The Big Picture

Pranab Deserves a 9 On 10
T T RAM MOHAN The Economic Times (03-03-2011)
Fiscal consolidation is undoubtedly the big story in Budget 2011. The consolidation underway in India is remarkable in itself; it looks even more remarkable when compared with what is happening elsewhere in the world. The accompanying table shows the IMFs debt-to-GDP projections for 2014 for various countries and country groups. It shows India as having a debt-to-GDP ratio of 76.8% in 2014. The Economic Survey expects the ratio for the Centre and the states together to be 65% in 2014-15, way below the IMF estimate. It is also below the Thirteenth Finance Commissions (TFC) target of 68%. The Budgets projections for the Centres own debt-to-GDP ratio take ones breath away. The medium-term fiscal policy statement, presented along with the Budget, shows a debt-toGDP ratio of 41.5% for the Centre in 2014-15 compared to the TFCs target of 47.5%. The ratio for 2010-11 itself is below the TFCs target for 2014 -15! Whether the fiscal deficit of 4.6% estimated for 2011-12 is realistic or not is, thus, inconsequential. The fiscal deficit target is only a means to the end, which is the debtto-GDP ratio. Few could have bargained for the kind of fiscal consolidation we are seeing. That is because few had expected the economic rebound to be as strong as it has turned out to be. During the subprime crisis, when Indias economic growth dropped to 6.8% in 2007 -08, many rushed to the conclusion that the 9% growth seen in the previous years was entirely an outcome of the global boom. Since the global bubble had been pricked, India would have to settle for a lower growth trajectory than the one in the India Shining years. This conclusion is now being proved wrong. Indias economic growth is far less dependent on exports than that of other emerging markets. Moreover, as the Economic Survey points out, growing trade links with emerging markets make up, to some extent, for loss of exports in the advanced economies. The slowdown in 2007-08 was not because of Indias links with the global economy through trade, it was on account of our links with global finance. There was a temporary withdrawal of finance from emerging markets following the crisis. Global flows resumed thereafter, enabling India and other emerging markets to recover quickly. We are out of sync with the advanced economies in respect of fiscal consolidation because we are also out of sync in respect of growth. The resumption of rapid growth renders consolidation easier. On top of it, tax revenues have been boosted this year by inflation. Many commentators are sceptical about the fiscal deficit target for 2011-12. They believe expenditure has been understated, including expenditure on subsidies. But, in all probability, so have tax revenues. The Budget projects nominal growth of 14%, comprising real growth of 9% and inflation of 5%. The inflation rate is likely to be closer to 7%, which would yield nominal growth of 16%. Even if the expenditure estimates go awry, the finance minister will be sitting pretty. The medium-term prospects for revenues are also promising. Apart from strong growth, we have the Direct Taxes Code kicking in from 2011-12. The goods and services tax should,

hopefully, soon follow. Both will be revenue-enhancing. The Economic Survey believes that the medium-term inflation rate will be closer to 5% in the coming decade, which also augurs well for revenues. The Centres tax-GDP ratio for 2010-11, estimated at 10%, is still below the peak of 11.9% reached in 2007-08, which points to untapped potential for revenues. It is hard to see where fiscal consolidation can go wrong. The fly in the ointment is the persistence of a high rate of inflation. The Economic Survey argues persuasively that we may have to settle for a higher inflation rate than assumed in the past. First, financial inclusion, by bringing savings held as cash into the financial system, enlarges the pool of money supply. Secondly, as per-capita incomes rise with growth, prices of non-traded goods and unskilled labour tend to catch up with those in industrialised countries. Both factors are inflationary. The best the finance minister can do in such a situation is not to aggravate inflation through high fiscal deficits. Aggressive actions to lower the inflation rate could derail growth. When revenues are as buoyant as they are, there is no need for dramatic gestures from the finance minister. All he needs to do is use revenues made possible by growth to step up spending on the social sector. That is exactly what Pranab Mukherjee has attempted. Growth takes care of the urban constituency. The rural constituency is best addressed through expenditure targeted at it. This is smart economics as well as smart politics. For taking such a course and showing he has a mind of his own, Mr Mukherjee surely deserves a 9 on 10.