For most of the past year, Finance Minister P Chidambaram had to deal with inflation control, with growth being taken for granted. But now, weakness in the global economy has added uncertainty to growth.
Now that it is nearly election time, the question remains will it be growth or inflation control that would rule the day? Would Chidambaram complete the unfinished reform agenda or just stick to populist mandate?
Discussing these questions were RBI’s professor Dr Shankar Acharya, who was involved in the making of 15 budgets; Oxus Investments MD, Surjeet Bhalla and Senior Fellow of the National Institute of Public Finance and Policy, Ila Patnaik.
So far, the fiscal and monetary measures taken by the government to contain inflation haven’t really thrown growth back. Growth is still being expected to be at about 8.7 per cent this year.
But given that there are signs of an international slowdown–as yet restricted to the financial sector–and given that Indian growth is in doubt through the coming year, it may not be able to maintain the 8.79 per cent.
Dr Acharya agreed. “I think some slowing down in growth should be expected, possibly even to below eight per cent in the coming fiscal year, essentially because of the headwinds arising from the international economies,” he said.
“I think it is becoming more and more serious as the days go by,” he said.
Acharya felt the Finance Minister needs to take action outside the budget, such as, “encouraging the Central Bank to reduce the policy rates of interest,” and encouraging the Central Bank to reverse the appreciation in the Rupee.
“I think those are, perhaps, more important actions than immediate budget actions,” he said, suggesting that Chidambaram may like to consider some sort of gesture towards the corporate sector such as, “the abolition of the Fringe Benefit Tax.”
Acharya recommended that Chidambaram should go for conservative budgeting owing to the uncertainty over the sixth pay commission award.
“If he has some powder up his sleeve, some revenue surplus, he should keep it dry at this point,” he said.
Chidambaram has a revenue surplus of Rs 60,000 crores.
The question was raised if repackaging existing measures would satisfy Chidu’s political masters.
Agreeing with Shankar Acharya, Surjeet Bhalla also said that the budget is not the only thing going
“Neither is it the most important policy going,” he said, adding that policies outside the budget, which impact the economy, need to be addressed by the Finance Minister.
Bhalla felt that the huge amounts raised by taxation should be spent in stabilising the economy.
“We’re growing at eight per cent. Maybe we’ll grow somewhat lower. I think we can be lulled into thinking that eight per cent is very good, so let’s have tight monetary policies, tight exchange rate policy and we grow at 7 per cent, with the headwinds blowing in the world – it’s not such a bad deal. And the Finance Ministry can say, why are you complaining, we’re the second or third fastest economy growing in the world and it would be right next day if we grow at six per cent,” he said.
Pointing out that assessments are made on potential growth rates of the economy and not the absolute levels of GDP growth, Bhalla observed that the GDP grew below potential, at 38.5 per cent.
“Phrased differently, your investments are going to waste. You are putting in all those investments and getting very low returns,” he declared. “Therefore, I think the FM has to look at the economy in terms of what is the potential and why are we not growing at our potential.”
What is our potential rate of growth and what do we have to do to get to that potential rate of growth?
Ila Patnaik also threw in her support for stable growths.
“There is pressure on the Rupee to appreciate.. that could impact exports and the domestic economy,” she pointed out.
“You need to have policies that cut interest rates. At the moment, all corners of the Trinity agree on that except the RBI. This is not the time to have a tight monetary policy,” she insisted.
Pointing out that a lot of important subsidies have gone off budget, amounting to 1-2 per cent of GDP, Ila Patnaik confessed that she was afraid the union budget may throw off any semblance of fiscal consolidation.
“In addition to that, we have a clear pressure from the Congress to forget about the FRBM, with state elections coming up, with general elections coming up next year,” she noted.
Echoing Ila Patnaik’s fears, Shankar Acharya said he was afraid it would be “a rank, bad, populist budget in fiscal numbers.”
“If there are big, populous kind of giveaways (even if you hide this in the budget numbers), like debt relief to farmers – pay up to a certain loan size – which really thoroughly undermines the whole credit system, I think that would be terrible,” he said.
Acharya added that it would also be bad if Chidambaram showed no progress in the process of integrating excise and services taxation and moving towards the national GSP.
Fiscal interests versus political demands
In the context of inflation, moving any kind of indirect tax rate up – even if its on services – is something politically they may hesitate to do, but if they just dropped the central rate on commodity taxes in order to bridge the gap, that could open up a fiscal problem, Shankar Acharya pointed out.
Ila Patnaik, meanwhile, reminded everyone that Chidu took an important initiative a couple of years ago – the revenue foregone budget and what it indicated is that he is losing a large amount of revenue on account of a long list of exemptions that are being given.
Acknowledging that some exemptions, such as health and defence, may be justified, Ila pointed out that the list of exemptions is “very, very long” and “he can do away with the bulk of them.”
Ila not just called this possible, but said that it would also keep the Left happy.
“This is something the Left has been asking for,” she pointed out.
Surjit Bhalla, meanwhile, said that the idea that the Indian rupee has to appreciate over time, because India is a developing country, is a misconception.
“You can’t just say it can appreciate. You have to look at the level at which it is at, and what are the indicators that you look at whether level is correct or not is the current account deficit,” he stated.
Pointing out the nation’s current account deficit to the GDP is at 2.5 per cent – the lowest since 1992 – Bhalla said that the FM’s belief in the rupee’s appreciation is “erroneous”.
“It is not substantiated by any of the facts. And therefore, it is high time we come back to what we started on – that the interest rates in India are geared towards giving you a high current account deficit and a high rupee,” he said.
Bhalla exhorted the FM to pay attention to the two major policy measures available to him – the Fiscal and the Monetary policy, vis-à-vis interest rates.
He added that the nation has already arrived at the infrastructure investments-GDP ratio, which the Planning Commission had targeted for 2012 at 8 per cent GDP.
“This is not something the FM can target or should target, but in any case because of the growth environ, we’re already investing that much,” he said.
In everyone’s interest
Although monetary policy is the RBI’s domain, Chidambaram has given enough signals to the RBI, said Ila.
“Public Sector Banks have cut interest rates,” she pointed out.
She added that the need of the hour are bond-currency derivative markets.
“He (Chidambaram) can take steps to develop those markets. They call it the BCD nexus and we need those markets so we can have efficient utilisation of the capital that is coming into the country, that there is less speculative capital and it doesn’t push us or make us lurch from one end to the other end in terms of our monetary policy framework,” Ila suggested.
Recounting that some steps on the development of bond markets had been announced last year, Ila pointed out that nothing much was seen of them during the year.
“This time may be a good time because given that he can’t do much else, he might give in to populist pressures for expenditure,” she said.
“If Chidu cannot influence RBI’s monetary policy too much, the least he can do, then, is take a look at the development of financial markets, worry about markets and institutions and see what reforms he can bring in there so that the damage being done on the others is minimised,” she stated.