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Just a Union budget

It carries little that is surprising. State budgets matter much more.

Written by Neelkanth Mishra | Published:July 12, 2014 3:05 am
What has been fascinating about the India growth story, particularly over the last 10 years, is the remarkable improvement in governance at the state level. What has been fascinating about the India growth story, particularly over the last 10 years, is the remarkable improvement in governance at the state level.

Deep within us rests the desire for quick fixes, of happy endings. Simple narratives are, after all, less taxing on the mind and therefore more attractive. Nothing else can explain the inflated expectations from the presentation of the Union budget: broken system, new government, first speech and fixed!

Even before we get to what the government could have done, it’s worth questioning if the budget day hype is at all warranted.

Let’s start with economic salience. Shouldn’t we instead be focusing on state government budgets, given that they together spend nearly 40 per cent more than the Central government? Hasn’t their spending been growing at 17 per cent a year for the last four years, whereas Central government spending has grown at only 8 per cent? More importantly, isn’t their spending on education more than five times that of the Centre? Don’t they spend more than six times as much as the Central government on healthcare and nearly three times as much on rural infrastructure? While the Central government’s opening of new IITs and AIIMS gets ample media coverage, shouldn’t we also be interested in the efficacy of the far more critical spend on primary and secondary education, which are state subjects?

What has been fascinating about the India growth story, particularly over the last 10 years, is the remarkable improvement in governance at the state level, across many states. This is visible not just in the delivery of basic services but also in surprisingly disciplined state fiscal balances, with only a few exceptions. Encouragingly, this has been achieved through an increase in revenues. Tax collection efficiency, as measured by sales collected as a percentage of state GDP, has improved in all major states, and sales tax growth has compounded at a rate higher than 20 per cent.

Thus, while net Central government spending as a share of national GDP is at multi-decade lows and the fiscal deficit prevents any meaningful increase, total state expenditure as a share of national GDP is the highest since 2004 — and the combined state deficit is very much under control. So, from the perspective of economic importance as well as in terms of delivering basic social services, state budgets matter much more.

To digress a bit, in my view, this is the way it should be. Take the example of a larger neighbour whose wondrous growth we envy: the reforms unleashed by Deng Xiaoping in China in 1978 were more bottom-up, less top-down. He gave fiscal freedom to local governments, which then built up local infrastructure and industry at an unprecedented pace. Non-agricultural output of rural enterprises in China grew at a mind-numbing annualised rate of 26 per cent from 1978 to 1990. When we fret about the shining cities and try to make a Shanghai out of Mumbai, we forget that it all started in the villages and in provincial governments that drove the change.

Coming back to the Union budget, what further reduces its relevance is that only a sixth of spending is discretionary. The rest is interest payments on loans, salaries to government employees, expenditure on defence, hard to cut subsidies and some basic expenditure on education and health. The government cannot cut spending on these categories. Not surprisingly, as expected, there wasn’t much difference between the budget presented by the UPA in February and this one. If there is no element of surprise or some new information, doesn’t it become a non-event?

Let’s get to the more forward-looking statements in the budget. Many have criticised the lack of a “vision” or any further clarity on critical issues like GST timelines and PSU bank recapitalisation. Notwithstanding the basic fact that the budget presentation is not necessarily the best forum to announce economic reforms, this is unfair and unwise. Some have pointed out that the historic budget speech in July 1991 was also drafted in a month’s time. It is an inappropriate comparison, given the perilous state of the economy then and the near-complete dependence on foreign help.

Some amount of empathy can help understand this better. Think of how long it takes to turn around businesses and how this turnaround is approached. If the leader taking the decision isn’t fully aware of the underlying facts, can we expect the best decision? After all, once the giant government machinery commits to a plan, it is hard to change mid-way.

Take the example of troubles in the power sector. The approach so far had been of fire-fighting, curing the symptoms and not the disease, from forcing Coal India to sign fuel supply agreements with power producers, making fuel costs “pass through” to power prices, to restructuring of loans with five state electricity boards (SEBs) in return for promises to raise power tariffs and cut distribution losses. More than two years into the process, we are still struggling with empty power plants and near-bankrupt SEBs. At least the current dispensation has already understood that tariff hikes are not the solution, and rightly so: the marginal cost of power in India is already much higher than global averages. Had we thought this through in 2012, we would have saved two years and a lot of stress.

Each of the major “expectations” in the budget, that is, the GST, cuts in subsidies and PSU bank recapitalisation require institutional preparedness and clarity in longer-term policy implications. For example, it is easy for the top 1 per cent of the population to demand a cut in subsidies but hard for a democratically elected government to act on it. An Aadhaar-based direct benefits transfer scheme for major subsidies is the solution that pleases all but it will take several years to implement.

The government is clearly in no hurry — the intent seems to be to do things slowly but surely. Play like it is a 50-over match (which it is), not a Twenty20. The legislative agenda for the monsoon session of Parliament, the longest in a while with 29 sittings, includes 20 bills, of which only five have economic relevance. But even getting these passed would make 2014 the most legislatively prolific in years.

The patient demands immediate succour but the medicine is long-acting. The challenge for the new government is likely to be in managing expectations of the pace of change. It should be relieved that after the budget speech, there is no big event at which it needs to perform till the budget speech in February next year.

The writer is India equity strategist and managing director at Credit Suisse


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