Vinayak Chatterjee, an infrastructure expert, writing in the Business Standard ( March 15, 2010) mentions that the total size of the Union Budget is about Rs 11.09 lakh crore. The infrastructure allocation is thus 16 per cent of the Union Budget. Of the Rs 373,000 crore of Plan expenditure, the infrastructure allocation is Rs 1.73 lakh crore or 46 per cent of Plan allocation. So it would seem that the government is taking infrastructure very seriously indeed.
But how much of these allocations actually result in the creation of infrastructure assets? For example, the allocation of Rs 40,100 crore for the National Rural Employment Guarantee Scheme (NREGS) in the Rural Development Section, does not all go towards creating infrastructure. Probably only a very small proportion does. But as Chatterjee mentions, this is the way the finance ministry currently "defines" infrastructure!
As per the 11th Plan, the nation needs $500 billion (Rs 22.5 lakh crore), or $100 billion per annum. This translates into a requirement of Rs 450,000 crore per annum. Of this, the Union Budget is able to provide for Rs 173,000 crore, or roughly 38 per cent. Chatterjee argues that this is very much in order, considering 30 per cent is slated to come from public private partnerships (PPP), and the balance of 32 per cent from states and off-Budget resources. I tend to disagree. Much of the so called budget allocation will not lead to capital formation but will go into revenue spending or in a worst case scenario, end up as leakages.
I have a simple question. Why does it need someone like Chatterjee to do all these calculations and figure out what is going on? If Pranab Mukherjee is truly convinced that what he is doing for infrastructure is enough and far more than any other budget in recent years, why could he not give us all the relevant facts? The very fact that we still do not know for sure what are the tangible outcomes of a flagship program like NREGS shows that the government has no accountability whatsoever. It can keep rattling off figures and we would never know what is the ground reality.
Tuesday, March 16, 2010
Friday, March 12, 2010
The Non Operating Income Trap
Writing in Business Standard (March 11, 2010), the reputed economist, Shankar Acharya has reiterated a basic flaw in the government’s approach to fiscal consolidation. The 1.4 % reduction in the fiscal deficit in the coming year will rely heavily on a few items: an additional Rs 15,000 crore of PSU disinvestment proceeds, Rs 35,000 crore of the much-postponed 3G telecom auction proceeds, about Rs 20,000 crore saved on account of no Pay Commission arrears, about Rs 15,000 crore saved on account of no loan waiver payments and Rs 10,000 crore saved on account of no oil/fertiliser bonds. Together, these five items add up to Rs 95,000 crore or 1.4 per cent of fiscal deficit ratio improvement claimed by the Finance Minister!
But many of these items are one-off in nature. And in corporate language they would be called non operating income. In other words, the worry is how will further deficit cuts be achieved?
The bond market is usually a powerful judge of government policies. In the second week of March, the 10-year benchmark interest rate crossed 8 per cent, reflecting the concerns of that market. The hardening of yields is also a sign that markets are anticipating higher inflation.
Meanwhile, the government has sought to assure industry that there will be no crowding out effect due to government borrowing. But Acharya mentions that unlike last year, excess liquidity may not remain as the RBI will most likely continue its exit from its expansionary policy introduced at the peak of the global meltdown in 2008. At the same time, commercial banks are already holding almost 30 per cent of their assets in the form of government bonds. They may have little appetite for more such assets, especially when there is a risk of capital losses due to higher interest rates. So, the only way to offload government paper may be to offer higher interest rates. This will drive up interest expenses for the government adding up to the structural deficit. More importantly, by increasing the cost of funds, investment and growth may also be affected.
In other words, the budget has painted a far more optimistic scenario than would be justified if we take into account the ground realities.
But many of these items are one-off in nature. And in corporate language they would be called non operating income. In other words, the worry is how will further deficit cuts be achieved?
The bond market is usually a powerful judge of government policies. In the second week of March, the 10-year benchmark interest rate crossed 8 per cent, reflecting the concerns of that market. The hardening of yields is also a sign that markets are anticipating higher inflation.
Meanwhile, the government has sought to assure industry that there will be no crowding out effect due to government borrowing. But Acharya mentions that unlike last year, excess liquidity may not remain as the RBI will most likely continue its exit from its expansionary policy introduced at the peak of the global meltdown in 2008. At the same time, commercial banks are already holding almost 30 per cent of their assets in the form of government bonds. They may have little appetite for more such assets, especially when there is a risk of capital losses due to higher interest rates. So, the only way to offload government paper may be to offer higher interest rates. This will drive up interest expenses for the government adding up to the structural deficit. More importantly, by increasing the cost of funds, investment and growth may also be affected.
In other words, the budget has painted a far more optimistic scenario than would be justified if we take into account the ground realities.
More about PSU disinvestment
John Samuel Raja of Outlook Business (March 20, 2010) has provided a comprehensive picture of PSU disinvestments in our country. Currently there are about 808 PSUs. Their revenues add up to about Rs. 20,55,000 crores and their net profit to about Rs. 107,000 crores. Their assets are currently valued at about 103% of GDP. But their overall financial performance is disappointing. As many as 360 of them posted a loss in 2008-09. Some 212 PSUs posted profits of below Rs. 10 crores. The net profit was only 1.68% of assets for the PSUs as a whole. The corresponding figure for the BSE Sensex companies is 4.2%.
The PSUs which have been privatized seem to be doing well. Balco and Hindustan Zinc have been turned around by Sterlite. Maruti has also done well after the government offloaded its stake. The same goes for CMC, IPCL, VSNL and Jessop. In contrast, where small stakes have been sold and the government retains control, the functioning has become more transparent and accountable but the improvement has been less spectacular.
