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Of Reforms, Deficit And Inclusive Growth
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Much is being expected from the first union Budget to be presented by the new UPA government's Finance Minister, Pranab Mukherjee. The current slowdown has raised expectations among businessmen that this budget will do something to help the economy get back to its 8 per cent-plus growth rates. Meanwhile, the constant references to inclusive growth by various ministers have made most anticipate a huge increase in social sector expenditure. The fiscal situation is not particularly pretty, but there is a school of thought that says one can ignore fiscal deficits in order to promote economic growth. In theory, the Union Budget is supposed to be nothing more than a statement of the government's proposed expenditure and revenues for the year ahead. In practice, many finance ministers have used the budget speech to signal policy changes and reforms. What will this year's budget look like? Four senior economists and policy watchers — Pronab Sen, chief statistician & secretary, Ministry of Statistics & Programme Implementation, Omkar Goswami, chairman of CERG Advisory, Abheek Barua, chief economist, HDFC Bank and Laveesh Bhandari, director of Indicus Analytics, debated the issues before the government for over an hour and a half with BW's Prosenjit Datta and Rajeev Dubey. Excerpts:
Prosenjit Datta: Gentlemen, thank you for joining today's discussion. Because of the backdrop against which this budget will be presented, expectations are sky-high. It is expected to kick- start growth, usher in major tax reforms, announce significant social reform measures... But given the fiscal deficit situation, can it really do much? Or will the finance minister ignore the fiscal deficit?
Abheek Barua: Let me start with a favourite joke of mine. A former US treasury secretary was asked, "What would you like to be reincarnated as?" He said he would like to be reborn as the bond-market so that he could come back and intimidate everyone. I take what the bond-market says very seriously. And the bond market is telling us that any fiscal slippage below the base of the levels set out in the interim budget will have a very bad effect on the lending rates.
What I expect from this budget is that it will bring back some sense of fiscal discipline, so that we don't have an overwhelmingly large government borrowing programme. Perhaps this can be done through selective increases in the taxes or some cuts in the stimulus spending. But what I clearly don't want to see is more stimulus being announced that translates into a larger fiscal deficit. If we are fiscally reckless at this stage, then, over the next 6-7 months, we will run into a situation where government borrowings will begin to infringe on the private sector. And this will spook whatever little recovery party we have had till now.
There are various options before the government. If you talk about balancing the budget, you have to rein in expenditure and raise more revenues. I think we have some non-borrowing funding options. In particular, disinvestment.
Datta: But will that be possible this year?
Barua: Well, if you look at the disinvestment possibilities and things like the 3G spectrum auctions, we can realistically raise between Rs 30,000 and Rs 40,000 crore, which is perhaps minuscule when compared to the total government borrowing programme. But it will be a good start.
Laveesh Bhandari: On your key point I totally agree. I am a fiscal conservative and I don't see any way that this government will be able to keep up with the interim budget numbers. However, this economy is being driven more by expectations than what is happening in the markets on a day-to-day basis. So, one thing this budget will need to look at very seriously is how it's going to manage expectations.
It's clear that we are very ambitious on the major social sector programmes. These are going to be strengthened. Given that, growth will also be an objective. And that will require a range of reforms. Now that's where my opposition to creeping disinvestment comes from. We have to, at some level, take some tough decisions. We need to look at some very serious administrative reforms. We need a much higher end IT back-end in our government departments to be able to implement the social programmes. Tough decisions need to be taken.
Pronab Sen: I wish the debate was not couched in terms of whether we are fiscal conservatives or fiscal liberals. Fiscal decisions really are, and should be based upon an appreciation of what the drivers of the economy are and what role the budget is playing in all of that. Now, in terms of the pressures towards fiscal liberalism — all of it emanates from what is happening in the rest of the world where every government is going berserk in terms of the budgetary numbers and 10-12 per cent fiscal deficits are not merely common, but expected.
There is this view in India which says, "look at what the rest of the world is doing, and we should do it too". The counter argument is that "no, this is a terrible thing to do". Both are ideological positions, which I find unacceptable. The proper argument is saying that the Indian experience is completely different from what's happening in the rest of the world. In the rest of the world, the slowdown has been driven by consumer spending crashing. Wealth has crashed, and consumers have pulled back. In India, nothing of that kind has happened.
The slowdown that we are witnessing is primarily the outcome of what's happening in the export market — which is consumer spending elsewhere crashing. Your budget can do precious little about that. And investments are falling in tandem. Now in a situation like that, a high fiscal deficit doesn't necessarily add to the recovery process directly.
The real issue is: what's our take on exports and investments. Exports are out of our hands and any effort at trying to replace export demand through enhanced domestic spending is not only futile, but also silly. The other issue is investment. And here, the question is: what is the role of interest rates on the one hand, and expectations on the other — the two points that were brought up by Abheek and Laveesh. I would go along much more with Laveesh. It is really the expectations which are the bigger drivers. And today, we don't have a clear take on what is driving investor sentiments.
