respect to higher foodgrain production, procurement, storage and distribution. Overall, the NFSB does little for food security but will surely increase fiscal insecurity.
What is the outlook for government borrowing?
Higher borrowing facilitated elevated government spending in recent years, boosting consumption instead of being used for growth-enhancing and investment-friendly initiatives. This, in turn, worsened inflationary pressures and fueled macro imbalances.
Following the recent cancellation of the last auction of the fiscal year, gross government borrowing in FY13 stood at Rs 5.58 trillion (Rs 5,58,000 crore) compared to Rs 5.7 trillion (Rs 5,70,000 crore) pegged in the FY13 budget. Our expectation is that gross market borrowing in FY14 will be marginally higher at around Rs 5.97 trillion (Rs 5,97,000 crore). This is based on the likely official fiscal deficit forecast of 4.8 percent of GDP. The size of the borrowing in rupee terms will be a record-high, although it’ll be down as a percentage of GDP. The combination of gradual fiscal correction and the scope for further monetary easing sets up a favourable backdrop.
Do you think the medium-tem fiscal consolidation roadmap by the government is credible?
The ambitious path of fiscal correction announced by the government looks good, but only on paper. It is sensible to be sceptical about the targets beyond FY14 as implementation will be exceptionally challenging. The path envisages the federal fiscal deficit shrinking to 4.2 percent of GDP by FY15 and to 3.0 percent by FY17. To put the forecast in the proper context, India’s fiscal deficit averaged 3.3 percent per annum in the three years to FY08 when real GDP growth averaged an unprecedented 9.5 percent annually. India is not in a similar up-cycle in the coming years by any stretch of the imagination.
Also, the government’s plan does not take into account three factors which could adversely affect the fiscal correction. First, a general election has to be held by May 2014 (but could be earlier in late-2013). Consequently, the sizeable reduction in spending will be challenging. Second, the official fiscal roadmap does not include any impact from the anticipated hit from the Food Security Bill. This is a key initiative of the Congress party’s leadership and is likely to be launched ahead of the next general election.
Third, the Fourteenth Finance Commission (FC), a constitutional body set up every five years to make recommendations on the distribution of sharable taxes between the central and state governments) would form the basis for the fiscal policy after FY15. Thus, the fiscal correction path after the general election and after incorporating the recommendations of the Fourteenth FC is bound to look different from the current official indicative path.
Any suggestions for the finance minister?
Chidambaram cannot please everyone. He should be mindful that unrealistic assumptions for GDP growth, revenue mobilisation and/or spending cuts will be treated negatively, even if they aid him in delivering on his fiscal deficit guidance.
This could also unnecessarily negate some of the gains he has made in the last few months. The key message has to be credible fiscal correction, and he will be judged not just by what he shows on paper but also by whether he sticks with the fiscal discipline over the course of the year.
Finally, he and the government should be aware that the populism and fallout from the NFSB will not be ignored by investors or credit rating agencies, even if the cost is initially underfunded in the forthcoming budget.
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