Outlook Business quoted Vijay Kelkar, Chairman of the 13th Finance Commission: “The motivation for disinvestment or privatization should not be narrowly seen as being only about maximizing proceeds from the sale of assets. The real big gains come from the full picture. We gain when the private sector attains higher productivity. And this happens even with mere disinvestment, but it happens much more strongly with privatization.”
It is estimated that a 10% stake sale in all the listed PSUs alone could result in revenues of Rs. 180,000 crores. That would help bridge almost two thirds of the revenue deficit. More importantly, by disinvestment, the government can free up resources that can be better utilized for education, health care and various items of physical infrastructure.
Clearly we need a much bolder vision than what the finance minister has articulated in the recent budget.
The PSUs which have been privatized seem to be doing well. Balco and Hindustan Zinc have been turned around by Sterlite. Maruti has also done well after the government offloaded its stake. The same goes for CMC, IPCL, VSNL and Jessop. In contrast, where small stakes have been sold and the government retains control, the functioning has become more transparent and accountable but the improvement has been less spectacular.
Outlook Business quoted Vijay Kelkar, Chairman of the 13th Finance Commission: “The motivation for disinvestment or privatization should not be narrowly seen as being only about maximizing proceeds from the sale of assets. The real big gains come from the full picture. We gain when the private sector attains higher productivity. And this happens even with mere disinvestment, but it happens much more strongly with privatization.”
It is estimated that a 10% stake sale in all the listed PSUs alone could result in revenues of Rs. 180,000 crores. That would help bridge almost two thirds of the revenue deficit. More importantly, by disinvestment, the government can free up resources that can be better utilized for education, health care and various items of physical infrastructure.
Clearly we need a much bolder vision than what the finance minister has articulated in the recent budget.
Beyond the Budget 2010
Bibek Debroy one of my favourite economists (Business Today, March 21, 2010.) has come out with a wish list of items which should get implemented by the government in the next 4 years. I am listing below a few of them.
a) Budget speeches should be restricted to 500 words and seven minutes.
b) The fiscal deficit should come down to 3 percent of GDP and revenue deficits should come down to 0 per cent.
c) All off-Budget items must form a part of deficit calculations. All personal and corporate tax rates must be standardized, with no exemptions. All exemptions must go for indirect taxes too.
d) Subsidies must be replaced by direct, but conditional cash transfers. Using UID numbers and based on individual socio-economic criteria, below poverty line (BPL) households must be unambiguously identified. Non BPL households must not receive subsidies.
e) Over time, the secrecy surrounding the budget must go. The budget must be placed in the public domain even before it is placed before Parliament.
I am adding to Debroy’s list.
a) From now on, the finance minister must spend less time on grandiose promises and instead talk about what happened during the year that passed, what was achieved, what could not be completed and so on.
b) The finance minister should not throw up numbers that by themselves are prone to misinterpretation. Thus he must not just say that he is allocating say Rs 30,000 crores for roads. He must also indicate how much of road construction the country needs, how many kilometers of road can be constructed with Rs 30,000 crores, how much China is spending on roads every year, etc. Then the public can make an informed judgment about whether the allocation is adequate or justified.
c)The government is spending the tax payer’s money. So we have every right to know how our money is being spent. Which means fiscal discipline is crucial. The non plan expenditure must be subject to stringent controls. The minister should not just mention that the revenue deficit has been cut to 4% of GDP. He must indicate what items have been cut, what items remain. Then the public can understand whether fiscal discipline is being implemented cosmetically or by cutting unproductive expenditure.
d) The Finance Minister himself need not present the budget if there is a danger of putting people to sleep. A smart bureaucrat who is an excellent communicator can be chosen for the task. The budget should be presented in such a way that it is inspiring and impactful even if it does not throw up surprises. So I would probably suggest about 20-25 minutes may be given to make the presentation.
a) Budget speeches should be restricted to 500 words and seven minutes.
b) The fiscal deficit should come down to 3 percent of GDP and revenue deficits should come down to 0 per cent.
c) All off-Budget items must form a part of deficit calculations. All personal and corporate tax rates must be standardized, with no exemptions. All exemptions must go for indirect taxes too.
d) Subsidies must be replaced by direct, but conditional cash transfers. Using UID numbers and based on individual socio-economic criteria, below poverty line (BPL) households must be unambiguously identified. Non BPL households must not receive subsidies.
e) Over time, the secrecy surrounding the budget must go. The budget must be placed in the public domain even before it is placed before Parliament.
I am adding to Debroy’s list.
a) From now on, the finance minister must spend less time on grandiose promises and instead talk about what happened during the year that passed, what was achieved, what could not be completed and so on.
b) The finance minister should not throw up numbers that by themselves are prone to misinterpretation. Thus he must not just say that he is allocating say Rs 30,000 crores for roads. He must also indicate how much of road construction the country needs, how many kilometers of road can be constructed with Rs 30,000 crores, how much China is spending on roads every year, etc. Then the public can make an informed judgment about whether the allocation is adequate or justified.
c)The government is spending the tax payer’s money. So we have every right to know how our money is being spent. Which means fiscal discipline is crucial. The non plan expenditure must be subject to stringent controls. The minister should not just mention that the revenue deficit has been cut to 4% of GDP. He must indicate what items have been cut, what items remain. Then the public can understand whether fiscal discipline is being implemented cosmetically or by cutting unproductive expenditure.
d) The Finance Minister himself need not present the budget if there is a danger of putting people to sleep. A smart bureaucrat who is an excellent communicator can be chosen for the task. The budget should be presented in such a way that it is inspiring and impactful even if it does not throw up surprises. So I would probably suggest about 20-25 minutes may be given to make the presentation.
