Lacking ambition on long-term growth

Mr Chidambaram?s Budget has generally been seen as a goody-goody one that has delivered to the different segments of society and has not adversely affected any particular one. The larger question is whether it has lived up to the expectations concerning the broad issues of giving a direction to the economy, enhancing the growth rate and improving its longer-term sustainability, among other issues. Normally, immediate reactions as captured by the media fail to go into such details. How does the Budget fare on these considerations?

On the face of it, the FM has enhanced allocations for social sectors like education and health, the flagship programmes under NCMP, agriculture and infrastructure development, increased revenue impressively without raising direct taxes and actually reducing custom tariffs and rationalising excise duty structure. He has achieved all that while managing to bring down the fiscal deficit from 4.1% of GDP in 2005/06 (BE) to 3.8% in 2006/07 (RE). The plan expenditure has gone up from Rs 132,276 crore in 2004/05 (actual) to Rs 143,791 crore in 2005/06 (BE) to 172,728 crore in 2006/07. It would appear, therefore, that the quality of public expenditure has improved.

However, a detailed look would suggest that the capital expenditure proposed (which is a combination of non-plan expenditure on capital account and plan expenditure on capital account) has actually declined as a proportion of total expenditure from 22.77% in 2004/05 (actuals) to 13.45% in 2005/06 and marginally further to 13.43% in 2006/07. The proposed capital account expenditure for 2006/07 at Rs 75,799 crore, although higher compared to 2005/06, is yet to climb up to the level of Rs 113,331 crore achieved in 2004/05. To the extent it is capital investment that strengthens the longer-term sustainability of the growth process, there is not much room for cheer.

The finance minister seems to have attached a higher priority to fiscal consolidation. However, keeping in mind the fact that inflation has been in check despite sharp rise in oil prices, there was no urgency to bring the fiscal deficit below the level achieved in the current year.

The targets such as 5% that the Bretton Woods institutions advocate are, at best, rules of thumb and are not backed by theory that would suggest a similar target for all economies at different levels of development. Different economies have their own optimal levels for fiscal deficit. Obviously, a matured economy would have a different optimal level of fiscal deficit than a growing economy such as India. The finance minister had an opportunity to give a more ambitious boost to public investment in infrastructure, a major constraint on longer-term growth sustainability, and also for attracting greater magnitude of FDI inflows.

The FM has tried to give direction to making India a manufacturing hub, especially for employment-intensive industries such as food processing, textiles and garments, leather goods, automobiles and parts, IT hardware, etc by fine-tuning excise duty and customs duty structures. These initiatives are important for encouraging local value addition in these sectors. These policies need to be complemented by others that sharpen the global competitiveness of Indian products, such as a strategic thrust aimed at promoting excellence in domestic corporate sector.

Exporting is done at enterprise level. Studies find a wide variation in enterprise-level export performance within any industry. Enter-prise dynamism has an obvious role to play in producing export successes, besides various other factors. Policies should help in nurturing world-class enterprises or national champions in select sectors. These champions could be assisted to grow to world-scale and compete worldwide with their own brands, acquisitions and whatever it takes. They could be assisted for major R&D, product development, brand building and market development projects, among others. In particular, empirical studies point to the critical role of in-house R&D in strengthening enterprise competitiveness. So, it is disappointing to find no new initiatives for encouraging corporate R&D activity in the Budget. Given the market failure arising because of private returns being less than social returns in R&D activity, there is a high level of public intervention in R&D activity in developed countries, where the bulk of such activity is concentrated in the form of huge direct R&D subsidies given to national enterprises.

Over the past few years, India?s exposure to FII investments has grown sharply. FII inflows now exceed foreign direct investment (FDI) by a huge difference. Implications of such growing accumulation of FIIs in the economy need to be debated. Over time, one may expect the servicing burden to multiply in view of the very good returns that Indian bourses are now yielding. Besides the potential instability that they bring?given their essentially short-run and speculative nature ?these inflows also tend to put an upward pressure on the rupee, thus eroding the competitiveness of Indian exports. FDI inflows, in contrast, are long-term investments and augment the productive capacity of the economy. Therefore, while FDI inflows are more desirable, FII inflows need to be restricted. The finance minister has given mixed signals here. On the one hand, he has increased the securities transaction tax by 25% and that may curb such flows. But, at the same time, he has raised the ceiling for FII investments in Indian companies and government securities.

In conclusion, the finance minister missed a very good opportunity to give a greater thrust to infrastructure investments and enhancing the long-term growth potential of the Indian economy.

?The writer is DG, Research and Information System for Developing Countries (RIS). Views are personal