Finance Minister Pranab Mukherjee with budget proposal in hand
As suggested in my last post, the character of the budget Prime Minister Manmohan Singh’s presents for the fiscal year that begins April 1 will offer important clues about his political legacy. His budget plan was laid before Parliament last week to mixed reviews. Among its positive items are increased spending on desperately-needed infrastructure projects in the rural economy as well as steps to stimulate private investment in overall infrastructure development and the involvement of foreign investors in Indian capital markets. These measures gave the bearish Indian stock market a momentary bounce. Yet far more noteworthy is what the proposed budget does not contain – realistic assumptions and a commitment to press ahead with crucial items on the economic reform agenda.
The budget is laced with what will likely prove to be overly roseate expectations. Although large spending increases are slated for educational and social programs, the government is banking that faster economic growth will generate an 18-percent rise in tax revenue. Thus, even with higher spending, the government believes that it can cut the fiscal deficit from 5.1 percent of gross domestic product (GDP) in this fiscal year to 4.6 percent in 2011-12. It forecasts that the economy will grow 9 percent in 2011-12, up from this year’s expected 8.5-percent rate.
This key assumption is open to debate, however. The growth rate fell more than expected in October-December 2010, to 8.2 percent from 8.9 percent in the previous quarter. And the rate would have been even lower had it not been for the agricultural sector’s banner year. The sector’s projected growth rate of 5.4 percent in 2010-11 is a positive contrast to the dismal performance the sector has experienced in recent years, but is also largely due to an exceptional monsoon season rather than increased productivity brought about by far-sighted government policies.*
Other factors likewise point to an economic slowdown:
- The industrial sector witnessed a sharp decline at the end of last year, foreign direct investment fell 31 percent in 2010, and foreign institutional investors have pulled out $1.2 billion from portfolio markets since January.
- The overall inflation rate – clocked at an annual rate of 8.2 percent in January – is unlikely to moderate in the coming months as the government expects, especially given global trends toward higher food prices and rising fuel costs (see the analysis here and here). Indeed, India possesses the highest inflation rate among Asia’s ten largest economies.
- The deficit in the current account (which measures the country’s balance of payments) is very likely to widen from the 2.9 percent of GDP in 2009-10 to around 4 percent this year, in good measure due to the country’s very high dependence on imported oil.
The government’s hopes for lowering the fiscal deficit also rest on shaky grounds. The proposed budget maintains expensive fuel and food subsidies, whose costs appear to be underestimated but are certain to rise. With many subsidies off budget, their true costs are difficult to tally but Deutsche Bank estimates that costs will reach 2.5 percent of GDP in the current fiscal year, well above the government’s forecast of 1.8 percent. And the food security legislation that the government plans to introduce later this year would increase these costs even further. The ratings agency Standard and Poors concludes that “the government may struggle to meet its fiscal deficit target for 2011-2012 as pressure to step up spending mounts.”
Despite Mr. Singh’s promises in his televised press conference last month, his budget proposal is also noteworthy for the absence of reforms targeting the structural impediments throttling India’s full economic potential. With surging food prices largely driven by supply-side constraints – food inflation was at an 11.49-percent annual rate in mid-February – the budget presentation would have been an opportune moment to unveil a plan to liberalize the retail sector, especially for foreign companies with deep experience in running sophisticated distribution chains. Missing, too, was a commitment to open the insurance sector to overseas investment, a reform that many have long acknowledged as necessary.
A day after the budget’s presentation, these shortcomings were decried in a hard-hitting address by Mukesh Ambani, chairman of Reliance Industries and the country’s richest man. Speaking at the annual meeting of the Federation of Indian Chambers of Commerce & Industry, he rebuked the small-bore reform agenda pursued by Singh’s government and challenged the Prime Minister to undertake the type of “disruptive policies” that Singh unleashed as Finance Minister at the start of India’s growth trajectory two decades ago. The usually-reticent Ambani asserted that “India needs a bold new vision and a feasible action plan.”
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* I have written before about the dislocations caused by the Singh government’s use of social welfare spending to improve the rural economy, particularly how it comes at the expense of productivity-enhancing investments in irrigation systems and agricultural research and extension. A key case in point is the National Rural Employment Guarantee Scheme, the headline initiative that provides a hundred days of annual (often make-work) employment for adult members of rural households who are willing to do public-works related manual work at minimum wage. Now word comes, via Finance Secretary Sushma Nath, that NREGS is actually diverting the flow of labor from the private sector.