Wednesday, March 10, 2010
The need for a new approach to budgeting
The problems in Greece have alerted us to a fundamental problem with government accounting. It lacks transparency. The Greeks fudged their way through the process of meeting the Maastricht deficit/ debt criteria in order to gain entry into the Eurozone. Finally they have been caught.
What about India? How transparent are the Government accounts? Take the recent budget. Not a word about what was promised last year , what has been delivered during the year that has passed, why there were shortfalls and so on. In many cases such as infrastructure, highly aggregated figures have been provided that make it quite difficult to understand and assess the quality of spending. And the fact that the unproductive revenue deficit remains as stubborn as ever has been conveniently brushed under the carpet. Year after year, we hear the Finance Minister making pompous statements about the future. Each year, the Finance Minister talks about how he has put in place a budget that will promote inclusive growth and so on. As though his grandiose statements by themselves will generate growth.
And when all this happens, our media and business with some rare exceptions keep applauding from the sidelines. One well known personality even described the latest budget as the first non populist budget after independence.I have seen few articles in the media that have pressed for more information from the Finance Minister.
There is a saying that the people get the government they deserve. India is a shining example.
What about India? How transparent are the Government accounts? Take the recent budget. Not a word about what was promised last year , what has been delivered during the year that has passed, why there were shortfalls and so on. In many cases such as infrastructure, highly aggregated figures have been provided that make it quite difficult to understand and assess the quality of spending. And the fact that the unproductive revenue deficit remains as stubborn as ever has been conveniently brushed under the carpet. Year after year, we hear the Finance Minister making pompous statements about the future. Each year, the Finance Minister talks about how he has put in place a budget that will promote inclusive growth and so on. As though his grandiose statements by themselves will generate growth.
And when all this happens, our media and business with some rare exceptions keep applauding from the sidelines. One well known personality even described the latest budget as the first non populist budget after independence.I have seen few articles in the media that have pressed for more information from the Finance Minister.
There is a saying that the people get the government they deserve. India is a shining example.
Monday, March 08, 2010
Inadequate allocation for Infrastructure in India's budget
T N Ninan writing in Business Standard, 6-7 March 2010 ( Mamata's China tour) has nicely captured a fundamental flaw in the recent budget: the inadequate allocation for Railways. I mentioned in an earlier blog that too much has been made out of the allocation of about Rs 173,000 crores for infrastructure. Ninan has given useful comparative figures about China to drive home the point that the allocation is indeed puny.
China has connected Beijing / Shanghai, by high speed rail to Guangzhou, Wuhan, Zhengzhou, Tianjin, Nanjing, Xian, Taiyuan and other cities in China.These high-speed rail services operate at 350 km to 400 km per hour and extend over 3,300 km of track. The Middle Kingdom plans to offer some 40 such inter-city train services (including a new Beijing-Shanghai link), stretching over a total of 13,000 km of track, by 2012 — almost twice the distance of India’s “golden quadrilateral”. Even China's non-high speed trains now run at 200 km per hour or more.
In contrast, the best speed on Indian Railways has remained unchanged at about 130 km per hour for four decades. Some years back the Indian rail system was bigger than China’s. But now the Chinese rail system carries four times as much freight as Indian railways do. The gap will increase further. In 2009, China increased its investment in its railways by a staggering 80 per cent to about Rs 400,000 crore. Further increases in capital outlay are coming (Rs 550,000 crore in 2010).
Now compare these outlays with India's allocation of Rs 173,000 crores for total infrastructure. We can understand how our politicians make misleading statements and get away with them.
China has connected Beijing / Shanghai, by high speed rail to Guangzhou, Wuhan, Zhengzhou, Tianjin, Nanjing, Xian, Taiyuan and other cities in China.These high-speed rail services operate at 350 km to 400 km per hour and extend over 3,300 km of track. The Middle Kingdom plans to offer some 40 such inter-city train services (including a new Beijing-Shanghai link), stretching over a total of 13,000 km of track, by 2012 — almost twice the distance of India’s “golden quadrilateral”. Even China's non-high speed trains now run at 200 km per hour or more.
In contrast, the best speed on Indian Railways has remained unchanged at about 130 km per hour for four decades. Some years back the Indian rail system was bigger than China’s. But now the Chinese rail system carries four times as much freight as Indian railways do. The gap will increase further. In 2009, China increased its investment in its railways by a staggering 80 per cent to about Rs 400,000 crore. Further increases in capital outlay are coming (Rs 550,000 crore in 2010).
Now compare these outlays with India's allocation of Rs 173,000 crores for total infrastructure. We can understand how our politicians make misleading statements and get away with them.
Tuesday, March 02, 2010
The fallacy of public sector disinvestment
In his recent budget, Mr Pranab Mukherjee announced that through disinvestment of public sector undertakings ( PSUs) , he would be able to cut down the fiscal deficit significantly. The Finance Minister has projected that he will raise about Rs 40,000 crores through disinvestment in the coming fiscal year.
Immediately after he made the announcement there was an intense debate in the media about whether the estimate was too optimistic. I would suspect the projection is indeed too optimistic for a government which in the recent past has been tentative when it comes to bold economic reforms.
But I have a more basic objection to the money from disinvestment being used to reduce the fiscal deficit. As I mentioned in an earlier blog, almost 73 % of the fiscal deficit is made up by the revenue deficit. And revenue expenditure items are bad for the economy as they do not create long term income generating assets. So what the finance minister is telling us is that he will sell the family silver to meet current consumption needs.
