Confirming fiscal orthodoxy, assuring continuity

Written by Jahangir Aziz | Jahangir Aziz | Updated: Jul 11 2014, 14:07pm hrs
Clearly, the pressure to deliver a dream Budget was immense. And it was heartening to see the government resisting that temptation. By eschewing growth adventurism and sticking to the Interim Budget deficit target, the finance minister delivered a Budget that continues on the fiscal consolidation path of the last two years. Indeed, by committing to the fiscal path laid out by the Kelkar committee for the next two years, just as his predecessor had done, he reinforced the hard-earned macroeconomic stability that separates India from other emerging market economies today. The striking continuity with the previous governments approach of the last two years, not just in the fiscal numbers but also on several policy proposals, may have been inadvertent but it only goes to show how economic reality circumscribes policy options.

The commitment to macroeconomic stability reduces Indias tail risks when growth-inflation dynamics are precariously balanced. By not adding to aggregate demand, the Budget lowers the risk of an inflation flare up, an unwarranted widening of the CAD, and fears of the rupee coming under sudden intense depreciation pressures. What it indicates is that bringing down inflation rather than pump priming growth is this governments primary near-term objective and that it believes it is in it for the long haul and intends to focus on lasting reforms.

But like everything else, the devil is in the details. By committing to stick to the Interim Budgets fiscal deficit and not raising the privatisation target sufficiently despite the much more buoyant stock market, the government also bought into the Interim Budgets very ambitious 20% tax revenue growth. Under current growth and inflation forecast, it is very hard to see the revenue target being met. And that means that just like the last two years, this year too can see spending being strangulated to meet the deficit target.

Separately, one was also disappointed that the government did not take this opportunity to break away decisively from the policies and reforms of the previous government. One wasnt expecting a fully worked out work plan for the next five years, but one did expect a clearer articulation of the principles that would underlie the direction of future policies and reforms. Instead, the Budget reiterated the now old argument that much of Indias economic woes are simply a result of the dysfunctional decision making by the previous government. Perhaps this is what the new government believes. So, we should expect significant continuity with the previous government in policies and reforms except that these would be better implemented and more effective in delivering the intended outcomes, i.e. a very workmanlike approach to policymaking.

This may not be a bad approach at all. The UPA government had also preserved almost all the programmes initiated by the previous NDA administration and also pursued many of their reforms. In addition, several outstanding reforms and policy changes left behind by the previous government have gone through the usual vetting by experts and high-level committees and there is no merit in trying to reinvent the wheel. Thus, the commitment to implementing GST that remains a daunting political challenge; increasing FDI in insurance and defence; introducing REIT-type structures for infrastructure financing; continuing consultations on the proposed Indian Financial Code; extending the 5% withholding tax on foreign holding of corporate bonds are all positive signs. Allowing banks to raise long-term funds not subject to the existing regulatory costs as long as these are on-lend for infrastructure should help to ease funding constraints in that sector. Perhaps RBI may even later sweeten this further by allowing such bonds to be used for repurchase operations at its discount window. It was also heartening to see the RBI proposals of providing bank licences on tap and introducing differentiated banking licences being accepted by the government. These two changes have the potential of altering the state of Indian banking system dramatically. Interestingly, the market hasnt seem to have focused on the almost throwaway statement that RBI needed a modern monetary policy framework. One assumes this is an euphemism of accepting the Urjit Patel committee recommendations of moving to a flexible inflation-targeting framework. If this transpires, it would be a giant leap towards formalising macroeconomic stability as a formal objective of monetary policy.

Many will argue that this is not the time to worry about stability. Instead, the government needs to spur growth and create employment for the millions of new workers joining the labour force. One cant really argue against this objective. Redoing the land acquisition framework; labour market reforms; changing resource pricing rules; liberalising the domestic market are critical to get growth going and creating employment. But doing so with irresponsible spending isnt the solution. Reforms are. But such reforms are neither under the purview of the finance ministry nor the Budget the forum to talk about them.