Nothing exemplifies the dilemmas of policy-making in a fast growing, globalising India economy more than the latest budget presented by finance minister P. Chidambaram. In the spirit of the ‘Home and the World’ series that we were carrying on these pages as a run-up to the Budget, Chidambaram’s offerings must be viewed as being inclusive of the global scheme of things in which India is fast emerging as an economic power.
The big ‘change’ factor is the gathering storm clouds over India’s growth dynamic due to uncertainties in the world economy, including the prospect of a full-blown recession in the US economy. India cannot but be affected by these developments. Under these circumstances, what should be the stance of the Indian government?
When the economy has already slowed down with the prospect of a further squeeze on export growth due to recessionary winds blowing through the US economy, when capital inflows continue to surge unabated into the system, the budget clearly is expected to send out a strong message: the economy is relatively insulated from these developments. So the need is for a tighter fiscal stance or restraining the fiscal deficit to much lower levels than indicated in the fiscal responsibility legislation. In other words, it should be belt-tightening time.
As the latest Economic Survey takes note of, a further reduction of the fiscal deficit can reduce the pressure of excess demand created by the inflow of foreign funds. A lower fiscal deficit means a reduced supply of government securities. And for any given demand structure, a higher price for government securities and Treasury Bills, i.e. a lower interest rate. This will directly reduce the interest gap with the global rates.” So a lower fiscal deficit (read: borrowings) will serve to moderate these inflows that are showing no signs of slowing down, besides limiting their inflationary impact.
But instead of a tighter fiscal stance, the Budget pitches for greater spending — quite obviously with the imperative of fighting national elections very soon. It also mirrors political-economic factors, including the imperatives of running a coalition government at the national level that depends on the support of Left parties from the outside. This entails stepping up allocations for flagship National Common Minimum Programme schemes like the National Rural Employment Guarantee Scheme all over the country and Bharat Nirman to build national highways, rural roads and houses for the poor.
With this terrible pressure to spend, how can Chidambaram show lower deficits? In his Budget speech, the Finance Minister did grudgingly admit that the deficits are understated due to the practice of showing burgeoning subsidies on food, fertilisers and oil off-budget. If these are added to his estimates for 2008-08, the Centre’s fiscal deficit is no different from earlier years. All of this adds up to present a picture of stalled fiscal consolidation — a challenge for the next government to address on a priority basis. Clearly, the stance of the government is at odds with what is needed to deal with India’s place in a global environment.
The limited fiscal consolidation is, in fact, a missed opportunity for one of India’s finest Finance Ministers who has been lucky to have averaged 8.8 per cent growth in his five Budgets.
A fast-growing Indian economy provided a golden opportunity to tackle its fiscal challenges decisively. GDP growth of 8.8 per cent during the last four years provided a favourable context for lowering the government’s fiscal and revenue deficits, and reducing public debt levels relative to output. Sadly, the latest Budget has failed to make a strong statement in addressing these challenges.
And why is that? Thanks to rapid growth, there has been tremendous buoyancy in tax revenues. In the three years since 2003-04, gross tax revenues of the Centre have grown by 19.9 per cent, 20.1 per cent and 29.3 per cent respectively. Tax collections have also been bullish this year, with those on personal income and corporate taxes booming. Indirect taxes have registered increases. All of these provided Chidambaram room for manoeuvre to meet National Common Minimum Programme spending obligations and to fulfil electoral compulsions for populist giveaways — and to have remained fiscally responsible.
Despite tax buoyancy, however, spending commitments have only mounted. Take the revenue deficit. This is incurred when the government’s tax revenues cannot meet its routine administrative expenditures like wages, salaries and subsidies. Reining in such spending has eluded most Finance Ministers of coalition governments. Chidambaram is no exception. True to form, he has announced no fresh measures to lower subsidies in his latest Budget. The Sixth Pay Commission award looms on the horizon. Add up all the numbers — and how can he eliminate the deficit by 2008-09?
However, there is bad news. The growth momentum has slowed down this year, forcing Chidambaram to design a fiscal package to boost consumption and sustain demand for industrial goods.
No budget is, of course, complete without measures to address the acute agrarian crisis. This sector accounts for a shrinking share of the nation’s GDP. But 60 per cent of the population still lives off the land. With reports of farmer suicides across the country, the Finance Minister has announced a big waiver of farm loans, besides various other measures to stimulate slumping agricultural growth.
Returning to our ‘Home and the World’ theme, the limited budgetary thrust towards the global dimension is also presumably because of its uncertain impact. The Survey also admits that “slower Indian economic growth in 2007-08 relatively to 2005-06 and 2006-07 may also have a temporary dampening impact on capital inflows. On balance, the decline in capital inflows as a proportion of GDP in 2008 is also likely to be modest.” This indicates pressure on the rupee to appreciate would be less. But the big question is: will inflows decrease given that India remains one of the fastest growing economies in the world?
This Budget emphasised the government’s responsibility to manage these inflows more actively. But it didn’t mention imposing capital controls. In the run-up to the Budget, speculation was rife that some curbs would be imposed to moderate capital inflows. These inflows were sending stock indices to dizzying heights and lows and exerting pressure on the rupee. Net foreign portfolio investments have already crossed $18 billion while the rupee has appreciated by 8.9 per cent against the dollar. But contrary to expectations, there were no such curbs.
Nobel economist Joseph Stiglitz also suggested that India consider two policy options to curb the excessive fund inflows into its economy. One, impose a tax on short-term capital flows as Chile did during the 1990s. This tax changed the structure of capital coming in providing an incentive for long-term capital flows. Two, to increase capital gains tax on real estate profits. There seems to be no prospect of either these measures, exemplifying again the policy dilemmas of dealing with India’s growing role in the global economy.