Let me explain this point with an analogy. When we middle class people sell a property, it is usually to buy another property. if we do not buy another property, we would at least put the money in a long term investment that will yield good returns over a period of time. We don't sell our property to land up in the pub or shopping mall everyday! Nor do we do so to go on an expensive foreign holiday.
Another misleading argument given by a leading business magazine in the country is that disinvestment of PSUs will lead to wealth transfer from the government to the public. That can happen only if the Government starts selling its stake in PSUs at artificially low prices. Why should anyone sell the family silver at distressed prices? When divesting, the Government's concern should not be with wealth transfer. It should be with getting the best possible price. After all, the wealth of the PSUs belongs to the entire nation. if the Government sells off its stake at unrealistically low prices, the people who benefit will be the top 5% of the income group. Whereas if the Government gets a good price, it will have more money available to eliminate unproductive expenses and also deploy in schemes which can help the poor.
What should the Government actually do with the disinvestment proceeds? I think the best thing it could do is to reduce the debt burden which has grown to humongous proportions over time. Reducing the debt burden will bring down the interest outflows which today constitute the biggest expenditure item in the budget.In contrast, using the disinvestment proceeds to fund the revenue deficit would be unethical and bad for the economy. It would violate the basic principles of fiscal discipline.
Immediately after he made the announcement there was an intense debate in the media about whether the estimate was too optimistic. I would suspect the projection is indeed too optimistic for a government which in the recent past has been tentative when it comes to bold economic reforms.
But I have a more basic objection to the money from disinvestment being used to reduce the fiscal deficit. As I mentioned in an earlier blog, almost 73 % of the fiscal deficit is made up by the revenue deficit. And revenue expenditure items are bad for the economy as they do not create long term income generating assets. So what the finance minister is telling us is that he will sell the family silver to meet current consumption needs.
Let me explain this point with an analogy. When we middle class people sell a property, it is usually to buy another property. if we do not buy another property, we would at least put the money in a long term investment that will yield good returns over a period of time. We don't sell our property to land up in the pub or shopping mall everyday! Nor do we do so to go on an expensive foreign holiday.
Another misleading argument given by a leading business magazine in the country is that disinvestment of PSUs will lead to wealth transfer from the government to the public. That can happen only if the Government starts selling its stake in PSUs at artificially low prices. Why should anyone sell the family silver at distressed prices? When divesting, the Government's concern should not be with wealth transfer. It should be with getting the best possible price. After all, the wealth of the PSUs belongs to the entire nation. if the Government sells off its stake at unrealistically low prices, the people who benefit will be the top 5% of the income group. Whereas if the Government gets a good price, it will have more money available to eliminate unproductive expenses and also deploy in schemes which can help the poor.
What should the Government actually do with the disinvestment proceeds? I think the best thing it could do is to reduce the debt burden which has grown to humongous proportions over time. Reducing the debt burden will bring down the interest outflows which today constitute the biggest expenditure item in the budget.In contrast, using the disinvestment proceeds to fund the revenue deficit would be unethical and bad for the economy. It would violate the basic principles of fiscal discipline.
Monday, March 01, 2010
How non plan expenditure is wasteful
In my earlier blogs, I have mentioned that non plan expenditure is wasteful. Let us examine a few figures to understand this point.
The recent budget has earmarked Rs 735,657 towards non plan expenditure. Debt servicing accounts for Rs 248,664 crores , defence (revenue expenditure) for Rs 87,344 crores, subsidies for Rs 116,224 crores and pensions for Rs 42,840 crores. These are all expenses that do not really contribute to the creation of long term income generating assets. There are many other non productive items but I have only mentioned some of the more important ones. If our government is serious about fiscal discipline, it should make some efforts to control them. True in the recent budget, some effort has been to cut subsidies ( by about Rs 15,000 crores ) and defence services (by about Rs 1000 crores). But this is not enough. Meanwhile, the debt servicing burden has increased by about Rs 30,000 crores over the past year. Over the same period, the total non plan expenditure has increased by about Rs 30,000 crores.
These figures show that a lot more has to be done to bring back fiscal discipline.
The recent budget has earmarked Rs 735,657 towards non plan expenditure. Debt servicing accounts for Rs 248,664 crores , defence (revenue expenditure) for Rs 87,344 crores, subsidies for Rs 116,224 crores and pensions for Rs 42,840 crores. These are all expenses that do not really contribute to the creation of long term income generating assets. There are many other non productive items but I have only mentioned some of the more important ones. If our government is serious about fiscal discipline, it should make some efforts to control them. True in the recent budget, some effort has been to cut subsidies ( by about Rs 15,000 crores ) and defence services (by about Rs 1000 crores). But this is not enough. Meanwhile, the debt servicing burden has increased by about Rs 30,000 crores over the past year. Over the same period, the total non plan expenditure has increased by about Rs 30,000 crores.
These figures show that a lot more has to be done to bring back fiscal discipline.
Non Plan and Plan expenditure
In an earlier blog, I mentioned that the quality of spending is as important as the quantum. In the recent budget, the total plan expenditure is only Rs 373,092 crores. Out of this Rs 315,125 crores come under revenue spending and only Rs 57,967 crores come under capital spending.The non plan expenditure is as high as Rs 735,657 crores of which only Rs 92,508 crores come under capital spending. In general, non pan expenditure is wasteful stuff. Similarly revenue expenditure does not lead to long term income generating assets. In short, of the total expenditure of about Rs 11,08,749 crores, only about Rs 57,967 crores can be considered value adding. If this is the meaning of fiscal discipline, then there must be something wrong somewhere.
