Drought relief, poll freebies will widen fiscal deficit

When India\’s GDP growth declined to 6.5% last year, some shrugged it off as an aberration. But drought and industrial stagnation have led financial analysts like CLSA to slash their growth estimate for 2012-13 to 5.5%. Citibank fears it could fall to 4.9%. Consumer inflation remains high. Don\’t blame just the weather and global conditions, say the analysts. India\’s problems arise mainly from policy paralysis, misdirected subsidies and a big fiscal deficit (the excess of government spending over revenue).

TV anchors ask whether such problems will be solved by the return of P Chidambaram as finance minister, and the appointment of world-famous economist Raghuram Rajan as chief economic advisor. Can they revive the economy and cure its ills?

Alas no, not in the year ahead. The global slowdown and drought mean growth will be anaemic. Decision-making will be dominated by drought relief and populist schemes to sway vote banks in the next general election. Economic issues like reducing the fiscal deficit or encouraging foreign investment will take a back seat.

India\’s persistent high fiscal deficit may soon lead global rating agencies to downgrade India to junk status. This could induce foreign investors to flee, worsening the balance of payments, the rupee and stock markets. The RBI says the high fiscal deficit is exacerbating inflation. It would like to cut high interest rates that are hurting industry, but cannot do so until the fiscal deficit falls and curbs inflation.

Chidambaram has appointed an expert committee on cutting the fiscal deficit. Important though this issue is conceptually, the drought is more urgent. The budget assumed GDP growth of 7.6%, but actual growth may be 5-5.5%. This will mean a big shortfall in tax revenue. At the same time, drought relief spending will rise. The result will be a higher fiscal deficit.

Unwarranted subsidies on oil products, notably diesel, benefit not just farmers but rich diesel car owners. Price controls impose an annual subsidy burden of Rs 150,000 crore on oil companies, almost five times the outlay for MNREGA, the flagship rural employment programme. This reflects terribly distorted priorities.

Yet the drought has made diesel price decontrol politically impossible. Farmers need more diesel for irrigation in a drought. Indeed, the first relief package announced for farmers included a further diesel subsidy. Even if some small increase in diesel price is allowed, the oil subsidy looks certain to skyrocket above budget estimates.

To tackle the drought, MNREGA will be expanded greatly. It originally aimed to provide 100 days of work per applicant, but the government is thinking of increasing that to 150 days. Sales of subsidized food from ration shops will increase, raising the food subsidy bill. All these factors will raise the fiscal deficit. Whatever foreign investors might say, such spending is needed in a drought.

A bigger spending explosion will come from populist giveaways in the coming Budget, which will be framed with an eye on the next general election. That election is due only in 2014, but given its fragile majority, the government may fall in 2013. Even if lasts a full term, the 2013 Budget will be the UPA\’s last-the 2014 budget will be finalized only after the election.

So, schemes are afoot to win over voters disgusted by the government\’s corruption and policy paralysis. Slowing economic growth increases Sonia Gandhi\’s desperation for dramatic gestures to buy votes. One scheme on the anvil is free cellphones plus 200 minutes of talk time to the poor. Some media reports say the scheme will cover 6 million poor households at a cost of Rs 7,000 crore. But, because politicians treat BPL (below poverty line) cards as vote-buying cards, the food ministry says there are more BPL cards than households in Tamil Nadu and Andhra Pradesh! Nationally, four-fifths of all households have some sort of ration card. Sonia will want to include as many of these as possible. So this item alone could be a spending blockbuster.

A cellphone increases productivity and information access. As election freebies go, a cellphone is a pretty good choice. Many people with BPL cards already own cellphones. They will probably accept a free election cellphone, and sell it. This happened in Tamil Nadu when the DMK gave away free TVs to fulfil its 2006 election pledge.

To sum up, Chidambaram faces two contradictory pulls. Economists, foreign investors and stock markets want him to focus on cutting the fiscal deficit. But Sonia wants him to focus on explosive spending for drought relief and election freebies. No prizes for guessing the outcome.

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