The first Budget of the new UPA government was presented on July 6.
The buildup to the Budget included a sharp move in stock markets after the alliance's strong majority in the general elections. The move was fuelled by expectations from the UPA of sweeping reforms and deregulation. The Economic Survey released earlier added fuel to this fire of irrational expectations. Closer to Budget Day, the expectations marginally toned down. Nevertheless, on B-Day, the markets tanked by 870 points, around 6%, the largest fall in the history of Indian stock markets on Budget Day. Here, the first lesson is that Budget expectations could have been managed through the use of a more efficient communication policy.
Without going in the intricacies of the Budget, I would like to highlight the finance minister's first few statements, on the fact that the Budget is not the only event where policies can be framed, nor is it a magic wand to trigger off instant results. Reforms are a long-term process.
Maybe investors in India have gotten used to a 20/20 cricket match when they should be looking to win the Test matchseries, and hence the knee-jerk reaction on July 6.
This brings up another issue -- should the Budget be presented at 5 pm like in the earlier days, with no special Budget session, so that investors get a chance to react to it after due analysis?
Though the so-called "road map of deregulation, fiscal consolidation, and reforms" was missing in the Budget document -- which was the major source of disappointment for the markets -- there were many aspects which could benefit the country in the long run. Also, there was nothing in the Budget to lower the earnings expectations of corporates, except for companies which pay MAT, which was raised by 5%.
The focus of the Budget remained on bringing economic growth (9%) back on track by stimulating rural demand, creating jobs and boosting consumption by lowering direct taxes, which would leave more money in the hands of consumers.
Social and infrastructure sectors remained the focal points of the Budget. And note that excise benefits given earlier in the year as a part of the stimulus were not rolled back.
Another much-debated aspect of this Budget and the reason for the steep fall in markets was the ballooning central fiscal deficit which, now estimated at 6.8% of GDP, may be much higher if we add the state deficits and the off-balance sheet liabilities and be in the range of 11-12% of GDP.
differ on this debate over the fiscal deficit. Let us understand that in the last 18 months, the world has gone through the worst financial crisis since the Great Depression, and that India is not insulated from its effects.
Globally, governments and central banks are working overtime to enact stimulus and policies to bring growth on track. Fiscal stimuli and lowering of policy interest rates has been an integral part of their moves.
What the FM is doing, is adopting an "anti-cyclical fiscal policy" (raising public spending in economic downturns and vice versa), which every authority in the world is doing now, and rightly so.
Many of the countries have increased their deficits closer to double digits in their bid to stimulate demand by increasing spending. In fact, India should also move to a cyclically-adjusted fiscal deficit target, where the deficit targets move according to the prevailing economic cycle.
If growth has to be a priority, the temporary higher deficit is bearable and the ensuing growth will help the government to scale back expenditure and the deficits in coming years. But yes, sustained higher deficits -- if there is no revenue growth -- do create problems such as choking up growth, crowding out private investments and taking interest rates higher, which governments have to be wary of.
But an astute monetary policy and RBI's support to the government borrowing programme can counterbalance some of these ill-effects.
What is more important and relevant is that the deficits should not rise due to non-productive expenditure, viz, expenditure which cannot buoy growth in future. In the Budget, the significant rise in the allocations to infrastructure (up to 9% of GDP) and to the rural sector is an example of productive expenditure. And fiscal stimulus works through the real economy much faster than other policy tools like interest rate cuts.
Here, I wish to bring forward the economic theory of "Ricardian Neutrality", which goes: During periods of higher fiscal deficits, private economic agents (individuals, households, firms, etc) expect that there will be a rise in the future tax burden (to reduce deficits).
They accordingly save more of their current income to later offset the fall in the future income, which cancels out the negative effects of fiscal deficits on demand. For instance, the savings ratio in the US is at a 15-year-high now, when its deficit is rising.
If the global rating agencies move to downgrade India's rating based on a standalone factor of higher fiscal deficits, the rating of many other countries would have to follow suit.
The current situation does demand priority to growth over the risk of a downgrade. Among the factors taken into account by rating agencies are:
The country's openness to trade and capital flows and experience in adapting to associated fluctuations
The country's stable political system with strong, long-established institutions, its ability to respond to changing economic and financial circumstances, and its transparency in policymaking
India has achieved some of these, such as a stable political system with strong, long-established institutions and its ability to respond to changing economic and financial circumstances.
Conclusion
The Budget is not the end of the world, since it's only a projected statement of accounts of the government. It need not always be a long-term policy statement. Temporary higher fiscal deficits are not always bad in the short run, though if sustained, they can prove disastrous.
Reforms, divestments, fiscal consolidation and deregulation can follow and need not wait for Budget Day. India will continue to grow at 6-7% for the next few decades and hopefully, the FMs gamble of growth will work over the next few years.
There is nothing in this Budget to revise the corporate earnings growth lower. So why then did the stock market fall by 6%? Ask the short-term leveraged FIIs. Stay invested in Indian stocks and the magic will work in the long run.
The author is a qualified chartered accountant and an independent
financial expert.
