India’s Budget: the Good, the Bad and the Ugly

It’s been a week since India’s Union Budget was presented to Parliament, but it’s not too late to reflect on what it promises. The budget process follows the British model, and is a constitutionally required disclosure of the planned receipts and expenditures of the national government. At one stage, budget speeches by the Finance Minister began to be used for articulating the government’s economic reform agenda, but that practice has receded. Part of the reason for that has nothing to do with the salience of economic reform policies, but rather with the power of individual ministers – education reform was being discussed by the Human Resource Development minister before the budget, while the Civil Aviation minister made statements suggesting further airport privatization would not happen, also before the budget.

One reason there was some anticipation before the budget speech was that the Economic Survey of India had made some detailed suggestions for an economic reform agenda (see my last post). But this was possibly the swan song of the Chief Economic Advisor of the government, who is retiring, and may not have indicated anything about the politicians’ priorities. (Nevertheless, it was a useful list of potential reforms, and I come back to it below.) When the budget did not tackle some of the issues that investors were focusing on, the stock market dropped quite sharply, but my own feeling is that they were looking for an excuse, after the strong post-election run-up in stock prices. Bad news from the United States economy around that time did not help. Since then, after further drops, stock prices seem to be recovering a bit once more, though who knows what will next rattle investors. As an aside, India and its policymakers are going to have to get used to greater volatility in asset markets.

The fragile global economy should be kept in mind when assessing India’s Union Budget: generosity is called for. Before I present my own summary of what I like and what was disappointing in the budget speech and numbers, here’s a summary of a few other perspectives, mostly generous in their assessments. The first four are positive, the next two, less so:

M. Govinda Rao

“On the whole, the finance minister has done his best within the short time period that was available to him. What is important is, unlike the 2008-09 Budget, the current Budget seems to be much more realistic. Over time, hopefully we will move over to a simpler and more transparent fiscal regime.”

Rao is India’s foremost public finance economist, and his article provides a great analysis of the fiscal situation, and the reform agenda with respect to indirect taxes.

Surjit Bhalla

“All in all, one of the best Budgets I have seen in a long time”

Bhalla is an economist and fund manager, who expresses his opinions with force, and can be very critical – it was interesting to see him being so positive. His article seems to rely more on hope than specifics.

Ashok V. Desai

“Mr. Mukherjee [the Finance Minister] has corrected some of Mr. Chidambaram’s [his predecessor] mistakes, and not made any of his own. That is creditable”

Desai was one of the early policy-making reformers, and has since gone on to being a successful business consultant. His quote is from a summary prepared by him for Corporate Catalyst India, a monitoring and consulting firm, of which he is Chairman. He basically lauds the removal of some misguided taxes that came in under the previous coalition (led by the Congress party, as this one is).

Suman Bery

“I found few negative surprises and several positive ones.”

Bery is a macroeconomist who heads one of India’s leading applied research institutes, and he likes the macroeconomic framework of the budget speech, as well as the focus on keeping domestic demand and consumption buoyant.

Ajay Shah

“I did not see progress on fiscal, financial and monetary institution building”

Shah has been an advisor in the Finance Ministry, as well as playing a role on several reform committees. He is often a sharp critic of the current economic regime. In his piece, he also points out the dangers of a fall-off in private corporate investment. Private investment has been a key growth driver in India, so this is worrisome, and perhaps explains some of the stock market’s uneasiness.

T. N. Srinivasan

“The budget makes no innovations as far as I can see”

Srinivasan is one of India’s foremost economists, both on theory and policy. The quote is from a presentation he made on July 8th, at a budget discussion forum in New York, sponsored by KPMG and the Asia Society. He is an articulate proponent of economic reform, and is clearly impatient with the slow, politically-constrained progress of some aspects of reform.

It was interesting to see how six very prominent economists, all with academic credentials as well as policy experience, viewed the budget. Of course there are even more opinions out there.

What follows is my own take on the budget, from my piece in The Mint:

“The Good. This is my longest list, in keeping with my inclination towards generosity. There are suggestions that petroleum product prices will be decontrolled, the fertilizer subsidy made more rational and better targeted, and that introduction of the Goods and Services Tax will be kept on schedule (put aside all the follow-through and implementation issues). The services tax base will be expanded, most significantly to include rail freight. At the same time, the rate will be reduced.

