Global Outlook

Indian Union Budget 2010-11 was good at the micro level but the picture is not hunky-dory at the macro level

Contributed by Nirmal Bang

By Nirmal Bang

Time is the biggest healer. The reason lies in the 2010-11 Budget speech of Finance Minister Pranab Mukherjee.

He said, “In 2009 when I presented the interim Budget in February and the regular Budget in July in this august House, the Indian economy was facing grave uncertainties. Growth had started decelerating and the business sentiment was weak. At home, there was added uncertainty on account of the delayed and sub-normal southwest monsoon, which had undermined the kharif crop in the country.”

The FinMin added, “There were concerns about production and prices of food items and its possible repercussions on the growth of rural demand. Today I can say with confidence that we have weathered these crises well. Indian economy now is in a far better position than it was a year ago.”

Mukherjee said, “That is not to say that the challenges today are any less than what they were nine months ago.” The three challenges and the medium-term perspective that he had outlined in his previous Budget speech remain relevant even today. “These would continue to engage Indian policy-planners for the next few years.”

The first challenge that lies ahead of the country is to quickly revert to the high GDP growth path of 9% and then find means to cross the 'double digit growth barrier'. Growth is only as important as what it enables us to do and be. Therefore, the second challenge is to harness economic growth to consolidate the recent gains in making development more inclusive.

The thrust imposed on development of infrastructure in rural areas has to be pursued to achieve the desired objectives within a fixed time frame. That includes strengthening food security, improving education opportunities and providing health facilities at the household levels, both in rural and urban areas. And the third challenge relates to weaknesses in government systems, structures and institutions at different levels of governance.

“Indeed, in the coming years, if there is one factor that can hold us back in realizing our potential as a modern nation, it is the bottleneck of our public delivery mechanisms,”  the finance minister said.

While calling the fiscal year 2009-10 as a challenging year for the economy, the finance minister did advise preparedness for good and bad things in coming times. On the good side, even while the significant deceleration in the second half of 2008-09 brought the real GDP growth down to 6.7% from an average of over 9% in the preceding three years, “We were among the first few countries in the world to implement a broad-based counter-cyclic policy package to respond to the negative fallout of the global slowdown,” he said. It included a substantial fiscal expansion along with liberal monetary policy support. “The effectiveness of these policy measures became evident with fast-paced recovery,” Mukherjee added.

The economy stabilized in the first quarter of 2009-10 itself, when it clocked a GDP growth of 6.1%, as against 5.8% in the fourth quarter of the preceding year and then in the second quarter when the growth rate rose to 7.9%.

Referring to the odds, Mukherjee in his speech said the major concern during the second half of 2009-10 was the emergence of double digit food inflation. There was momentum in food prices after the flare up of global commodity prices preceding the financial crisis in 2008. It was hoped that the agriculture season beginning June ’09 would help in moderating food inflation.

However, erratic monsoon and drought-like conditions in large parts of the country reinforced supply side bottlenecks in some essential commodities. “This set in motion inflationary expectations,” said the finance minister. Since December ’09, there have been indications of rise in food prices along with the gradual hardening of fuel product prices getting transmitted to other non-food items as well.

The inflation data for January seems to have confirmed this trend. Against the Reserve Bank of India’s projection of inflation touching 7.5% by March ’10, the January number brought a shock with the wholesale price index touching 8.56%.

This should remind you that in its recent review of the monetary policy, the Reserve Bank had highlighted that inflation was a cause of concern. Economists believe that rising interest rates is a quick remedy to curb inflation and that has been tried and tested in India earlier.

The results were also encouraging. At a time when the government has rolled out three stimulus packages to pull the economy out of the slowdown, which was complimented by a loose monetary policy, any unidirectional step either from the government or the Reserve Bank, could turn out to be a costly mistake.

To avoid any such mistake, the RBI governor had called upon the government, through the monetary policy, to lay out a road map for fiscal consolidation. However, Mukherjee has rolled back partial stimulus and a lot more is yet to be done.

“Now that the recovery has taken root, there is a need to review public spending, mobilize resources and gear them towards building the productivity of the economy,” Mukherjee said.

And to do this in a more effective manner, the finance minister acted on the recommendations of the Thirteenth Finance Commission which has recommended a calibrated exit strategy from expansionary fiscal stance of the last two years.

“The Commission has recommended a capping of the combined debt of the Centre and the states at 68% of the GDP to be achieved by 2014-15,” Mukherjee said. Interestingly, according to the Commission’s report, the closing debt to GDP for 2009-10 is 82%.

“The task is not an easy one,” said an economist. “It’s for the first time that the government aims to target an explicit reduction in its domestic public debt-GDP ratio,” he said. Rising interest payments which do not contribute to productive use of the outgos are a serious drag on the present and future generations.

