Budget 2011: Between a rock and a hard place

February 18, 2011

(The views expressed in this column are the author’s own and do not represent those of Reuters)

The Union Budget will be introduced at the end of February and market expectations are quite high. There is a conundrum for the government this year: it needs to provide near-term income support for the poor without compromising medium-term fiscal consolidation, in order to maintain its power while pursuing efforts to tame inflation.

A bank employee counts currency notes at a cash counter inside a bank in Agartala February 26, 2010. REUTERS/Jayanta Dey/FilesWe certainly expect the budget intentions will focus on walking this tightrope, but implementation may be tougher as efforts could be hampered by corruption probes and external pressures such as commodity prices and liquidity bubbles.

Unfortunately, more often than not, the execution of the budget — if not the budget itself — disappoints in terms of expectations. India is not the only country in which hopes of bold leadership are dashed once a year. Against the backdrop of rising inflation, corruption probes and charges that the United Progressive Alliance led by Prime Minister Manmohan Singh abandoned its economic reform agenda, the upcoming budget is even more important this fiscal year.  PM Singh has promised that clear measures will be announced in this budget.

India is a supply-constrained economy in contrast to China, which is demand- constrained. In India, economic activity is constrained and inflationary pressures are exacerbated by the lack of adequate physical (and soft) infrastructure such as roads, ports, electricity and water that tilts the growth-inflation trade-off toward inflation.

In China, there is enough infrastructure to support strong and non-inflationary growth for a long period of time without hitting bottlenecks. Moreover, efforts to boost agriculture sector productivity and improve India’s human capital are still lagging.

While India has some of the brightest people on earth, its literacy rate still trails that of Indonesia. Measures taken such as the creation of the National Skill Development Co-ordination Board and the Skill Development Mission are commendable, but the quality implementation of these plans is key.

From an offshore investor’s perspective, the Union Budget needs to provide a set of road maps for:  (1) the implementation of the GST; (2) a reduction in the fiscal deficit through expenditure restraint (e.g. fuel and farm subsidy reductions); (3) inflation reduction; (4) improving corporate governance and reducing corruption; and (5) boosting farm productivity from field to market.

Measures aimed at fiscal consolidation are the most important in our view.  Expenditure as a share of GDP has risen by 4 percent since the Great Recession while the tax take remains low at roughly 10 percent of GDP. The government needs to push through the GST and rationalise the rest of the tax system.

Foreign direct investment into India from April through November fell sharply compared with the same period a year earlier. The government plans to spend $1trn on roads, ports and other utilities over the 12th five year plan (2012-17) to sustain a growth rate of 8-9 percent. An implementable model should be introduced for promoting public-private joint ventures to encourage infrastructure development.

So what do we expect from the upcoming budget?  Parliament’s final sitting of last year was the least productive in at least 25 years. Hopefully, the government will surprise on the upside as it did last year.

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