The Revenue deficit problem
Mythili Bhusnurmath, writing in The Economic Times, 1 Mar 2010,has come up with what looks to me to be one of the most incisive pieces of analysis on the Union Budget, 2010. While Finance Minister Mr Pranab Mukherjee has given the impression that the fiscal deficit is under control, what has been overlooked by most analysts is that the more dangerous revenue deficit is still far too high.
Revenue deficit as the name suggests is the gap between revenue receipts and revenue expenditure. By definition, revenue items do not lead to the creation of long term income generating assets.
As a proportion of the fiscal deficit, the revenue deficit has increased from just 41% in 2007-08 to 79% in the revised estimates for 2009-10 , and is expected to go down only marginally to 73% in 2010-11. So during the current year, out of every Rs 100 borrowed by the government, Rs 73 will be spent on consumption. Assuming an average interest rate of 8% on government borrowing , ie an interest outlay of Rs 8 ( on the borrowed amount of Rs 100), the government must earn a return of 8/27 or almost 30% on the remaining amount to be able to just meet its interest costs.
This kind of return would be a dream for even the most efficient private sector company. So, it is quite absurd to think that the government will be able to generate this kind of return. In short, the government will fall into a debt trap having no option but to borrow more and more simply to repay its loans.
As Ms Bhusnurmath has put it aptly, “ When a private party does this, we call it a Ponzi scheme and are quick to condemn it. But when the government does it, we fail to sit up and take notice.”
Revenue deficit as the name suggests is the gap between revenue receipts and revenue expenditure. By definition, revenue items do not lead to the creation of long term income generating assets.
As a proportion of the fiscal deficit, the revenue deficit has increased from just 41% in 2007-08 to 79% in the revised estimates for 2009-10 , and is expected to go down only marginally to 73% in 2010-11. So during the current year, out of every Rs 100 borrowed by the government, Rs 73 will be spent on consumption. Assuming an average interest rate of 8% on government borrowing , ie an interest outlay of Rs 8 ( on the borrowed amount of Rs 100), the government must earn a return of 8/27 or almost 30% on the remaining amount to be able to just meet its interest costs.
This kind of return would be a dream for even the most efficient private sector company. So, it is quite absurd to think that the government will be able to generate this kind of return. In short, the government will fall into a debt trap having no option but to borrow more and more simply to repay its loans.
As Ms Bhusnurmath has put it aptly, “ When a private party does this, we call it a Ponzi scheme and are quick to condemn it. But when the government does it, we fail to sit up and take notice.”
Projected revenues may not materialise
After the budget weekend, people have started analyzing the various proposals more deeply. It seems the revenues on account of the sale of 3G licenses may be less than projected to the extent of Rs 5000-10,000 crores or more. These doubts have risen because only three licenses are being auctioned instead of the original plan for four. The auction for the fourth slot has been postponed as the defence ministry has still not released the spectrum/radio frequencies. This may happen only in 2013.
The quality of Government spending is also important
Fisal discipline does not only mean reducing the gap between revenues and expenses. It also means cutting unproductive spending and raising productive spending. A good example of productive expenditure is infrastructure. It is estimated that a Rupee invested in highways can create Rs 7 of economic value.
Much has been made out of the fact that the Finance Minister has allocated about Rs 173,000 crores for infrastructure in the recent budget. But is this such a big deal? We are probably 40,000 - 50,000 km of highways short today, according to recent indications given by the Highways Minister, Mr Kamal Nath. To build a km of four lane highway it costs around Rs 8-9 crores. And to build a six lane highway, the amount would be about Rs 14 crores. Let us take an average of Rs 10 crores per km. So buiding highways itself calls for about Rs 400,000-500,000 crores of spending.
Mr Pranab Mukherjee's budget has allotted Rs 19,894 crores for road infrastructure. No doubt it is an increase of 13% over last year. But the amount will be sufficient to build only about 2000 km of highway. While the private sector will also chip in, we all know that the government has to lead the way in road construction. And our target is 50,000 km , not 2000km!
Similarly, an amount of Rs 16,752 crores ( increase of Rs 950 crores over the previous year) has been allotted for expansion of the railway network. This amount too looks grossly inadequate when we consider that the railways remain the lifeline for millions of people in the country. The Railways also remain the most cost effective mode of transporting cargo over large distances on land.
All this goes to show that the budget has serious lacunae. Unfortunately, the media has not bothered to drill deeper and do a rigorous analysis of the infrastructure proposals.
Much has been made out of the fact that the Finance Minister has allocated about Rs 173,000 crores for infrastructure in the recent budget. But is this such a big deal? We are probably 40,000 - 50,000 km of highways short today, according to recent indications given by the Highways Minister, Mr Kamal Nath. To build a km of four lane highway it costs around Rs 8-9 crores. And to build a six lane highway, the amount would be about Rs 14 crores. Let us take an average of Rs 10 crores per km. So buiding highways itself calls for about Rs 400,000-500,000 crores of spending.
Mr Pranab Mukherjee's budget has allotted Rs 19,894 crores for road infrastructure. No doubt it is an increase of 13% over last year. But the amount will be sufficient to build only about 2000 km of highway. While the private sector will also chip in, we all know that the government has to lead the way in road construction. And our target is 50,000 km , not 2000km!
Similarly, an amount of Rs 16,752 crores ( increase of Rs 950 crores over the previous year) has been allotted for expansion of the railway network. This amount too looks grossly inadequate when we consider that the railways remain the lifeline for millions of people in the country. The Railways also remain the most cost effective mode of transporting cargo over large distances on land.
All this goes to show that the budget has serious lacunae. Unfortunately, the media has not bothered to drill deeper and do a rigorous analysis of the infrastructure proposals.