What one reads in the newspapers suggests that investors are looking to the government. If that is the case, one needs to think about the fiscal decisions seriously. And then what it would suggest is that the level of the fiscal deficit is not that much of an issue… the issue is the type of expenditures that are built into the budget. There again, I think Laveesh is right that there is a lot of pressure of political commitment on social sector programmes — which, frankly, should not fill investors with any great joy.
On disinvestment, I disagree with both of them. If you are working on expectations, we should be very clear that it is not how much money that disinvestment brings in or whether it reduces the pressure on yields of government bonds, but the fact that it is a statement of intent. Today, you have a situation where the private sector has cut back on its investment and you want them now to start buying up the bonds of the PSUs. That is just as much crowding out as any government bond issue...
In summary, I don't think 5.5-6 per cent fiscal deficit is going to matter much. If it goes beyond that, issues will arise because that will set off expectations of massive increase in taxes because expenditure commitments are not going to be seen as being politically manageable in the future. And that is the kind of expectations that we do not need at this point. So fiscal conservatism in terms of sticking to 5.5-6 per cent is I think desirable. But to talk about 3 per cent fiscal deficit, I think can wait.
Barua: I am not suggesting that fiscal deficit should come down dramatically to 3 per cent this year and 2.5 per cent next year. I was suggesting that if you look at the expectations building up in the financial market, there seem to be expectations of more stimuli, which could take the deficit up beyond 6.5–7 per cent. I am comfortable with 5.5 per cent and a clear roadmap of bringing it down in the future.
Sen: I think setting timelines for bringing down fiscal deficit is dangerous at this point in time if you are managing expectations…
Barua: The absence of timelines could be equally dangerous…
Omkar Goswami: One has to understand what the Congress thinks its mandate was. I think the overwhelming consensus is that their mandate was inclusive growth. This mandate involves looking at significant increase in social sector programmes and social infrastructure. There is of course the issue of how well that can be implemented. But a necessary condition is that, both within the Centre, and from the states, funding is made available.
Also, for creating better physical infrastructure in upcountry India. The Bharat Nirman programme, unfortunately, came to an abrupt halt in the middle of the last UPA regime. Even if 50 per cent of that huge programme could be implemented, it will cause a fundamental face change in rural India. That's the mandate of this government. The mandate is not to ensure that the denizens of south Bombay, looking at Bloomberg terminals, remain incessantly happy.
If the government is clever, in order to execute the primary mandate, they will realise the need of finances and there are limits to which money can be raised by way of public sector borrowings. Therefore, you do need FDI going forward, and you need to do things that keep the capital market and investors happy.
You need to look at the budget — and the next one as well — within that framework. The government will do the things that are needed to be done in terms of inclusive growth in order to ensure that this translates to a much larger number of seats in the next elections.
I don't expect a fourth stimulus package. We are on a turnaround. I expect significantly large social sector spending. Go through the seven bullet-heads of the Bharat Nirman Programme and you know exactly where the monies are going to go. I expect some disinvestment signals.
My guess is that the finance minister is going to come up with a target for the remaining period of 2009-10 of something like Rs 15,000 crore to Rs 20,000 crore from disinvestment.
I agree on FRBM with Pronab. Whether today or three or four years down the line, talk is cheap. To commit to FRBM when three things fall in place. One, if all your assumptions on denominator buoyancy happens. It happens because your real GDP growth goes up, you have just the right kind of inflation to create a large, nominal GDP growth, and as long as your numerator increases at a rate lower than the denominator, that buoyancy takes you to some sort of FRBM target.
Second, when you start reducing significantly the rate of growth of the numerator. That is not going to happen. Because public expenditure is going to be the leitmotif of this government.
Number three method is if you can rationalise taxes. And I believe that is the way to go. In addition to the divestment schemes, you got to stop exemption schemes as you go along, you have got to get the corporate sector's average taxes today from 22 per cent or so to somewhere near 30 per cent. Will the finance minister do this today? No. Too early. You have got to build political consensus.
I would actually look, not at this budget — this budget is much more of a signalling budget — I would look at the next budget to see if he is serious about a) growth, and b) the deficits and the rationalisation. I would agree that we are looking at no less than 5.5 and probably around 6 per cent as the Centre's fiscal deficit.
Datta: What about FDI reforms?
Goswami: I am sure he will signal insurance (relaxation of FDI). It is in the Rajya Sabha, so there is no problem. I am almost certain he is going to signal pension reforms. But I don't think he is going to make the case for FDI in retail.
