Responses to the first budget of the new government have been diverse. Those thirsting for a quick return to the good old days of strong growth were willing to forgive a temporary breach of fiscal consolidation targets and, therefore, a bit disappointed. Conservative observers, on the other hand, are satisfied the red line in the sand has been respected. Sceptical ones have questioned the overoptimistic revenue and growth assumptions. Many have criticised the continuity of past government?s policies, while regretting an opportunity missed for structural reform initiatives. By far the most unanimous applause is over the balancing effort?between consolidating public balances and competing claims upon resource for growth-boosting expenditures.
Against this medley of perspectives, we urge that continued pursuit of macroeconomic stabilisation is the most important urgent policy priority for India at this juncture. Does the direction of fiscal policy then conform to that requirement?
The nuances of the macro framework underlying the Budget are rather disingenuous: It pushes up capital (productive) expenditures without switching spending from current expenditure or an offsetting tax increase. Current expenditure in this year will actually rise relative to that projected in February?s Interim Budget even as capital expenditure goes up; tax cuts accompany these increases to boost consumer purchasing power. Overall spending on both revenue and capital expenditure sides is, therefore, higher. The financing comes mainly from non-tax sources, chiefly divestment receipts, i.e. sale of some existing business interests of the government, helped by dividends, etc. This is assisted by overoptimistic tax revenue projections that have been well discussed in many other places. So, conforming to the 4.1% fiscal target mandated in the roadmap, the Budget can well claim devotion to consolidation.
The question from a stabilisation perspective. however, is of the net economic consequences of this fine balancing exercise. Does a budget balance that meets mandated consolidation goals, but otherwise increases total public spending of all hues and is financed by resource transfers from unlocking assets, constitute genuine fiscal restraint? Is not this boost to aggregate demand in conflict with the need to stabilise the economy, i.e. reduce inflation? And if the central bank is targeting aggregate demand, is it not counterproductive for fiscal policymakers to influence it in the opposite direction?
While respecting growth concerns, any deployment of fiscal policy to pump prime the investment cycle must come from an offsetting contraction elsewhere, viz. discretionary current expenditure, or a tax raise, so as to restrain overall demand relative to past period. Divestment receipts mask a higher deficit as these do not really change the government?s net worth position (assuming cash receipts from such asset sales equal the market value of the assets), which is why the IMF classifies such receipts as below-the-line financing item. From a consolidation perspective, if divestment receipts are not reinvested in equivalent yielding assets, revenues in subsequent periods will be diminished to that extent, opening up a larger fiscal gap. Since no privatisation is considered, there are no efficiency gains either from improved future economic performance and tax base. Plus, if projected tax collections do not materialise but spending is maintained, the risk of overshooting market borrowings and, hence, an expansion in the public balance sheet, is high.
The perception that the Budget implements strict fiscal discipline, without compromising on resources available for development is, therefore, misplaced?for the budget?s macro framework actually undermines ongoing macroeconomic stabilisation, the eventual purpose of which is to regain competitiveness, which then spurs growth. The first successes of structural adjustments that started more than a year ago are not visible so far. Foremost amongst this is the goal of lower inflation, which constitutes a prerequisite for regaining competitiveness. For India, the stress is so severe because the prolonged period of high inflation and risks created thereof render relative price adjustments much more difficult. A protracted period of gearing macro policies exclusively towards stabilisation is therefore essential to prompt a sustainable rebalancing of the economy. It also needs to be flagged that although the current account and fiscal deficits might have returned to respectable regions, saving and spending decisions are still artificially influenced rather than by relative price changes. And though last year?s devaluation did impart a
competitive boost, it also contributed
to inflation, while expected demand
support from this impulse transpires in an environment of competitive devaluations worldwide.
Many economic policy models have been suggested for the new government in the past few months?Thatchernomics, Abenomics? We think plain vanilla Cameron will do best instead. Post-crisis, the UK is the only example of highly successful recovery: Macroeconomic structural adjustments were sternly carried through by the government, despite sharp criticism over the severity, including from the IMF, and at considerable pain to voters. A hefty devaluation of the pound was followed by fiscal belt-tightening from brutal spending cuts on discretionary and other components, while monetary easing offered policy support. Few years down the line, the UK economy is reaping the benefits of the adjustments: Growth has rebounded, its pace taking the Bank of England by surprise; housing segment is booming to the point of eliciting financial stability concerns; while export growth is driving the manufacturing sector.
Compared to the UK, India?s problems are more severe for it suffers from inflation, whose drivers could be structural and still not fully understood. India?s macro conditions suggest that calls for a temporary setting-aside of fiscal consolidation for the sake of growth are incompletely considered. This doesn?t mean that policymakers shouldn?t go for growth: This can be got, but from structural measures to increase potential output and facilitate a rapid growth in productivity. Macroeconomic policies cannot substitute.
The author is a New Delhi-based macroeconomist