“So any move towards reducing government’s borrowing is a welcome change,” said the economist. Interest payments as a proportion of revenue receipts were at 52.1% in 1998-99, which came down to 31.6% in 2007- 08 and budgeted to reach 36.7% in 2009-10.

Let us now look at another critical indicator – fiscal deficit. The FM had expressed concerns about the high level of fiscal deficit. In his speech, the FM was happy to report that against a fiscal deficit of 7.8% in 2008-09, inclusive of oil and fertilizer bonds, the comparable fiscal deficit was 6.9% according to revised estimates for the year 2009-10.

The near 1% improvement comes out of the revised GDP numbers published by the Central Statistical Organization in February ’10, which pegged GDP growth at 7.2% in 2009-10 and includes what were earlier referred to as below the line items.

The finance minister, however, mentioned that he had made a conscious effort to avoid issuing bonds to oil and fertilizer companies. “I would like to continue with this practice of extending government subsidy in cash, thereby bringing all subsidy-related liabilities into our fiscal accounting,” Mukherjee said.

According to Standard & Poor’s Ratings Services, the budget marks the country's first step towards fiscal consolidation after two years of deteriorating finances. The increased certainty that the government can restore its financial soundness over the next several years will be the key to improving sovereign credit ratings on India, which stand at BBB- Negative.

According to Mukherjee the 2010-11 Budget showed a fiscal deficit of 5.5%, which works out to be Rs 3,81,408 crore. In the medium term fiscal policy statement, the rolling targets for fiscal deficit are pegged at 4.8% and 4.1% for 2011-12 and 2012-13 respectively. Taking into account various other financing items for fiscal deficit, the actual net market borrowing of the government in 2010-11 would be around Rs 3,45,010 crore.

“There will be enough space to meet the credit needs of the private sector,” said Mukherjee. This contradicts the fear raised by Reserve Bank’s Governor Dr D Subbarao in the policy review.

In its effort to get the fiscal discipline back, the government has already rolled back a few indirect taxes which were cut as part of the fiscal stimuli measures. The partial withdrawal of indirect tax cuts is a positive for government revenue, stated a Barclays Capital report. This is evident in the 15% annual growth target in tax revenues for FY 2010-11. The delay in 3G auctions was a major factor in the FY 2009-10 fiscal deficit coming in higher, the report added.

While a few are worried about the indirect tax roll back, not many share this view. The roll back on indirect tax cuts will not hamper the economy’s growth prospects, mentioned a research report by Crisil. And that cannot be argued because the proposals on direct taxes as mentioned in the Budget were estimated to result in a revenue loss of Rs 26,000 crore for the year.

Apart from marginal improvement in revenue owing to partial reversal of indirect taxes, the FM has laid impetus on disinvestment. “The government will raise about Rs 25,000 crore during the current year,” the FM said. “Through this process, I propose to raise a higher amount during 2010-11.”

Going forward, while the budget seems to be an optimistic one, the reality is that it can be called a ‘work in progress’ only. Many believed that even when the Reserve Bank asked for a fiscal consolidation road map in its policy, the government would have acted irrespective. But that is not true now.

A partial rollback of a few stimulus measures will not help the Reserve Bank in monetary management. Even at a lower fiscal deficit percentage, the government borrowing will be over Rs 3,45,000 crore. “That will put pressure on interest rates,” said an economist.

Barclays Capital expects credit growth to accelerate in the next six to eight months, as there is a lag of roughly two quarters between credit and GDP growth.

However, in light of higher GDP and the government's announced borrowing, Barclays Capital now believes that the chances of an intermeeting 50 basis points hike in the repo as well as reverse repo rates before end-March this year have dissipated.

Given that most lower deficit numbers were on account of cyclical rather than structural factors, HSBC’s Economist Robert Prior-Wandesforde believes the RBI may raise rates at or shortly before the next policy on 20th Apr ’10, given the combination of this modest budget disappointment and more inflation upside surprises.

“Risk of this may blunt any budget-related enthusiasm for stocks,” stated the HSBC report. So, what lies ahead is uncertainty. A few measures proposed by the finance minister as part of partial reversal of fiscal stimulus can lead to a vicious cycle in itself.

The proposed reinstatement of excise duty on fuel (Rs 2.71/litre for petrol and Rs 2.55/litre for diesel) would translate into higher inflation along with excise duties hiked on a few other products.

In a nutshell, the monetary policy management is meant to get tighter for the Reserve Bank. And rate hikes are just waiting to surface again. Possibly when the interest rates shoot again a lot of feel good factors of the budget would then just go for a toss. Needless to say, time will tell how good or bad the Budget has been.