Dull, not dreadful

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SummaryJuly 4th saw fireworks in a recession-hit America that is still contracting. But the Budget on July 6th was a damp squib in an India doing much better. Roger Federer turned in a more convincing performance at Wimbledon than the FM did in Delhi.

July 4th saw fireworks in a recession-hit America that is still contracting. But the Budget on July 6th was a damp squib in an India doing much better. Roger Federer turned in a more convincing performance at Wimbledon than the FM did in Delhi. The Budget had a lead balloon impact on stock markets and the investor community. Markets are not the best reflectors of an Economic Survey’s merits; nor of a Budget’s demerits. Still their movements in the first week of July suggested Survey-induced exuberance followed by overcorrection when the bubble was burst by an overly conservative, cautious, compromise Budget. It did not trigger much other than tedium and the disconcerting thought that this government may not deliver.

This year’s Survey was written by a team led by one of the finest minds in applied economics in India (contrary to public opinion some economic minds do apply themselves): Dr Arvind Virmani. It was informative, incisive, thoughtful, visionary and far-reaching; much bolder than is usual with North Block. Corporate and financial India took to its messages like ducks to water. It was manna from heaven. Perhaps they thought, not unreasonably, that the Survey affirmed the mandate that UPA II had been given.

Markets assumed UPA II understood that mandate, and would position itself to deliver on it. Having used the excuse repeatedly that its dependence on the Left had constrained UPA I from delivering on reform, it was not unreasonable for India to expect—with the Left having been voted into oblivion and the BJP (with some quite sensible economic proclivities) being humiliated—that UPA II would be unconstrained from proceeding with an urgent agenda of reform on several fronts at an accelerated pace. It assumed that the PM would want to secure his place in India’s history in what is likely to be his last term in office.

Unfortunately, this Budget does not signal that. It suggests—by implication—that the real resistance to the reforms which India needs lies within the UPA alliance. The Left’s opposition to common sense was merely a convenient fig-leaf for obscuring that inconvenient truth. The Budget confirms that the political (not technocratic) powers that hold sway within UPA remain counterproductively socialist; indeed they sometimes seem more like the Left than the Left. If this Budget is any sort of signal, then it says that UPA II is likely to retard India’s progress towards rightfully becoming the world’s third largest economy. Yet, India needs to get there sooner rather than later not just to relieve the poverty of its population but to ensure its survival and security in a hostile, fragile world in which power balances change kaleidoscopically. A strong country cannot be built on weak public finances with a weak, unduly politicised public sector that continues to make decisions and intervenes in the economy in ways that debilitate rather than strengthen India.

Taken at face value the Budget does not want to see an economy emerge in which: (a) the government/public sector’s role and power to intervene in the financial economy—thus pre-empting efficient, effective resource mobilisation while indulging in continued egregious (mis)allocation of resources—are reduced; and (b) the government’s highly inefficient and ineffectual direct involvement in the real economy—in areas such as food production, energy, public distribution, transport services (witness the debacle at Air India), and commercially viable urban infrastructure—is progressively phased out by 2015 or 2020 at the latest.

For that to happen, decisive moves in those directions need to be made now. Instead the Budget conveys the opposite signals with its odd stance on PSU’s. It is perplexing to a rational observer how any government that is in the fiscal straits this one is in—and that risks compromising the future of the next two generations if decisive action is not taken to reduce public deficits and debt—can argue for keeping PSUs, especially banks, insurance companies and financial institutions in the public domain. It simply cannot afford to do that. Nor should it try. Populist and economically uninformed political opinion may support such a stance. But it is the business of government to lead people towards the truth and not pander to a reassuring but dangerous fantasy that has become part of folklore. Resurrecting the ghost of the late Mrs Indira Gandhi to bolster that stance is hardly helpful. She was not right about nationalising banks in 1968. She was entirely wrong. India has paid a heavy price for it. That price may not be visible on the surface but is real. And it results in absurdities like thuggish MPs believing that they have the right to assault PSU bank managers without being incarcerated immediately for such revolting and astounding behaviour.

