By Jahangir Aziz, Chief Asia Economist, JP Morgan Chase It was supposed to have been a nonevent. For the most part yesterday’s interim budget did not even pretend to be otherwise except for a few surprise cuts in excise duties and some other small relief. For an election year budget this was admirable restraint. Constitutionally this vote-on-account budget could not propose any legislative changes thereby ruling out major direct tax cuts but despite this constraint the scope for much larger pre-electoral largesse was substantial. The government wisely chose not to do so.
Instead, it continued the fiscal consolidation process initiated by the current Finance Minister in September 2012 and delivered for the second year in a row a fiscal outturn better than budgeted. The means by which this was achieved inst the first best option. One would have much preferred stronger tax collection, higher disinvestment, and cutbacks in subsidies as the major contributors to the consolidation than squeezing out capital spending, postponing subsidy payments, and extracting higher dividends from PSUs.
But the first best is like motherhood and apple pie. What is often lost in discussions of the budget and in our collective lament over the lack of reforms to take back growth to the golden days of 2003-08 is the circumstances under which the consolidation was achieved. Remember September 2012? Growth had just fallen to sub-5%–only the second time since 2005; the current account deficit was threatening to run away; the rupee was falling like stone, the previous two months had seen an unprecedented outflow of foreign capital, inflation was running in double digits; most analysts were looking at 6% of GDP of fiscal deficit; and India’s credit rating was on the brink of been downgraded to junk status.
It was under these trying conditions that the current economic management team began the consolidation process. Stabilizing the economy and surviving the downgrade threat over next few quarters was far more urgent than worrying about medium-term growth. In the quarters that followed, emerging market assets worldwide were battered as global funding costs rose on the threat of QE tapering and India was in the direct firing line and once again preserving stability became more important than worrying about growth. This is not to let the government off the hook for the dysfunctional policymaking-not just in the slow approval of investment projects but also in running an excessively loose fiscal and monetary policies-in the previous three years that severely damaged corporate India’s confidence. Despite the global slowdown and the rise in funding costs, the damaged domestic investor confidence played a significant role in India’s growth woes.
But what should be recognized are the circumstances under which the consolidation was undertaken. In the last two years India cut the fiscal deficit by 1% of GDP to average 4.7% of GDP when growth averaged below 5%–the lowest in two decades-and disinvestment proceeds recorded less than 0.5% of GDP. Just two years back in 2010-11, when GDP growth hit 9.3% and the government received nearly 2% of GDP in disinvestment and spectrum sales, the fiscal outturn was 4.7% of GDP- the same as in the last two years! Not many were complaining of the government’s fiscal stance back then. Next consider the state of reforms. Of course reforms should have done the heavy lifting rather than leave all the burden of adjustment to fiscal and monetary policies. That did not happen. . But ponder this for a moment: in the last two years every entitlement bill tabled by the government whether the food security bill or the land acquisition bill (and yes I am including it in this category) was embraced by the opposition and almost every market reform bill was either resisted and rejected! So much for reforms.
This brings me to the real event in this interim budget. It was the government’s next year’s deficit target of 4.1% of GDP. Even under normal circumstances a 0.5% of GDP of fiscal consolidation is tough, but when growth is floundering at sub-5%, capital markets weakened by a global sell-off in EM assets, and election uncertainty looming in the first quarter of the year, achieving a 19% higher tax revenue and more than double in disinvestment sales as assumed in the budget is doubly difficult. But the current economic management team did just that in the last two years. So for the next government to start its term by backing off from this challenge isn’t going to be easy. And the rating agencies will be watching very closely.