As finance minister P Chidambaram takes a mark for the 2013-14 Budget’s home run dash, he will be aware of one widely used concept of economic theory: constrained optimisation.
It represents arriving at a set of best solutions to a matrix of problems. In a real economy, however, the most favourable way out for one set of problems could harm prospects somewhere else. Ceteris paribus or other things remaining same, the most basic assumption in any economic modelling, may thus not apply at all in most real cases. For instance, if prices are rising steeply, slashing high interest rates may sometimes end up fanning inflation further. Striking a balance may involve a painfully long process of slow, gingerly taken steps.
In the UPA government’s 10th year, macro-managers are stuck with major headaches. Listing out major constraints may well be the first step in finding optimal solutions to these.
There have been very few periods in India’s contemporary history when prices have remained so stubbornly high for such a long period. The same amount of money now buys fewer goods. Economic theory calls this phenomenon as a fall in real income. It’s a reality any government can ignore only at its own peril.
India’s business leaders have been rachetting up their demand for lower borrowing costs. Their argument: costly loans and inputs have upset their plans. Companies can go ahead with their capacity expansion plans only if borrowing costs come down. The Reserve Bank of India (RBI), like all other central banks, seeks to tame prices by keeping interest rates high and demand under check. The jury is still out on when it starts turning the clock back on lending costs.
Corruption scandals are hitting political sentiment that can in turn hurt business climate. India has been rocked by major scams last year, including the Coalgate scandal that has put government behaviour under scrutiny. Spats between Opposition and the government and resultant logjam in Parliament affected the passage of key legislations and critical reform measures
Wobbly world economy
The US, the world’s largest economy that accounts for about quarter of global GDP (gross domestic product), is struggling to find its way out of a “fiscal cliff.” It is the effect of a series of enacted legislation which, if unchanged, will result in tax increases and spending cuts of about $700 billion in the US starting 2013. Europe, on the other hand, has been hit hard by sovereign debt worries. It’s hurting India as nearly two of every three products that India exports are shipped towards these two markets.
India needs about $1 trillion (about R45 lakh crore) over the next five years to shore up its crumbling, inadequate infrastructure. That will not happen unless a regulatory environment is created where investors are not scared of locking up capital in long-gestation projects such as roads, ports and highways.
High subsidies, however, has widened its fiscal deficit — shorthand for the amount of money the government borrows to fund its expenses — limiting its elbow room to spend on investing in infrastructure and development schemes to spin jobs and multiply income.
Politics of populism
With the next budget (2013-14) likely to set the tone for the 2014 Lok Sabha elections, political expediency will demand a fair sprinkling of populism even as industry captains and economists will be keenly watching the pace at which reforms are initiated. Straddling both worlds could involve a delicate tight rope walk for the government.
Finding an equilibrium set of answers to these problems may not be easy. But some years do stand out from the crowd in the continuum of the nation’s history. If recent events are any indication, this could well be one such year. There is an unmistakable air of anticipation about a swift turnaround. In 2013, expect a lot of action on at least on the following fronts:
Taxation: A uniform, pan-India goods and services tax (GST) could save billions of dollars, cut corruption and boost economic growth. A confusion of taxes such as excise, customs, octroi and VAT (value-added tax) would be abolished. In the next 12 months, we can expect two of India’s biggest tax reforms initiatives, GST and the Direct Taxes Code to replace archaic income, and wealth-tax laws to take off.
Finance: The money from savings could be boosted by foreign and domestic capital if Parliament clears the Pension Funds Regulatory Development Authority Bill and the Insurance (Amendment) Bill, easing the path for savings to be used for infrastructure investments.
Land: Apart from increasing agricultural productivity, the government will need new industrial towns to generate employment. A robust, fair relief and rehabilitation framework — a new law before Parliament — is central to India’s growth story.
The burden of reform expectations on the government is too heavy, as also the need for firm fiscal situation. It’s time to walk the talk.