Had the late Mrs Gandhi and her father made the right economic and social choices in the 1950s, 60s, and 70s instead of being seduced (owing perhaps to lack of economic nous coupled with an over-opinionated sense of their political wisdom) by the wrong ones (incubated in the failed former USSR), India’s per capita income today might arguably have been $5,000 instead of $980. Poverty would have been eradicated by 1995 rather than by 2040 at the present pace. So let’s not have any more false ex-post rationalisations and justifications of history that fly in the face of global experience and reality. To suggest that the global meltdown of 2008 vindicates the late Mrs Gandhi’s position on nationalising banks is to misunderstand what happened and is still happening. Interestingly it is becoming apparent now that those banks in the UK, US and EU that were forcibly embraced by the incompetent hug of government intervention are now dead in the water and having the most difficulty climbing out of problems. Those that eschewed government assistance and struggled to remain private are recovering faster.

Besides one should never confuse what might be necessary with intensive care as the norm for a steady state of regular operation.

Obviously this Budget moves away from restoring as quickly as possible the strength of rapidly deteriorating public finances from a headlong rush over a public deficit -debt precipice. It compounds that failure by emphasising reliance on wasteful price subsidies and not moving more decisively towards income support instead. It leaves too many essential actions to be taken later. The argument that in these economic times it is essential to relax the deficit and provide an extra (unaffordable) fiscal stimulus to growth as the rest of the world is doing is odd. Unlike the rest of the world, India is growing at 6+%. And India was running large fiscal deficits in boom times, which has led to its gross public debt (on and off balance sheet) now approaching 90% of GDP. So the argument that in keeping with the rest of the world, India must also have a fiscal stimulus holds no water. The best stimulus for India would be a reform stimulus that improved public finances, rather than a contra-reform fiscal stimulus that simply expanded the deficit for counter-productive populist expenditures, which did not immediately translate into aggregate demand expansion.

This Budget does not accept that the more appropriate path for India is to avoid using the global recession as an excuse (India was never in recession) and work in the medium term towards shrinking the gross budget deficit (i.e. including Centre, states and PSUs) from 13% of GDP to under 5% of GDP by 2014. That is best done—with significant concomitant positive effects for economic efficiency—by reducing the asset side of the public balance sheet through divestment and privatisation sufficiently quickly to bring liabilities down to where all public debt (on and off balance sheet) amounts to no more than 40% of GDP. This need not and cannot be done tomorrow. But it needs to be done in the next 5-7 years. A start needs to be made now.

Finally, the Budget does not appear to recognise or accept that the engine that powers growth and equity in India is private investment. For India’s future to be secured, that engine must be unleashed rather than being constrained and obstructed in any way that is possible but not obvious! The Budget could have gone further than it did; especially in opening infrastructure investment opportunities for unconstrained domestic and foreign private investment in urban conurbations where infrastructure is most deficient and where early relief of constraints would have high economic pay-offs. It could have recognised the need for commercially viable urban infrastructure to be undertaken exclusively by the private sector with much larger foreign involvement; thus releasing scarce public resources to focus on rural infrastructure (where the votes lie).

Regrettably, the Budget made it clear that it will be business more or less as usual. Maintaining status quo was the dominant theme, with accompanying timorous incrementalism in the mind-numbing excess of marginal rate changes to trivial taxes. Should an FM really waste his time and that of Parliament indulging in a litany of utterly meaningless changes in customs duties and excise taxes on things like cotton waste from 7% to 5% and so on ad nauseam? To be fair, the Budget did get rid of some bad taxes like the FBT and CTT, which were not significant revenue earners. But it failed to carry that logic through consistently by signalling a phased demise of STT as well. Although it is a significant revenue earner, it is a patently bad tax as is any tax that attempts to increase transactional friction to throw sand in the wheels of useful economic machines.

The Budget was not awful, dreadful or disastrous. It could have been worse. But it could have been better. Instead it was dull, insipid and disappointing. The Budget speech started off well with the reminder that this government was focused on restoring a growth trajectory of 9%. That signalled its implicit belief that high growth had delivered more for India, and for the poor in India, than any number of direct poverty reducing programmes, or the plethora of counterproductive producer price subsidies that India has sustained to its detriment for too long. But with that intention declared up-front, the rest of the Budget had no connection with positioning the government to deliver on its promise of growth or fulfilling its renewed mandate. Overall this Budget gets a mark of 3/10.

Hopefully in February 2010 it might learn from its mistakes and do better to strive to achieve a mark of at least 7/10.

The author is an economist and a corporate finance expert

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