It has been clear for some time that the economy was sinking. The front page of The Telegraph carried colourful graphs on June 27 last year showing what was happening. Its conclusion was that “The root cause of the general slowdown was a serious industrial recession”. It attributed the slump to a collapse of industrial investment: capital goods led the decline. The cause was initially financial: investment fell because of cost inflation, which led to a fall in the growth of revenue and profits. Costs went up partly because of a rise in costs of imports: depreciation of the rupee and a rise in oil prices were the main contributors. They also rose because of agricultural inflation: the government pushed up agricultural prices.
That is as far as the story could be traced then. It is carried forward in the Economic Survey that the finance minister tabled in Parliament yesterday. It expects growth in gross domestic product at factor cost, which was 9.3 per cent two years ago, to fall to 5 per cent in 2012-13 (which will end in March). More important, it expected growth in GDP at market prices to fall from 10.5 to 3.3 per cent. The difference between factor cost and market prices is taxes on goods and services. What it was saying was that as the economy slumped, the share of taxes in the prices of goods and services had gone up; if one only looked at what the producers received and not at what people paid, the growth had fallen to a third of what it was two years ago.
It also confirmed our guess about what was behind the meltdown. It showed that manufacturing growth had fallen from 9.1 per cent in the second quarter of 2010 to -0.3, .02 and 0.8 per cent in the first three quarters of 2012. It expected growth of fixed investment to fall from 14 per cent in 2010-11 to 2.5 per cent this financial year; there would be a less severe fall in private consumption growth, from 8.6 to 4.5 per cent. Incidentally, one component of the slowdown is in people’s purchases of gold and jewellery, which get the Reserve Bank of India hot under the collar. Two years ago, they rose 32.4 per cent year-on-year; this year they are expected to fall 18 per cent. The Economic Survey contested the RBI’s paranoia about gold, and showed that gold purchases were people’s hedge against inflation.
In brief, the economy is in free fall; that is the reality the finance minister had to face in his budget. Conventional wisdom says that in times of recession the government must increase deficit spending — tax less or increase expenditure. The Congress government does so all the time; it has run a fiscal deficit of 5-6 per cent of GDP since 2008-09. But instead of raising it, the finance minister proposes to bring it down to 4.8 per cent next year. He is not living up to his reputation as a deficit addict. Why?
The answer lies in the balance of payments. India runs chronic payments deficits. The current level is $70-80 billion a year. That is fine as long as foreigners are investing in India. But the finance minister can no longer bank on it. The economic environment in industrial countries, whence most of the investment funds come, is fragile; and the downturn in Indian economy makes it less attractive to foreign investors. The RBI has tried to redress the balance of payments by devaluing the rupee, but it has not led to a noticeable improvement. So the only way to improve the balance of payments was by disinflation; that is why the finance minister has been so moderate in deficit finance.
That was at the expense of his normal style. He, like his predecessor, has hitherto been a classic Congress finance minister: they have used government expenditure to benefit the poor. Every budget saw massive increases in expenditure on flagship programmes like subsidized food and public works. This time, however, he resisted the temptation. The existing schemes will devour larger sums. But he has been extremely stingy on plan expenditure, which will rise by only 6 per cent in the coming year. The normal rise would be at least at the rate of nominal income — roughly 15 per cent.
But the economy is suffering from a downturn; if he cannot stimulate it with deficit spending, how can he revive it? There he has directly addressed the slump in the capital goods industry. He increased the deduction of investment expenditure from profits to 150 per cent and extended it to some more industries. He could have done more. It is a sad fact that P. Chidambaram is intelligent and addicted to complicated provisions. This and many other proposals of his could have been simpler, and simplicity would have added to their effectiveness.
The biggest surprise in Chidambaram’s budget has been the largely missing populism. He is a loyal member of the Congress, which drowns in tears for the common man. The political compulsions are understandable. This is its way of confronting the communalism of the Bharatiya Janata Party and the progressivism of Left parties. But the results are dire; nine years of Congress rule have seen the budget getting utterly cluttered with dozens of populist schemes for people young and old, male and female, rural and urban; people are cut up into interest groups, and each is rewarded with schemes named after members of the Nehru family. Chidambaram did not eschew this approach entirely; he had to come out with a proposal of a women-only bank. He did not disclose whether he would be inaugurating it, what he would wear on the occasion, whether men would be allowed to enter the bank, and up to what age boys would be allowed to accompany their mothers into the bank. These details will no doubt be given in the piles of rules the finance ministry issues some months after the budget.
Just why Chidambaram forgot his vote-buying mission is a mystery. It may be due to confidence. The Opposition parties are in disarray; it seems unlikely that they will be able to mount a serious challenge in the general election next year. There will, of course, be opportunistic coalitions; but the Congress is no less adept at them than its competitors. Alternatively, votes are important, but something else became more urgent this time. The economy is in poor shape; worse, it is subject to great risk, especially from outside. Chidambaram had to shore up the balance of payments. One of the external risks arises from the foreign capital that has flowed in in recent years. If foreigners started taking it out of India, the balance of payments would be in deep trouble. A responsible finance minister had to ward off the possibility, especially if he expected his party to return to power next year. That he takes the rest of the world seriously is suggested by his recent travels; he has shown the same concern in this budget. Both the external orientation and the long view are welcome; for once, the finance minister has done the right thing.