Comfort for markets with political stability

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: The finance minister has taken advantage of strong economic growth and the economy’s healthy state to bring the fisc back on track for achieving FRBM targets. This is indeed good news, as is the sustained rise in tax to GDP ratio for the third year successively. However, as I have argued earlier, the reduction in the revenue deficit should have been larger this year because at its estimated level of 2.1% in 2006-07, it will require a full one percent point reduction in the next two years, when the pressures on expenditures will be even greater.

The Budget ratios are dependent on the assumption about nominal GDP growth in the coming year and here, the bar for economic growth has been raised even higher. A simple reworking of the numbers indicates that nominal GDP growth has been estimated at about 14.2%, which will yield a real GDP growth of about 8.5%, assuming that inflation remains at about 5.5-6%. The slightly higher inflationary expectation may be on account of some pass-through of higher global oil and commodity prices that expected to remain firm on account of demand pressures arising from Chinese and Indian growth. We are, however, left unclear on the possible pass-through of these higher global prices to the domestic economy.

The FM has been able to achieve a fine balance between coalitional pressure for increased social expenditure and maintaining fiscal prudence, but perhaps at the cost of lower than necessary increase in plan capital expenditure, and a somewhat weak effort at resource allocation for physical infrastructure. The strategy seems to be to take on rural infrastructure development and income transfers to poorer sections and regions and leave physical infrastructure development largely to the private sector. This is workable, as long as India continues to attract increasing volumes of foreign equity and direct investment. But regulatory mechanisms and inter-ministry coordination will have to be put in place to facilitate private infrastructure investment.

It would also help if infrastructure was given priority sector status for bank lending. The weaknesses in the banking sector—which still does not try to create innovative packages for infrastructure lending and leaves approximately two thirds of rural households outside formal banking—will have to be addressed head on, if the expectation of private funding of infrastructure is to be borne out.