Indian Budget 2013 – fix between economics and politics

By Barun Mitra

With just over a year before the next general election, the government has presented a budget, where it seeks to balance its political needs with economic promises. Either the economy will perform as promised, and the voters may reward the government at the poll, or the political promises will flounder on an economy that fails to perform, and the voters may hold the government accountable at the election.

India’s finance minister P. Chidambaram presented the budget for the national government on February 28, 2013. This will be the last budget, in the five year term of the government, before the national general election scheduled around April 2014. Therefore, the political impact of the budget will be as significant, as the economic projections will be debated.

The budget this year perhaps best illustrates the divide between the perspectives of economists and politicians. And the challenge which any finance minister faces as he tries to balance the conflicting demands of these two elements. One set of economists wants fiscal prudence, while another wants the government to stimulate the economy with greater investment and expenditure. One set of politicians are concerned about political fallout of persistently high inflation and rising prices of daily necessities. Another set of politicians wants the government to allocate liberally to social and welfare schemes and protect the poor, in economically difficult times. Ideological differences are to be expected, but what is really interesting this time is that even economists, who otherwise appreciate the reformist inclination of Mr. Chidambaram, are split in their assessment of his budget.

Economic challenges

Indian economy faces perhaps the most severe challenge since 1991. The growth rate has slipped to around 5%, reflecting the classic double dip, since 2007. The inflation rate has hovered at around 9% over the past 2 years, highest among the emerging economies. The fiscal deficit had threatened to touch 6% of GDP, and the current account deficit has crossed 5% of GDP, putting huge pressure on the exchange rate.

In such a context, this budget seems to be a holding operation, and gives contradictory signals. The budget proposes to reduce the total subsidy bill by about 11% from the over USD 300 billion at present. Smaller than expected allocation on food security at Rs 10,000 crore (USD 20 billion) and food subsidy at Rs 80,000 crore (USD 160 billion), have been proposed. But last year, the actual subsidy bill was 38% higher than what was projected in the budget in 2012.

The ideological signal from the government was clear, and this time it came with an international justification. The additional tax on super-rich, individuals earning above Rs 1 crore (USD 200,000), will affect about 42,800 people. Domestic companies earning above Rs 10 crore (USD 2 million), will also face an additional tax burden. Taxes have been increased on “luxury goods” including mobile phones and SUVs. The government also made its intention to aggressively target those attempting to avoid or evade taxes. The economic impact may not be significant, but clearly the government expects some political dividend from the anti-rich strategy.

With an enormously complex tax code, and consequent opacity in tax administration, an aggressive approach to tax compliance would only lead to litigation, corruption, and capital flight. According to one estimate, tax evasion and avoidance could amount to well over USD 300 billion annually. In addition, about USD 50 billion worth of taxes are being legally disputed. The government is harnessing information technology to mine information about personal income and expenditure, and have sent tax notices to 35,000 people.

While a lot has been said about the need for tax reforms, actual progress has been very slow. Another factor a critical one at that, why many people may not feel motivated to pay their full taxes is because they doubt the credibility of the government and efficacy of expenditure. Credibility contributes to trust between citizen and the government.

Likewise, another such symbolic gesture is a new bank by and for women. With majority of Indians still without a bank account, there is little reason to believe that a women’s bank will perform any better. Particularly when women’s participation in the workforce has been stagnant at a very low 12% (urban), and about 20% (rural).

Those who believed that the finance minister would be able to give a fresh impetus to the economy and growth, by giving another stimulus to the economy, particularly in the form of infrastructure expenditure and sops to industry, apparently fail to realise that  such stimulus would further contribute to the inflation (leading to higher interest rate) which will prove to be too costly politically, in an election year.

Those who believed in an election year, the minister may announce a slew of welfare schemes also failed to see that such an approach would worsen the fiscal deficit, squeeze growth further, and fuel inflation. This too would be politically suicidal.

So to an extent, the budget has attempted to give the impression of being economically realistic, and politically restrained. Facing a possible downgrade to junk, by international rating agencies, which would led to flight of capital leading to devaluation of rupee, and sky rocketing inflation, the budget has lowered the prospect of any immediate downgrade.

On the other hand, the economic realism may not materialise as much as the year goes by, because the political pressure to loosen the purse strings in an election year will be that much higher. And without the policy changes (on a range of issues, like land acquisition, insurance, and clarity on retrospective law), and administrative and regulatory changes (environmental clearances, discretionary interpretation of tax laws), the impediment to investment and growth may not materialise. Without the nominal growth of 13% (growth projected between 6.1 and 6.7% in real terms), the highly optimistic projection of 19% nominal increase in revenue may not happen either.

The government has proposed to raise Rs 55,000 crore (USD 11 billion) in the financial year 2013-14, from the sale of public sector companies. This is more than double of the Rs 24,000 crore (USD 4.8 billion) that is expected in the current financial year. The government has identified a number of public sector companies whose shares it hopes to divest. But it is an open question whether the political environment and market conditions would permit such a sale. Secondly, sale of such capital assets should ideally go to reduce the national debt, instead, the government typically looks at such proceeds as revenue to meet current expenditure. It is like sale of family silver to fund current consumption, instead of investing for future.

If any of these assumptions fail to materiaise over the next 6 months, then by the time the general election takes place (scheduled in the early summer of 2014), the fiscal deficit will again spiral out of control, and inflation may rise just as the election campaign gathers steam.

The finance minister acknowledges that without economic growth the social goals and developmental targets cannot be met, and says improving growth is the first priority of the government. If everything goes as being projected in the budget, and with a bit of luck, Chidambaram believes the growth could be back to over 6% by the end of the year. However, a year ago, his predecessor had projected a 7.5% growth. The growth rate had plummeted to 4.6% in the period October – December 2012. At the end of the current financial year, in March 2013, the annual growth rate is expected to average only around 5%.

But there are many who are skeptical about the key numbers in budget – increase in growth rate from 5% to well over 6%, decline in fiscal deficit from 5.2% to 4.8% of GDP, increase in spending by 17%, and increase in revenue by 19%.

This budget perhaps best illustrates the divide between the perspective of economists and politicians. And the challenge which any finance minister faces as he tries to balance the two. In this budget economic realities have subdued the political instincts to some extent. If the budget projections on fiscal restraint and economic growth are realised, then inflation may be reined in, and new economic opportunities may emerge. If this happens, it would surely improve the political prospect for the governing alliance in the forthcoming national election, and perhaps establish a new economic paradigm for the political leaders to follow.

The author is the Director of The Liberty Institute, an independent think-tank.