On budget day, the Sensex tanked 869 points and gilt yields rose 30 basis points. The markets seemed to be repelled by Pranab Mukherjee’s budget. In fact, the budget does a good job of dealing with a Great Recession. That is a substantial achievement, notwithstanding some confused thinking and lousy presentation.
The markets skyrocketed 20% after the Congress election victory, thinking UPA-II would go for radical economic reform to celebrate independence from the Left Front. This was irrational exuberance. A party that has achieved 9% GDP growth and won re-election will naturally opt for continuity, not radical reform.
Mukherjee has opted for continued emphasis on the aam admi, infrastructure, anti-poverty spending, social spending and agriculture. Why change a winning formula? Congress is intrinsically left of centre, so it’s logical for UPA-II to opt for Common Minimum Programme-II.
Markets are dismayed by the rise in the fiscal deficit to 6.8% of GDP, up from 5.5% in the interim budget in February. Add state deficits of 4% plus extra oil and fertiliser subsidies if their global prices rise, and the total fiscal deficit may be 11-12% of GDP.
But so what? Fiscal deficits are solutions, not problems, in a recession: they stimulate economies. Accelerated spending proposed by Mukherjee on infrastructure and safety nets is sound policy. Having achieved 5.7% GDP growth in the two worst quarters for the world economy, India can take credit for handling the recession pretty well.
Some analysts fear, legitimately, that India’s fiscal deficit is structural rather than cyclical. Mukherjee needs to prove this is not so. He failed to announce a road map in his speech for reducing the fiscal deficit in coming years — a communications blunder. Hidden deep in the budget papers was a medium-term fiscal policy statement projecting the fiscal deficit falling to 5.5% in 2010-11 and 4% in 2011-12. It might just be possible to return to the FRBM target of 3% by 2012-13. Had Mukherjee mentioned this — or come out with a cyclically adjusted deficit target — the reaction to his speech might have been very different.
Investors were spooked by the fact that government borrowings would cross Rs 400,000 crore to finance the deficit. This could crowd out private investment and raise interest rates. Late on budget day, the finance secretary clarified that the RBI would mop up half the fresh government debt, so banks would have to provide only half of the Rs 400,000 crore. Again, had this been spelled out in the budget speech, the reaction would have been different.
Mukherjee proposed raising just Rs 1,200 crore from disinvestments in public sector undertakings. Since shady real estate companies had raised more than this in recent days, the target was pitiful. The Economic Survey had suggested raising up to Rs 25,000 crore. So, Mukherjee’s pitiful target was interpreted by markets as timidity and lack of conviction.
He could have outlined some reform measures that his government is contemplating. He could have said that coal and nuclear power will be opened up to the private sector, but chose to remain silent. His own ministry has a Bill in the works to raise foreign direct investment in insurance from 26% to 49%, yet he kept silent on this. This silence created the impression that the government is at best a reluctant, low-key reformer.
His one firm reform proposal — implementing the goods and services tax (GST) by April 2010 — was widely ridiculed as unrealistic. So much work remains to be done on procedural and training issues that he should have put off the GST deadline by a year.
When the market crashed, the finance minister sought to reassure TV audiences that he had by no means abandoned reform. He said it was not necessary to spell out every reform in the budget, and that the budget was only one of several instruments at the government’s disposal. Very true. But if indeed silence was such a virtue, why did he go out of his way to declare that bank nationalisation 40 years ago was “wise and visionary” and “continues to be our inspiration even as we introduce competition and new technology in this sector?”
There was plenty wrong with both what Mukherjee said and did not say. This was due only in part to poor communications. It also reflected timidity: instead of deregulating petroleum products, he appointed yet another committee to study the issue. And this timidity reflected internal contradictions in Congress thinking about reform.
Ideological confusion was evident in his abolition of the surcharge on income tax. This benefited only those earning over Rs 10 lakh per year, meaning the aam Ambani rather than aam admi. More logical was the shift of fringe benefit tax from corporates to individual beneficiaries, and the rise in MAT to an effective 17%, reducing unwarranted benefits to low-tax corporates.
In a recession, finance ministers are under pressure to resort to protectionist dramatics. To his credit, Mukherjee has resisted such pressures. Most of his small changes in import duty lowered rather than raised tariffs. He also showed courage in extending service tax to railway traffic, creating a level playing field with road and air traffic, and ending the preferential rail treatment that Laloo Yadav once revelled in. Lawyers are a powerful lobby, but Mukherjee extended service tax to legal advice, consultancy and technical fees. One hopes this does not exempt earnings from court hearings: that would be farcical.
Congress may be confused and half-hearted about longer-term economic reform. Mukherjee’s communications strategy and skills may have been wanting on budget day. But history will judge this budget not by the immediate stock market reaction but by its success in combating the recession. Mukherjee has raised the fiscal deficit, accelerated infrastructure and safety-net spending, and monetised half of government borrowing. Such boldness is entirely warranted in a recession. The big risk is that he will not be able to roll back the fiscal deficit in coming years. Let’s cross that bridge when we come to it.