The silly fringe benefit tax and the commodity transaction tax will both be withdrawn. There will be better tax incentives for investment and for research and development, though more could have been done to foster start-ups. There are other miscellaneous tax code improvements, and, while every budget provides tax breaks for specific interest groups, there is nothing egregious in that category.

There is a specific plan for improving infrastructure financing through the India Infrastructure Finance Company Limited, and greater outlays for roads, railways, irrigation and urban infrastructure. There is a stated intention to “remove policy, regulatory and institutional bottlenecks for speedy implementation of infrastructure projects” – again, one hopes for specific follow-up.

One can also classify as good the increased outlays for education, for rural development, and for various worthy groups and causes, though I have concerns I will return to later. Finally, there is the previously-announced Unique Identification Authority of India, under Nandan Nilekani, which will work to create a nationwide identity system that improves targeting and flows of government funds to intended recipients. This is a small step toward improving expenditure efficiency in that realm.

The Bad. The praise of bank nationalization struck me as a bad sign. The idea that the dominance of heavily controlled public sector banks saved India from the worst of the financial crisis is very misguided. Macroeconomic management and regulatory supervision (both capably provided by the Reserve Bank of India) work fine with private sector banks. It was disappointing not to see any follow-up on the Raghuram Rajan committee report, which laid out a brilliant framework for inclusive financial development (separate from that report’s more controversial suggestions on macroeconomic management).

The statement on disinvestment was weaker than the run-up to the budget had led some to expect: just a platitude that the “Public Sector Undertakings are the wealth of the nation,” and so majority ownership should stay with the government. This was made even more explicit for the financial sector. Selling minority stakes to raise quick money is a poor substitute for real organizational and institutional reform of public sector undertakings.

A small quibble is with the raising of personal income tax exemption limits – better to keep the base broad, so more voters are direct taxpayers. Reduce rates at the lower end instead.

Finally, there was nothing substantive on improving expenditure efficiency, both through better design and monitoring of the various categorical transfer programs and investment projects, and more fundamentally through civil service reform. The previous incarnation of this government, even though it was weaker in some respects, made bolder statements on these issues, and it is sad to see no real progress or even goal-setting. The lack of a reform program here tempers the goodness of much of the budgeted spending.

The Ugly. The fiscal deficit, and its subset, the revenue deficit, are ugly numbers. They are certainly not good, but they cannot be called bad given the fragile and uncertain economic recovery. There is a nod to returning to fiscal responsibility targets, but no indication of how. Earlier, fiscal goals were met through strong growth and resulting buoyant tax revenues. This budget could have done more to outline steps to achieve higher growth, consonant with the Economic Survey.”

Here are the grades I gave the Economic Survey reform proposals – all good grades, but some better than others. T. N. Srinivasan was not happy with the lack of prioritization or overall conceptual framework, and that is a weakness, but it’s good to at least have some ideas laid out for discussion. As I noted, the Survey is more explicit than the Budget on policy reforms to restore and sustain high growth

  • Public finances – B+
  • Financial sector – A-
  • Energy – B
  • Investment environment – A-
  • Institutional reforms – B
  • Education and employment – B+

The lowest grades go to institutional reforms – because the Survey really doesn’t get to grips with key issues such as civil service reform – and energy, because there is no solid discussion of getting the power sector into a state where it performs adequately. The power sector remains the biggest constraint on India’s growth, and has been for two decades.

Finally, here is my optimistic conclusion to my budget piece, highlighting two positives to look forward to in the coming months:

“Two catalysts for future growth may come from entirely outside the budget. My hope is that the 13th Finance Commission will offer some radical innovations for restructuring public finances across the tiers, which in turn will improve efficiency and accountability.  And placing foreign investment in higher education on the reform agenda by the new minister for human resource development can lead to a blowing away of this current major constraint on India’s growth – not enough high-quality higher education. It’s comforting to think that India can do so much better even without spending more public money.”