Indian Economy growth rate has decelerated to 5 per cent, the lowest in the decade.
The retail consumer prices have risen by more than 10 per cent. When economy stagnates prices should have fallen. Here we have a classic case of stagflation.
This situation makes it terribly difficult for the Finance Minister to manoeuvre: to keep the inflation in check he has to curtail government expenditure; to stimulate the economy he has to increase the expenditure. What is Chidambaram going to do?
The current account deficit is at its historic high, 5.4 percent of GDP. Reserve Bank considers 2.5 as the prudent norm. In the short run there is no solution other than to ensure net foreign investment inflow equivalent to the external gap. But there is nothing more abhorring to finance capital than high fiscal deficit. It is the mother of all financial troubles. The finance capital has successfully imposed austerity in the deviant European countries. They expect India also to follow the same route. The rating agencies are demanding an reduction in the fiscal deficit to minimum 4.8 per cent from the expected 5.3 per cent for 2012-13. But the Indian electorate demand ameliorative measures for the miseries.
To whom is Chidambaram going to lend his ear?
It is elementary macro economics that current account deficit is equivalent to the difference between domestic saving and investment. The deceleration in investment has been as important a factor as depressed consumer demand for the present economic downturn. The animal spirits of the investors have taken a beating.
The CII’s survey has shown that majority of investors do not foresee any major improvement either global or domestic in the investment climate in the immediate future. This atmosphere has to be changed and investment buoyed up. But will it not lead to widening of the current account deficit and increase the risk of a foreign exchange crisis and run on the rupee?
What will Chidambaram choose between domestic growth and external stability? The Finance Minister is in an unenviable situation - between the devil and the deep sea as they say. My expectations regarding the response of the Finance Minister in his budget tomorrow are the following:
One, the fiscal deficit will be reduced to 4.8 per cent. His focus will be on the expenditure side rather than the revenue side. Though there are talks about super rich tax, dividend tax and so on, they can be only tokenism, lest the Finance Minister offend the investors. But for certain tinkering with income tax and possible sops to investors in SEZs, there will not be many concessions. It may be remembered that the direct tax concessions of the UPA period total over Rs 5 lakh crore. Be sure that there will be no roll back.
Two, Food Security Program with an additional expenditure of rupees 50 to 60 thousand crores will be budgeted. This is the concession that the Finance Minister is going to make to the forthcoming election. Other sops such as expansion of direct cash transfer will not involve any additional expenditure. How will he reconcile the food security expenditure with the goal of reduction in fiscal deficit? The only choice for him is drastically squeeze the expenditure on other items. Stage has been set for reduction in subsidies for petroleum products through de-control and fertilizer etc through direct transfer system. The overall expenditure will be more or less pegged at the same level as at the budget estimate of 2012-13. In real terms there will be reduction in overall expenditure.
Three, there will be additional incentives for exports, may be an additional tax on import of gold. But there is little chance that there would be any significant reduction in external current account deficit. Though fears of yet another collapse in the West have receded, the growth scenario is not very encouraging. The global growth may increase from less than 3 per cent to 3.5 per cent. It may be remembered there was absolute reduction in exports from India despite near 20 per cent depreciation of Indian Rupee in 2012-13. We cannot expect any dramatic upturn in exports. On the other hand, it may be noted that despite the stagnation, the imports continued to increase or its reduction was so marginal that the current account deficit widened. In this situation the Finance Minister will have to put up a brave face, announce additional incentives for exports and hope for the best.
Four, the domestic investment decline has been accompanied by an even more drastic decline in domestic saving. The domestic savings have shrunk from 36.8 per cent in 2007-08 to 30.8 per cent in 2011-12. There has been reduction in house hold savings. People seem to prefer to save in gold rather than in financial instruments. These trends have to be reversed. There have been suggestions for concessions to interest income, reduction in the lock in period for bank deposits eligible for tax rebate, broadening Rajeev Gandhi Equity Savings Scheme etc. Some of them will necessarily have to be taken up.
Five, having burnt the other bridges, only solution for the finance minister to kickstart the economy is to arouse the animal spirits of the investors. Getting more and more embroiled in one scam after another, the strategy of encouraging primitive accumulation by permitting the plunder of common natural resources cannot be pursued as enthusiastically in the past. Be sure, more public sector will be put up for fire sale. The budget platform will be used to proclaim to the investors, both domestic and foreign, that India will pursue the liberalisation policies resolutely. The ascension of Chidambaram to the chair of Finance Minister has been accompanied by a sleuth of structural reforms in financial and retail sectors. The budget will give strong message that despite the elections the unpalatable reforms will continue. Land Acquisition Bill, Mines and Minerals Bill, Pension Bill, Goods and Service Tax and Direct Tax Code are pending. A time bound road map for their implementation can be expected. Chidambaram is laying most of his budget eggs to hatch in the expected confidence that the budget would arouse in the investors particularly the foreign ones. This is not a good election strategy. But he is riding the tiger and has little choice. Compare the predictions of his forth coming budget with the dream budget of the past and we will understand why this situation is largely his own making.
(The author is former Finance Minister, Kerala, and a former professor at Centre for Development Studies, Thiruvananthapuram)