Where’s the vision?
Pranab Mukherjee’s budgets never had a major impact on growth, and were never visionary, bold or presaging new policy directions. With little resistance to the proposals in this budget, will the economy improve in this financial year? My argument is that 2012-13 will be a dismal year for the economy in almost all sectors. Inflation, volatile rupee value and see-sawing share prices will last the year and 7 to 9 per cent growth will not happen.
Growth with moderate inflation was the objective. Growth has been stunted by declining private (and even public) investment and high interest rates. Private investment in infrastructure gets a boost from the budget and should stimulate the economy. Tax-free bonds, external commercial borrowing, private-public partnerships and massive public expenditures will stimulate infrastructure growth. The expanded definition of viability gap funding to include irrigation, and so on, will, however, take long to fructify till all the details are worked out. Infrastructure investment is the one important stimulus to growth in this budget.
The increases in excise duties and service taxes will make consumption goods (both fast-moving and durable consumer goods) more expensive and depress demand for them. We may, therefore, not see consumption-driven investment and growth as we did in UPA I. Foreign direct investment has no positive signals in the budget except for consideration of FDI in the aviation sector. A strong negative signal was the introduction of retrospective taxation on foreign purchases of Indian assets since 1962.
The finance minister has since clarified that this does not imply reopening old tax cases. (Then why was this clause introduced?) It is a negative signal to foreign investors about stability in the taxation regime. The review petition against the Supreme Court’s favourable judgement in the Vodafone case shows that the government is determined to tax proportionate capital gains on Indian assets when they are part of an overseas share purchase. This budget will not stimulate private domestic or foreign investment.
However, foreign institutional investment (including those made by non-resident Indians) will remain volatile and buoyant. To prevent investors who have name-plate addresses in countries like Mauritius, with whom we have tax exemption agreements, from using that route to avoid Indian taxes, there will now be insistence on the investors having operations in the remitting country. This might reduce use of the ‘Mauritius route’ by foreign investments and consequent volatile fund inflows. However, participatory notes enabling anonymous investments from overseas will continue. The considerable interest advantage announced by the Reserve Bank of India earlier, to NRIs on repatriable bank deposits, will bring a flood of NRI deposits. There is no disincentive in the budget to root such foreign fund inflows into the country for at least one year through a special tax. Volatile inflows will, therefore, continue. They will help meet the deficit in the balance of payments on current account and continue the volatility in share prices and the external value of the rupee because of opportunistic inflows and outflows of foreign funds. This, in turn, will make it difficult for exporters to pursue a consistent export strategy.
Two years of inflation, especially of food products, were mainly a result of supply constraints and massive government deficits. The attempt by the RBI to control inflation by raising interest rates did not help. There was little effort to reduce government expenditures or stimulate food production. In this budget, there is a commitment to restrain subsidies to 2 per cent of the gross domestic product. Since food subsidies are not to be restricted and are planned to increase, reductions must be expected in subsidies on petroleum and oil products and on fertilizers.
Among these, the largest increase will have to be on diesel prices. Since this will have a ripple effect on all prices, we can expect political opposition (led by Mamata Banerjee) to this measure. If diesel prices do not rise substantially and subsidies are not capped at 2 per cent, the deficit will have further inflationary impact. If it is capped, and diesel and other prices rise sufficiently, they, along with the budgeted excise duty and service tax, will see a significant rise in price levels this summer. Whether prices can be contained will depend on international oil prices, the monsoon and the state of food production. The budget does little to raise agricultural productivity. It is inevitable that inflation will remain a major threat to the economy in the coming year.
Inflationary pressures will be strengthened by the lack of perceptible effort to make government expenditures more efficient and less wasteful. Large-scale thefts of government funds allocated for social programmes should have been contained. While the proposed direct cash transfers to bank accounts will help, there are many beneficiaries without bank accounts. Identifying beneficiaries will remain a problem since the unique identification number is yet to cover over half the population and its use has not commenced.
Going by the RBI’s past actions, it is unlikely to reduce interest rates over the year to levels that might attract private corporate investors and consumers. If it does reduce interest, the reduction will be modest and not stimulate growth. Continuing high interest rates will depress demand for housing, cars, refrigerators and other high-expenditure items that require borrowed funds. Demand will also be retarded because of higher prices of products due to the additional indirect taxes and higher cost of imported components because of the declining value of the rupee. New incentives for savings (tax-free bonds, tax incentive on share purchases up to Rs 50,000), will also weaken consumption expenditures. It looks as if stagnation in industrial production (except where infrastructure related) as in 2011, will continue.
The budget could have been a stimulant to growth if it had reformed policies on agriculture. These should have related to investment in small irrigation projects, monitoring ground-water usage, massive programme for constructing storage, independent regulation of water usage and pricing, removing the bureaucracy in agricultural marketing, rationalizing the price policies (procurement, minimum support price, and so on) to improve incentives to farmers, and a crash programme to reach productivity enhancing scientific methods to farmers. However, as in past years, agriculture receives cursory but verbose attention. Its growth will remain a “gamble on the rains”.
Admittedly, the budget is no longer a policy document as it was till the early 1990s. However, this budget does not even make much effort to introduce policy reforms in areas that are within the purview of the finance ministry. The ongoing squabble with the state governments on sharing of lost revenues when central sales tax is abolished has held up the introduction of a major policy reform, the goods and services tax. The direct tax code is held up for no known reason. Seizing black money and expropriating it for national use is yet to be initiated. Money laundering has been encouraged by government policy on foreign institutional investment.
This year’s budget is not going to stimulate growth. It will keep India on edge through the year on expectations of high inflation. This will hurt investment, consumption and growth. Industrial production will be stagnant except for sectors connected to infrastructure. Agricultural production will remain a gamble. Exports will meet depressed overseas markets while import costs will keep rising with rising oil prices. The rupee exchange value will fluctuate considerably, on a downward trajectory, and adversely affect corporate results. The stock markets will fluctuate wildly.
The crooks and thieves who divert government funds or evade taxes for their personal use will thrive as before. We will become a more indebted nation, especially to foreigners. This is a do- little budget that will lead to a poorer economy in 2012-13.