FE Editorial : Reading the hand

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SummaryVote on account can’t be a stimulus. So, UPA did right. But its fiscal math is suspect

The hype over what was always certain to be a vote-on-account was unwarranted. So were expectations by capital markets, industry chambers and those who professed to speak for the urban middle classes that expansionary fiscal policy (read: tax concessions) would be unveiled on February 16, over and above the two fiscal policy packages already announced. Remember here that monetary easing has also took place and more will almost certainly come. Expectations having been created, disappointment followed. Pranab Mukherjee wasn’t presenting a Budget for financial year 2009-10 and any tax changes would have required passage of the Finance Bill, a parlous proposition under present circumstances, even setting aside propriety. Legally, morally and practically, this was always going to be a vote-on-account. The Budget speech can indeed be faulted on diagnosis: appropriating credit to the UPA for the shining story (across indicators) till 2007-08. It can also be faulted on diagnosis of reasons for inflation. For instance, would capital inflows have been 9% of GDP had RBI not prevented rupee appreciation? In similar vein, the slowdown in 2008-09 is underestimated and entirely attributed to global shock from end-September 2008. This affects deficit calculations for 2008-09, expected to be 4.4% of GDP for revenue deficit and 6% for fiscal deficit. These are based on GDP growth of 7.1% projected by CSO and the PM’s Economic Advisory Council. If CSO has overestimated growth then, with denominator increasing, these deficit figures will go wrong. Budget estimates expected revenue deficit of 1% and fiscal deficit of 2.5%. If the revised figures are so far off the mark, that wasn’t because of two fiscal packages in December 2008 and January 2009. Not only had items been left unbudgeted (Pay Commission, farmers’ debt relief, NREGS), expenditure on flagship programmes had also increased.

The UPA cannot be commended on fiscal rectitude or fiscal marksmanship and the external scapegoat is no more than that. Similar arguments can be extended to 2009-10, with Budget estimates of 4% (of GDP) for revenue deficit and 5.5% for fiscal deficit. Even if the economy recovers in the second half of financial year, with inflation at low levels, it is impossible to obtain 11% growth in nominal GDP and a folly to assume increase in tax revenue. Dilution of the FRBM Act is, therefore, certain with relaxation at the Centre followed by inevitable dilution at the state-level.

Monetary policy

This is certain to continue in 2009-10 and this year, there will be recommendations of the 13th Finance Commission, with states already demanding 50% of the divisible pool. Had fiscal reforms been introduced in years of growth and public expenditure been contained, India would have had fiscal space (like China) to introduce counter-cyclical fiscal policy. Without off-Budget items (read: fertiliser and oil bonds), deficits will be 10% of GDP, a figure mentioned by the PM’s Economic Advisory Council. It will be a long haul to get fiscal reform back on track and the goods & services tax stands indefinitely postponed from 2010. Tax changes are improper for a vote-on-account. And there are limited degrees of freedom on fiscal policy, though monetary policy cannot be delinked from fiscal policy (small savings rates, government borrowing). Not much can be done on exports, barring some changes on export credit. Hence, the UPA government’s hopes are based on monetary policy (with more loosening in March/April) and increased public expenditure. With increased non-Plan expenditure provided for, Pranab Mukherjee’s speech toes the same line.

However, notwithstanding dismal news on exports, both consumption and investment should begin to recover in the second half of 2009-10, providing endogenous sources of growth. One should flag that good agricultural performance (at least in irrigated rice and wheat areas) has insulated India somewhat from external shocks. Nevertheless, the incoming government will have a fiscal management task on its hands, since growth won’t recover to 9% levels and in export-intensive and urban segments, there will be job losses. There will also be reverse migration to rural areas, which NREGS cannot presently handle. But given constraints, and problems left by fiscal laxity, Mr Mukherjee should be lauded for sticking to the vote-on-account agenda (there is a promise of lowering taxes in future) and not embarking on additional flagship programmes. There is no denying an election manifesto tone in the speech. Nor can one eliminate the possibility of off-budget sops before the model code of conduct kicks in. But for the moment, unlike the rail budget, nothing improper has been done. Notwithstanding what industry bodies and capital markets think, that warrants giving Pranab Mukherjee a big hand, even if he did mischievously invoke the hand in concluding his speech.

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