Sunday, February 28, 2010
Understanding the real meaning of economic reforms
It is quite clear that the recent budget presented by Mr Pranab Mukherjee had little by way of structural reforms. A few economists and businessmen had the courage and conviction to point this out while others, who valued their relationship with the finance minister more, made weak or no references to this aspect of the budget. It is about 20 years since India embarked on the path of economic reforms. So this is indeed a good time to take stock of the situation. But before we do that we need to understand he meaning of the word, " Reforms".
It would be too much to cover the topic exhaustively in a blog but I shall make an attempt to convey the essence. Reform means a new approach to doing things.For example, if the Government has been running certain businesses so far, where it is not really needed, it must gracefully withdraw and pave the way for the private sector to take over.
Reforms also mean that there is no free lunch. If we as consumers have been getting something free or at lower than the market prices, we need to start paying more so that over time the inbuilt subsidy is eliminated.
Reforms means that the Government gives up its powers in areas where it does not need to be a policeman so that businessmen can spend more time strategising and running the business instead of worrying about taking approvals from the government and complying with regulations.
Reforms mean that unproductive and wasteful activities that are a drain on our limited resources are stopped. This is turns means an easy exit route that enables companies to shut down operations which cannot be turned around.
Reforms means making the government's activities more transparent and imposing accountability on Government staff.
And now let us try understand what the word" Reforms" does not mean.
Reforms does not mean postponing price increases of items as justified by market trends.
Reforms does not mean giving lollipops to people by way of ad hoc tax reductions.
Reforms does not mean tinkering with excise and customs duties from time to time and thereby creating uncertainty in the minds of entrepreneurs.
Reforms does not making various futuristic statements of good intentions without the data to back them or the discipline and will power to implement them.
Reforms does not mean making grandiose announcements to spend more for the poor but without even bothering to check how much of this money will ever reach the poor.
Now examine the proposals in the recent budget. It will be amply clear how committed our Government is to structural economic reforms.
It would be too much to cover the topic exhaustively in a blog but I shall make an attempt to convey the essence. Reform means a new approach to doing things.For example, if the Government has been running certain businesses so far, where it is not really needed, it must gracefully withdraw and pave the way for the private sector to take over.
Reforms also mean that there is no free lunch. If we as consumers have been getting something free or at lower than the market prices, we need to start paying more so that over time the inbuilt subsidy is eliminated.
Reforms means that the Government gives up its powers in areas where it does not need to be a policeman so that businessmen can spend more time strategising and running the business instead of worrying about taking approvals from the government and complying with regulations.
Reforms mean that unproductive and wasteful activities that are a drain on our limited resources are stopped. This is turns means an easy exit route that enables companies to shut down operations which cannot be turned around.
Reforms means making the government's activities more transparent and imposing accountability on Government staff.
And now let us try understand what the word" Reforms" does not mean.
Reforms does not mean postponing price increases of items as justified by market trends.
Reforms does not mean giving lollipops to people by way of ad hoc tax reductions.
Reforms does not mean tinkering with excise and customs duties from time to time and thereby creating uncertainty in the minds of entrepreneurs.
Reforms does not making various futuristic statements of good intentions without the data to back them or the discipline and will power to implement them.
Reforms does not mean making grandiose announcements to spend more for the poor but without even bothering to check how much of this money will ever reach the poor.
Now examine the proposals in the recent budget. It will be amply clear how committed our Government is to structural economic reforms.
The real meaning of fiscal deficit. and why it should be under control
In the recent budget, the finance minister, Mr Pranab Mukherjee has sought to give the impression to the media and the general public that he has heroically cut the fiscal deficit even as he has handed out lollipops to the middle class in the form of widening of the income tax slabs. We need to understand why the deficit matters instead of getting lost in the numbers.
A huge fiscal deficit means the Government has to bridge the revenue expenditure either by borrowing from the market or by printing money. if the Government borrows, the private sector will be crowded out, ie it will be able to borrow less at the current interest rate. And we all know the Private sector, driven as it is by the profit motive, uses capital more efficiently than the government.
On the other hand, if the government prints money, it will lead to more rupees chasing the same quantity of goods, leading to inflationary pressures.
Sound principles of economic policy making dictate that during the good times, the Government should build budget surpluses that it can run down during recessions. This is exactly what is happening in the US where the deficit as a percentage of the GDP has reached double digits.
In our country, there was a minor slow down after the collapse of Lehman Brothers in September 2008. So there was probably a case for increasing the deficit in the last budget to make up for the reduced global demand. But today, there is little justification.
The developed countries have to be cautious about how they withdraw the fiscal stimulus because the recovery there is still fragile. However, this argument does not apply to India. We must also remember that notwithstanding the Finance Minister's claims of having the deficit well under control, if all the items like the shortfall on the oil account and the deficits of the states are considered, our country's deficit would also be running into double digits. That is why it is a little funny to see so much premature celebration over Mr Mukherjee's deficit cutting efforts.
A huge fiscal deficit means the Government has to bridge the revenue expenditure either by borrowing from the market or by printing money. if the Government borrows, the private sector will be crowded out, ie it will be able to borrow less at the current interest rate. And we all know the Private sector, driven as it is by the profit motive, uses capital more efficiently than the government.
On the other hand, if the government prints money, it will lead to more rupees chasing the same quantity of goods, leading to inflationary pressures.
Sound principles of economic policy making dictate that during the good times, the Government should build budget surpluses that it can run down during recessions. This is exactly what is happening in the US where the deficit as a percentage of the GDP has reached double digits.
