Budget 2013 not a death knell for reforms

March 4, 2013

(Any opinions expressed here are those of the author and not of Reuters)

In announcing the new budget, Finance Minister P. Chidambaram tried to square the circle. On the one hand, with the prospect of elections next year or possibly sooner, handing out costly goodies was always going to be a temptation. On the other hand, like its Western counterparts, the Indian government was faced with the fact that it must rein in public spending, which could anger some voters, not to mention dampen economic growth.

The trick, therefore, was to cut spending on areas where the negative impact would be least damaging. On that count, the budget met our expectations. We had long thought the deficit could be cut from 5.2 percent of GDP to 4.8 percent in 2014. And while the underlying nominal GDP growth assumption of 13.4 percent may be a stretch, we didn’t think it was beyond the realm of possibility.

What we found interesting is that the planned portion of the budget, which includes schemes for rural areas and construction, is programmed to rise by about 29 percent, whereas the relatively large non-planned portion should rise by a mere 11 percent. The latter includes expenditure on government operations that hardly help stimulate growth, as well as subsidies which are slated to fall by a heartening 10 percent.

The upshot of this manoeuvre is that it improves the budget mix: the spending on the more productive areas outpaces the economic growth rate, whereas the spending on the less productive ones rises at a slower pace, or even shrinks.

A more disciplined Indian budget is not just a worthy end in itself; it can also aid growth. One important implication is that the less the government borrows, the less money the Reserve Bank of India (RBI) needs to print to finance it, thereby minimizing the risk of inflation. As a result, all else being equal, the RBI could loosen monetary policy and thus ease the burden of high interest costs for many companies.

Needless to say, with a slower borrowing pace and lower interest rates, the Indian government could also save on interest payments, one of its biggest budget items. To put it in context, India spends twice as much on interest payments as it does on defence.

But for many reform watchers, the ultimate question is whether Chidambaram’s budget speech marked the end of the government’s reform efforts, which had progressed quite satisfactorily in the past year. Judging by the market reaction, many investors were disappointed not so much by what the speech contained, but more so by what it did not. With no actual reform announcements, the speech failed investors’ high expectations for such announcements, arguably triggering the selloff.

Since the budget is not usually an instrument to discuss reform initiatives, we think investors were somewhat misplaced to expect it to mention breakthroughs on issues such as land acquisition reform and power sector debt restructuring.

Admittedly, we had hoped to see progress on the Goods and Services Tax, since revenue generation is directly related to the budget. Any encouraging signal would have been welcome but we too were disappointed.

Still, we do not believe Chidambaram’s speech was a death knell for Indian reforms. We believe the current administration is acutely aware that stalling on reform would not only undermine India’s economic growth, but also, as a consequence, diminish its odds for re-election.

We note that one revenue measure in the budget was the surcharge on taxes for the wealthiest Indians and companies. However, this is only good for one year. Chidambaram probably thought that the economy would recover enough in fiscal 2015 and that the tax revenue then would be sufficient even without the surcharge.

We are optimistic that Chidambaram and administration officials realise that for this recovery to happen, they cannot pause on policy improvements. Any measures toward investment recovery, ideally coupled with lower inflation, would work wonders to lift the mood through higher incomes and a stronger job market — and, perhaps, even appeal to the electorate.


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