Column : A call for rebalancing

Written by Sajjid Z Chinoy | Updated: Feb 28 2013, 06:04am hrs
There are two ways to read the Economic Survey. The first is to focus exclusively on the numbers. Predictably, thats what many onlookers did. Can growth pick up to between 6.1-6.7 %, as the Survey projects Will inflation really fall to 6.2-6.6% in March as the Survey expects Does the Survey imply this years fiscal deficit number will be contained to 5.3% of GDP

I would call this a relatively blinkered approach of interpreting the Survey. Private and public sector forecasts came with (an often significant) margin of error. Recall, last years Survey projected growth at 7.6%. Instead, growth will likely print closer to 5%a whopping 30% miss! Risks of forecast errors are heightened in the current uncertain global environment, and a domestic environment peppered with state and general elections that are likely to constrain policymaking. Forecasts are also particularly vulnerable at turning points. Given all this, focusing primarily on the numbers is missing the forest for the trees.

Instead, in the current contexta high fiscal deficit, falling savings and investment, a high current account deficit (CAD), high retail inflationits more useful to glean what the overarching theme of the Survey is. Is there an urgent call to action in some areas What should be the policy priorities and how should they be optimally sequenced

Using this lens, I would argue that the leitmotif of the Survey is rebalancing across various areas. This comes across explicitly in some areas such as reorienting national spending, but often implicitly in others such as the nature of fiscal consolidation and manner of financing the CAD.

At the heart of all this, however, is a seeming inconsistency. Exact magnitudes apart, the Survey calls for sustained fiscal consolidation, but projects a reasonably strong uptick in growth next year, and a moderation in inflation. But, on the face of it, arent these mutually inconsistent outcomes Fiscal consolidationas desirable as it is in the medium termwill be a drag on near-term growth next year. Dont look any further than this year to see how and why. The government likely sticking to the revised fiscal deficit target of 5.3% of GDP, has meant thaton a cyclically-adjusted basisthe fiscal drag on activity this year has been a whopping 1.5% of GDP. No wonder growth has slowed much beyond expectations. This is not necessarily a bad thing, and an adjustment that needed to happen. More generallygiven our past excessesfiscal policy is forced to be pro-cyclical. But the fiscal drag from this needs to be part of future growth forecasts. So, if the government targets another 0.5% of fiscal consolidation next year, it will continue to impede growth. And if, as the Survey projects, exports dont pick up in a hurrywhere will the meaningful pick-up in growth come from

Furthermore, if growth were to accelerate appreciably, wont this increase pricing power and put more pressure on inflation How then can one project inflation moderating In sum, doesnt a tight fisc, accelerating growth, and slowing inflation constitute the impossible trinity

The only way all three outcomes can be simultaneously achieved is if we witness a sharp pick up in private investmentthat boosts growth but simultaneously creates capacity to keep a lid on prices. And this is where the Survey makes an urgent call to rebalance national spending away from consumption towards investment. This entails sustained fiscal consolidation but also de-bottlenecking supply constraintsland, coal, raw materials and clearances. To its credit, the Survey highlights the critical importance of releasing these constraints, even as it forecasts some monetary easing.

Key to achieving the aforementioned rebalancing is also credible and sustained fiscal consolidation that opens up space for private investment. But, even as markets celebrate this years likely outturn at 5.3% of GDP, remember it has been achieved by slashing expenditures. Given the flab in the system, this is not necessarily a bad thing for a year or two. But achieving medium-term fiscal consolidation only through squeezing expenditures is neither tenable nor desirable.

And heres where the survey (implicitly) makes its second case for rebalancing, urgently arguing for higher tax-GDP ratios, which are currently almost 2 percentage points lower than the pre-Lehman period. Given this focus, it will not be surprising to see some direct taxes (surcharge for the wealthy) and indirect taxes (possibly customs and excise) rise in todays Budget to make the 4.8% deficit credible. The game-changer, however, will be a specific, time-bound road-map to implement GST and boost medium-term revenues.

The third area of concern is predictably the bloated CAD. Here the Survey made all the right noises on reducing gold and oil demandthereby arguing for the continued increase in fuel prices and suggesting that another gold duty hike is possible later in the year. More importantly, there is an (implicit) call for rebalancing how the CAD needs to be financed. It was a welcome relief to hear authorities worried about the ever-growing quantum of external commercial borrowings (ECBs)particularly for firms with no natural hedgesand the dangerous consequences of unhedged dollar liabilities for corporate balance sheets. Given this, the Survey rightly argues for more rupee-denominated instruments, hinting that the withholding tax on corporate bonds could be streamlined, and FII limits for rupee-denominated debt increased further, and other rupee-denominated instruments considered. Remember, foreigners hold the risk on these instruments as opposed to Indian corporates in the case of ECBs.

In sum, the Survey makes an urgent plea to rebalance the economy to help generate non-inflationary growth, sustained fiscal consolidation and more secure financing of the CADthree of the most pressing issues facing policymakers today.

The disappointment, if any, is that there were no new ideas or policy-prescriptions to boost flagging household financial saving. To be sure, the Survey acknowledges the extent to which household financial savings have fallen, and talks about the role of inflation in eroding returns. But given how urgent an issue this is, one would have liked more ideas and policy prescriptions on incentivising long-term, contractual financial savings, and broadening and deepening domestic financial markets, more generally. Remember, the only way to boost investment without worsening the current account is to boost domestic financial savings. Therefore, dont be surprised by a number of tax initiatives in todays Budget to boost household financial savings and channel them to the infrastructure sector.

More generally, expectations have been secularly rising since the finance ministers road-show that this could be another dream Budget in the current contextcredible fiscal consolidation but also a focus on boosting savings and infrastructure investment. Its a mighty challenge, but not one thats impossible. The Economic Survey has whet the appetite. Now we await the main course.

The author is India economist, JP Morgan