In our country, there was a minor slow down after the collapse of Lehman Brothers in September 2008. So there was probably a case for increasing the deficit in the last budget to make up for the reduced global demand. But today, there is little justification.
The developed countries have to be cautious about how they withdraw the fiscal stimulus because the recovery there is still fragile. However, this argument does not apply to India. We must also remember that notwithstanding the Finance Minister's claims of having the deficit well under control, if all the items like the shortfall on the oil account and the deficits of the states are considered, our country's deficit would also be running into double digits. That is why it is a little funny to see so much premature celebration over Mr Mukherjee's deficit cutting efforts.
No attempt to cut unproductive expenditure in India's Budget 2010
If the Government was serious about fiscal discipline, it would have done a lot to bring unproductive and wasteful expenses under control. Unfortunately, this has not happened. The total expenditure proposed in the budget is Rs 11,08,749 crores, an increase of 8.6% over the previous year. But more importantly, the unproductive non plan component works out to as much as Rs 735,657 crores. On the other hand, the Plan expenditure amounts to only Rs 373,092 crores.The non plan expenditure was only Rs 608,721 crores in 2008-09. In the next three years( including the forthcoming year), while non plan expenses would have gone up by about Rs 227,000 crores, the plan expenditure would have gone up by less than Rs 100,000 crores.The revenue deficit which is what really needs to be attacked, would have gone up by about Rs 23,000 crores over the same period. In short, the structural part of the deficit is only increasing year after year, notwithstanding the claims of the government.
Why are the country's top businessmen supporting India's budget 2010?
A quick glance at the leading dailies after Pranab Mukherjee presented the budget on February 26 reveals that most of our top businessmen are quite happy with the budget. It is quite clear that in the budget, there was not even a pretence of carrying out any structural economic reforms. Except for some tinkering with tax rates/ slabs, optimistic revenue projections and some lofty intentions, there was little really to suggest that the Finance Minister was on top of his job and knew what was needed to streamline the economy and boost the animal spirits. Very little ( if at all anything) has been done to bring the structural part of the budget deficit under control. Yet our leading industrialists are patting the Finance Minister on the back. Why is this so?
The answer lies in the mindset of the business class in the country. Right from the British days,our businessmen have believed in a marriage of convenience with the ruling class. People familiar with Indian History would know that the business class, though it always projected itself as a patriotic group, did not support Mahatma Gandhi in the freedom struggle throughout. When they realised that Gandhi was crossing the limits and their relations with the British Government might be severely damaged, these businessmen conveniently distanced themselves. At the same time, when their business interests were severely threatened, they came together and were quite vociferous in making various demands of the Government. The Bombay Plan is a good example.
Barring a few of our businessmen who have the courage and conviction to stand up to the politicians, most of the others are happy to allow the current state of affairs to continue. They are well aware that in an economy where the Government still plays such a central role, picking up fights with ministers, expecially the Finance Minister does not really make good business sense! The message of this blog is that let us not guage the quality of the budget from the reactions of our businessmen!
The answer lies in the mindset of the business class in the country. Right from the British days,our businessmen have believed in a marriage of convenience with the ruling class. People familiar with Indian History would know that the business class, though it always projected itself as a patriotic group, did not support Mahatma Gandhi in the freedom struggle throughout. When they realised that Gandhi was crossing the limits and their relations with the British Government might be severely damaged, these businessmen conveniently distanced themselves. At the same time, when their business interests were severely threatened, they came together and were quite vociferous in making various demands of the Government. The Bombay Plan is a good example.
Barring a few of our businessmen who have the courage and conviction to stand up to the politicians, most of the others are happy to allow the current state of affairs to continue. They are well aware that in an economy where the Government still plays such a central role, picking up fights with ministers, expecially the Finance Minister does not really make good business sense! The message of this blog is that let us not guage the quality of the budget from the reactions of our businessmen!
More about India's 2010 budget.
In the budget presented to the Parliament on Feb 26th, Mr Pranab Mukherjee projected revenues in the coming year from disinvestment of PSUs to be around Rs 40,000 crores and from auctioning of 3G licenses to be around Rs 35,000 crores. Together they add up to Rs 75,000 crores or about 1.1% of the GDP. These are very optimistic projections indeed and are based on a favourable economic and political climate, abundant risk taking by industrialists and strong foreign investment inflows.
It is quite possible that Mr Mukherjee's optimism is justified and may well turn out to be true. But the global economic recovery certainly looks fragile at the moment, expecially in view of the huge budget deficits in many developed countries and pressure to bring them under control quickly if not immediately. Look at what is happening in Europe. And it is quite evident that the global economy has still not returned to normal. India as we saw towards the end of 2008, is very much a part of the global economy. Under the circumstances, what is really inexplcable on the part of the Finance Minister is to give away about Rs 26,000 crores to the middle class by widening the income tax slabs. In my earlier blogs, I mentioned that salaried professionals like us have benefited from this move. But is it really good for the economy? Could Mr Mukherjee have not maintained the status quo if he was so serious about fiscal discipline?
Clearly Mr Mukherjee was more intent on playing to the galleries than on taking tough measures that would be good for the economy in the long term.
It is quite possible that Mr Mukherjee's optimism is justified and may well turn out to be true. But the global economic recovery certainly looks fragile at the moment, expecially in view of the huge budget deficits in many developed countries and pressure to bring them under control quickly if not immediately. Look at what is happening in Europe. And it is quite evident that the global economy has still not returned to normal. India as we saw towards the end of 2008, is very much a part of the global economy. Under the circumstances, what is really inexplcable on the part of the Finance Minister is to give away about Rs 26,000 crores to the middle class by widening the income tax slabs. In my earlier blogs, I mentioned that salaried professionals like us have benefited from this move. But is it really good for the economy? Could Mr Mukherjee have not maintained the status quo if he was so serious about fiscal discipline?
