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.
Sunday, February 28, 2010
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.
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