Budgets are made around a central assumption: how fast will the economy grow next year? At the best of times this is a parlous but necessary exercise. It becomes diabolically difficult when the economy is approaching a turning point as ours is now. Not only do you need a fair idea of how
far down the line the tipping point is, you also have to guess the speed of the rebound. An alphabet soup of recovery shapes stare at the forecaster—V, U, W, L.
P Chidambaram has settled on V with the budget for 2013-14 operating on its rising arm. Gross domestic product should grow by 6.1-6.7% is the finance minister’s view. Which implies the economy would have bottomed out this year, when it is expected to grow somewhere between 5%, according to the Central Statistical Organisation (CSO), and 5.5%, according to the Reserve Bank of India.
The finance minister has tailored his budget accordingly. Government spending next year will rise slower than revenue to bring the fiscal deficit to a pre-committed 4.8% of the GDP. Chidambaram does his numbers well and his secondary assumptions on tax buoyancy and expenditure compression are very likely as watertight as they come. But what if the original assumption were to fail? The 6.1-6.7% growth range has been endorsed in the Economic Survey prepared by Raghuraman Rajan, chief economic adviser in the finance ministry and a former chief economist of the International Monetary Fund. This, in turn, presupposes all three major sectors of the economy — agriculture, industry and services — will perform better next year than they did in 2012-13.
Here lies the uncertainty. It is too early to get a fix on the monsoon. Industry is on its knees and a turnaround is predicated on the government vacating fiscal space and the central bank easing up on credit. A chunk of services is in the nature of derived demand with business depending on how the rest of the economy is doing. The Economic Survey’s GDP forecast for next year is loaded with caveats.
Now for the turning point. GDP growth has been declining steadily for the past seven quarters from 9.2% to 4.5% . The CSO’s estimate is the economy will grow 5% in 2012-13. Sequentially, growth has slid from 5.5% in the first quarter to 5.3% in the second and 4.5% in the third. If the CSO scenario were to play out, growth in the last quarter of 2012-13 will be 4.7%. Thus the economy would have bottomed out sometime between October and December 2012.
Next the speed of the rebound. To do better than this year, agriculture and industry would need to grow faster than 2% and services 7%. These are far below the trend rates of the recent past and it is eminently reasonable to assume these thresholds will be crossed. A single shock, like scanty rains or a delayed industrial recovery, will be offset by the sheer momentum of the other sectors. Finally, the shape of the recovery. India is emerging from the second dip after Lehman Brothers collapsed in 2008. We went through the first relatively painlessly because of a fiscal stimulus that some would argue was an overdose. In the process India lost the fiscal headroom for a second shot, making Chidambaram’s job much more challenging. In the alphabet metaphor India is in the second half of the W and the second recovery is unlikely to drag. Manmohan Singh is not being optimistic when he says 8% growth is within sight.
Chidambaram may be leading the economy out of the woods but there remains a question mark over inflation. The interplay of income with prices in India does not lend itself neatly to forecasting. Price movements are guided inordinately by the government’s misplaced belief that it can smooth out market volatility, particularly in food and energy. It’s good to see budget making began last September with efforts to tease suppressed and structural inflation out of the system. Going forward, subsidy compression through better targeting ought to reduce this source of uncertainty in budget plans.
The external environment is the other big imponderable for an economy that must shop abroad for essential energy. An oil price spike or a further deterioration in the eurozone could upset some of Chidambaram’s meticulously laid plans. India is highly vulnerable to external shocks with a current account deficit in excess of 5% of the GDP. If savings recover to levels Chidambaram is comfortable with, India will regain its buffer.
There would have to be an incredible coincidence of adverse circumstances for Chidambaram to have to think of a Plan B. He has been working on the flanks well before he presented a prudent fiscal policy document last week. He has not only been shaping the policy environment that will deliver his anticipated revenue and expenditure outcomes, he has also tried to cover the unknown unknowns.