Clearly Mr Mukherjee was more intent on playing to the galleries than on taking tough measures that would be good for the economy in the long term.
Why India's budget is misleading
The key theme of this year's budget was supposed to be fiscal consolidation. We indians are good at making simple things complicated. So let us start by understanding the meaning of this term. The word fiscal consolidation is bombastic and misleading. A better and simpler term would be cutting the deficit.
Very broadly speaking, the deficit can be reduced in two ways: by cutting expenses and by increasing revenues. In general, a combination of the two approaches is needed to bring down the deficit. One approach alone may not be enough.
I was hoping that Mr Pranab Mukherjee would tell us how he was going to eliminate wasteful expenses incurred by the Government year after year. But it is quite obvious that he did not even make a semblance of an effort in this regard.
Instead, Mr Mukherjee chose the easy way out. He tried to increase the excise duty and brought more services under the tax net. At least, if he had remained focused on additional tax revenue mobilisation, we could have given him the benefit of doubt. Instead, he has actually reduced income tax for many people by widening the slabs. This is a gesture which benefits the richer members of the middle class ( including people like me) but is of questionable merit as far as the economy is concerned.
Mr Mukherjee has also further complicated things by announcing more tax exemptions. This is something clearly unwarranted when the Government has already committed itself in public to a new and completely overhauled direct tax code in about a year's time.
Last but not the least, the finance minister has made convenient assumptions that he will be able to raise plenty of non tax revenue through public sector disinvestment and auctioning 3G telecom licenses. Imagine a CEO of a loss making company at the Annual General meeting announcing to the assembled shareholders nothing whatsoever about how he will cut overheads and improve efficiencies. Only that he will cut losses next year by selling off the company's real estate/office space. What kind of reaction can he expect from the shareholders? It would be very surprising indeed if paper rockets were not thrown at him.
The puzzling point is that the stock markets have reacted favourably to the budget. And market reactions are often correct. There is only one explanation for this phenomenon. Those segments of the society who are active stock market investors seem to have benefited handsomely through the widening of the income tax slabs. An equally probable reason is that the stock markets had such low expectations from Mukherjee that they were relieved when they saw the budget proposals.
Watch out for more in my forthcoming posts.
Very broadly speaking, the deficit can be reduced in two ways: by cutting expenses and by increasing revenues. In general, a combination of the two approaches is needed to bring down the deficit. One approach alone may not be enough.
I was hoping that Mr Pranab Mukherjee would tell us how he was going to eliminate wasteful expenses incurred by the Government year after year. But it is quite obvious that he did not even make a semblance of an effort in this regard.
Instead, Mr Mukherjee chose the easy way out. He tried to increase the excise duty and brought more services under the tax net. At least, if he had remained focused on additional tax revenue mobilisation, we could have given him the benefit of doubt. Instead, he has actually reduced income tax for many people by widening the slabs. This is a gesture which benefits the richer members of the middle class ( including people like me) but is of questionable merit as far as the economy is concerned.
Mr Mukherjee has also further complicated things by announcing more tax exemptions. This is something clearly unwarranted when the Government has already committed itself in public to a new and completely overhauled direct tax code in about a year's time.
Last but not the least, the finance minister has made convenient assumptions that he will be able to raise plenty of non tax revenue through public sector disinvestment and auctioning 3G telecom licenses. Imagine a CEO of a loss making company at the Annual General meeting announcing to the assembled shareholders nothing whatsoever about how he will cut overheads and improve efficiencies. Only that he will cut losses next year by selling off the company's real estate/office space. What kind of reaction can he expect from the shareholders? It would be very surprising indeed if paper rockets were not thrown at him.
The puzzling point is that the stock markets have reacted favourably to the budget. And market reactions are often correct. There is only one explanation for this phenomenon. Those segments of the society who are active stock market investors seem to have benefited handsomely through the widening of the income tax slabs. An equally probable reason is that the stock markets had such low expectations from Mukherjee that they were relieved when they saw the budget proposals.
Watch out for more in my forthcoming posts.
Saturday, February 27, 2010
A quick glance at India's 2010 budget
With a few lollipops here and there and some clever jugglery of numbers, our finance minister seems to have made a favourable impression on the media and the general public. True I myself have benefited from the budget through the rise in the peak income tax slab. But if fiscal prudence was the theme of the budget, Mr Mukherjee should not have cut income tax. He should have raised it. And if tax rationalisation was what he was trying to achieve, he should have removed, not added exemptions. He should also have shown more commitment to the GST( Goods and Services Tax) framework.
Mr Mukherjee has tried to paint a rosy fiscal picture by making some unrealistic and convenient assumptions such as heavy inflows due to disinvestment of PSUs and also cellphone license revenues. But if the opposition politicians could make such a hue and cry in Parliament about a small hike in the price of petrol/diesel, will the Congress Party really have the stomach to push through PSU divestment? And will license revenues be all that much as projected?
Watch out for more in my blogs starting from tomorrow.
Mr Mukherjee has tried to paint a rosy fiscal picture by making some unrealistic and convenient assumptions such as heavy inflows due to disinvestment of PSUs and also cellphone license revenues. But if the opposition politicians could make such a hue and cry in Parliament about a small hike in the price of petrol/diesel, will the Congress Party really have the stomach to push through PSU divestment? And will license revenues be all that much as projected?
Watch out for more in my blogs starting from tomorrow.
Subscribe to:
Posts (Atom)
