In a year when almost every major governmental macroeconomic forecast (growth, inflation, fiscal deficit, government borrowing) was challenged as not being credible by market participants, it is indeed refreshing to see a healthy dose of realism in this year?s Economic Survey. Markets must now be hoping that this same sense of realism and credibility seeps into the Budget.
It starts right at the top with the growth forecast for the upcoming fiscal. Recall, last year?s Survey projected growth at 9%, something that was immediately and universally criticised as being overly ambitious, given that inflation was running in double digits and the economy was in the midst of a rate tightening cycle. Worse, the overly-optimistic 9% forecast was the bedrock on which the overly ambitious fiscal consolidation was predicated. The rest is history.
It is, therefore, indeed a relief to see this year?s Survey peg growth at 7.6% (with its customary confidence interval of +/- 25 bps). Some might argue that even this is too ambitious. Most non-governmental forecasts have growth just above 7% for FY13 and the downside risks have increased substantially on account of the political uncertainties over the last two weeks. However, I would argue that 7.6% is not out of the realm of possibility, if policymakers get their act together. Furthermore, there is bound to be an aspirational element to growth forecasts in the Survey so that growth is not deemed to be exogenous but instead a function of the policy path the government chooses to pursue. In that sense, the Survey is consistent?it provides a plethora of measures that authorities should adopt. A 7.6% growth rate is possible if a core sub-set of these prescriptions are followed, and would be a reasonable starting point for crafting a Budget.
More importantly, the Survey is honest in identifying the key drivers of the slowdown. One can perhaps quibble that it attributes too much emphasis on global uncertainty in explaining India?s current slowdown (remember, exports are still growing twice as fast as GDP!) but it does eventually admit that domestic factors are primarily to blame. Here, it talks about the role of high interest rates, but is also candid in blaming the pressures of democratic politics on slowing reforms.
Most importantly, the Survey identifies a downshift in India?s saving-investment dynamic as being a particularly worrying. The recent plunge in household financial savings is well known and it is reassuring that policymakers recognise that negative real interest rates were partly to blame?hopefully resulting in less pressure on RBI to engage in premature easing. More generally, the Survey repeatedly emphasises the need for fiscal consolidation (more of that below) to boost savings, and drive a pick-up in investment.
The second dose of realism is evident in the Survey?s emphasis on the need to maintain low and stable inflation. Recall, last year?s Survey had set the cat among the pigeons by suggesting that India needs to get used to living with a higher rate of inflation as we push growth and head towards middle income status (a notion quickly rebuffed by RBI). This was exacerbated by the notion, in some quarters, that conventional monetary policy instruments have very little efficacy in bringing inflation down. This year?s Survey sings a very different tune. Specifically, it throws down the gauntlet that inflation needs to be brought down to below 5%. Moreover, in a fascinating theoretical discussion on the efficacy of monetary policy, it admits that conventional tools work, albeit with a lag.
One of the most significant and recurrent themes of the Survey, however, is the need for government to return to rapid fiscal consolidation. But, that said, the document makes a critical inter-temporal distinction. While it argues for the need to bring the deficit down to crowd in private investment and allow a better trade-off between inflation and unemployment in the medium term, it explicitly argues for not being too aggressive on deficit reduction this year to avoid compounding the growth slowdown!
Interestingly, it argues that the principal means of achieving fiscal consolidation should be through raising the tax-to-GDP ratio and cutting down wasteful expenditure (though these are not identified). The Survey also spends time discussing creative solutions to rationalising subsidies and moving to a more market-determined pricing system, and even proposes a fixed subsidy per litre for diesel as an intermediate step. The criticism, if any, is that this is presented more in the form of clever, market-based solutions rather than a firm, pressing or passionate conviction that subsidies are at the heart of India?s current fiscal bleeding and therefore need to be rationalised at any cost, come hell or high water.
So what signals can we extract for the Budget? First, that the Budget is unlikely to make the same mistake as last year by targeting an excessively optimistic consolidation. Instead, any budgeted consolidation is expected to be modest (and hopefully realistic). Second, that increasing the tax-to-GDP ratio is imperative. So, expect to see a roll-back of the tax cuts for 2008 (excise, service) and a broadening of the base (service). The corollary of this, hopefully, is that policymakers avoid overly ambitious estimates of asset sale revenue. Third, the right noises will likely be made on the need to rationalise subsidies and plug leakages through cash transfers. But don?t hold your breadth on dramatic reform on this front, given that this was not a leitmotif of the Survey. Finally, don?t rule out an increase in customs duties for gold as a means to discourage unproductive investment and boost financial savings.
All in all, it?s been a tumultuous 24 hours for policymaking in India. On the one hand, RBI should be commended for sticking to its guns and bucking market pressure to prematurely cut rates and the Economic Survey deserves kudos for injecting a welcome dose of realism into the policy discourse. On the other hand, the drama surrounding the events of the Railway Budget demonstrate the fragile political-economy that policymaking has to contend with. Let?s hope the Budget emulates the former and is able to escape the clutches of the latter.
The author is India Economist, JP Morgan