India’s economic success—as highlighted in the recent Union Budget—rests on four pillars: the GDP growth rate at 7.6%, a drop in inflation (as measured by the CPI index) of around 6%, a record stock of official reserve at $350 billion and, most importantly, a reduced fiscal deficit at 3.5% of current GDP.
Looking beyond the official figures to convey the positive note, one comes across reservations. First, GDP growth, calculated by the earlier method followed for so long, would have generated a rate of around 5%, not more. Second, the stock of official reserves has much to do with inflows of short-term and volatile capital flows, which may evaporate without much warning. Third, the comfortable inflation at present may not last very long if the current lows in oil and commodity prices reverse. Finally, to come to the claim of achieving growth via financial stability with reduction in the ratio of fiscal deficit to GDP, the argument does not stand scrutiny.
Let’s spell out what a reduced fiscal deficit implies for the economy. Unlike the earlier practice of meeting the deficit with money printed by RBI with the consent of the government, the gap now can only be met by additional borrowings of the state from the capital market. Incidentally, that too is considered ‘harmful’ in terms of what are considered as ‘prudent’ fiscal practices, with state borrowings likely to pre-empt borrowings by private agencies.
As for the fiscal deficit which is necessarily funded with market borrowings, it simultaneously generates fiscal liabilities in terms of interest payments which incurs corresponding expenditures in the fiscal budget. In addition to the fiscal deficit, the Budget document provides two more estimates of the deficit. Of the latter, the ‘primary deficit’ is arrived at by deducting interest payments from the fiscal balance. With the fiscal deficit at 3.5% and interest payments alone accounting for 3.3% of GDP, the estimated primary deficit comes to less than 0.3% of GDP. This, going by the major heads of expenditure in the primary Budget, would imply cuts in social sector spending and capital expenditure, the two major heads of spending in primary Budget other than defence. It is little surprising that subsidies on food account for less than 0.9% of GDP.
What, then, has the Budget offered to the economy in general? The adherence to the fiscal deficit target may project financial stability and a better investment climate to those who have faith in the magical consequences of a smaller deficit as a curb to inflation and its conducive effects on investment. It is, however, another matter that reduced public spending—as goes with cuts in fiscal deficit—may actually turn out to be a dampening factor for investment. This will be matched by the inability of the state to instil demand by its own spending, as capital expenditure and social sector spending, both of which are potentially income-generating, and in addition redistributive—an aspect which is crucial in the context of the prevailing inequality and poverty in the country.
While recognising the uncertain and depressive global trends which could disrupt smooth sailing of the domestic economy, the Budget seeks to instil confidence by taking comfort in what it observes as a path of macroeconomic stability, by achieving a pace of non-inflationary growth. The complacency is overrated, with the absence of any proposed firewall to counter the current and future shocks to the economy which may arise from a sudden withdrawal of speculatory or short-term capital flows. Nor is there an attempt to prepare the economy to weather shortfalls in export earnings that may arise with recession as well as protectionism in the global economy.
Thus, it may look rather disconcerting that notwithstanding the problems with the vagaries of global finance, the Budget announces further opening of financial markets with schemes for new derivatives to be launched by Sebi and options for insurance companies to invest in stock markets. The moves are in accord with the ongoing facilitation at an official level to risk-taking in markets, which includes the use of derivatives like futures as hedging instruments. Little, if any, concern is there on the part of the government to arrest the spate of speculation in stocks, property, currency and even in commodities.
The economy is much dominated by finance, which has little to do with the real economy of output and jobs. With uncertain markets generating the need to hedge financial assets by using derivative instruments like futures, options and swaps, the gains and losses therefrom are like transfers across the economy which do not account for changes in the GDP. A rise in stock market transactions which pushes up indices like the Sensex has no reason to be associated with simultaneous or a lagged response with a rising GDP in the real economy. Speculation in uncertain markets of the economy have been used to operate with shadow banking practices, much of which are responsible for the growing incidence of NPAs in PSU banks and large number of scams in the economy.
The Budget is remarkably tolerant of those developments, as can be gathered by its enthusiasm in opening the floodgates of speculation in the economy. Nor is it preparing the economy against job losses in the event of shortfall in exports which may be round the corner. Do we then brand the Budget as one more attempt to achieve the so-called ‘financial stability’ at the cost of real economy?
The author is a former professor of economics, JNU
sunanda.sen@gmail.com