Bhandari: This will be a cautious budget, but at the same time some tough decisions will have to be taken. And this is the best time when the government is starting off. There are two or three areas — administrative reforms of a particular type, and there are some budgetary allocations that can signal that… these are very, very critical for the long term. I would agree with Omkar that we will see some minor action, some signaling of FDI… insurance of course, definitely not in retail.
Goswami: Don't be too hopeful about 3G spectrum in the short run. The persona of the minister and very quick, efficient, transparent allocation of the 3G spectrum seem to be antithetical to each other. So, I don't expect a large amount of money coming through 3G spectrum in this fiscal.
Rajeev Dubey: From all the discussion, there is this sense that the government is almost dismissive of fiscal prudence. But do you think that the stimulus packages have had any effect?
Bhandari: I think that the stimulus package has worked on the monetary policy front. On the fiscal end, I don't think it has.
Barua: I think the pay hikes of the government employees came in handy, and that combined with lower rates of leverage, for borrowing, the reduced rates for the retail borrower has actually helped some segments — like the passenger cars, for instance. So one could make the case that both the pay hike as well as the rural loan waiver, which was really a default stimuli has been far more effective than the excise cuts. If you look at the excise cuts and the prices, the prices were cut and then they moved up again. So I would say the excise cuts didn't help…
Sen: First of all, the smoke and mirrors bit. If you really look at the stimulus packages, other than tax cuts, everything else was bringing in on paper what was done in actuality much before. If my problem is not the consumer, then a tax cut does not have a lot of effect anyway.
This is why we really need to look at the budget differently. The tax cut, we should not have expected it to have any effect, except for a psychological one, which it did. So, in the budget, do you need to keep that tax cut? The logic of economics says it is not necessary. The logic of expectation management says it may be a good idea.
Barua: Dr Sen — you do have the expenditure side of the breakdown of the GDP. In the case of the car market, was it getting into a bit of a problem before the pay hikes kicked in?
Sen: There was certainly a problem but that problem emanated from the financing side, and not from the desire side. Prices were off. It's just that you were not getting finance. And that is much more of a monetary phenomenon…
Goswami: It is an interesting point. If investments need to come back in a big way, the people who invest, that is the businessmen, have a great deal of say in tax policy — particularly in rebates on investment, in tax holidays on investments. So, the pressure is going to be intense on the North Block to maintain and indeed increase tax holidays for investments.
Datta: Do you all agree that the finance minister has limited leeway in making substantive reforms in taxes in this budget or even in the next few?
Sen: So far as any significant tax reforms are concerned, there are two kinds of situations when you can do them. Number one is when you are in a crisis and everyone knows you are in a crisis. The other is when you have spent enough time in building consensus. The only discussion that has taken place in terms of consensus building is to move to the GST. And that is not something that can be announced in this budget. For nothing else have you had any consensus building of any kind. So, I just couldn't see any tax reform happening. The only moot question is whether you are going to increase the roll back on excise and if so, to what extent.
Dubey: Are we as a nation already beginning to rejoice a recovery? When you are saying that advanced tax collections are stagnant and industrial production has just turned from negative to positive, isn't it too early to celebrate?
Barua: I have serious issues with some of the government macro data that comes out. But clearly you see that there are expectations of a recovery. In terms of hard numbers, except for a couple of markets, things are still very sluggish. The credit market is very sluggish. Perhaps you can say we are on the cusp of a recovery. It is too early to rejoice.
I think in order to sustain growth at 7.5-8 per cent, because of the context — we are talking too much of the nitty-gritty fiscal issues. Going forward, one of the problems I see is that perhaps because of the crisis in the global economy, we may have learnt the wrong lessons.
For example, sub-prime has become a dirty word. Asset-backed securitisation has also become a dirty word. For the growth of economy and penetration of credit, going forward would involve lending more and more to riskier borrowers, and we need to put in place the right systems which will curb the banking system from a very sharp unwinding of risks. These are things we need to look at. I feel, talking to people in the RBI, that we have become a little too careful. There are a number of institutional issues that are beyond strictly the fiscal domain that will determine the growth rate. We need to take a very serious look at these issues…
Sen: I completely agree with you. I think we are learning the wrong set of lessons, especially in asset-backed securitisation. We have taken baby steps, and now we have completely withdrawn, which is the wrong thing to do.
The one that we are not backtracking on is universal banking, and this surprises me. In the US, when they repealed the Glass-Steagal Act and brought in universal banking, they did it as a conscious measure. In India, we followed that example through the back door. There were no change in our banking laws, but we forced our banks to become universal banks. It's terribly dangerous. Now, this may not be a budgetary issue, but it certainly needs to be brought out in budgetary discussions. At the end of the day, this is not something that RBI can do. Legislative action has to come from the finance ministry.
Bhandari: I don't think anyone can argue against this point. The budget also sets a direction — sends signals. And there are decisions where one should start building a consensus on.