It is now over a month since the new government in Delhi took charge amid high expectation of reform and policy correction. So far, there have been few big-bang announcements. Instead, the new administration has moved cautiously, focusing on calibrated changes. Some of these have worked, while others had to be pared back due to political considerations. More importantly, there hasn’t been a mad rush to prop up growth by any means necessary. Rather, the government has reassuringly attended to bringing inflation down as a priority. These are all positive signs that the new government believes that it is in it for the long haul and intends to focus on lasting reforms.
But this perceived reticence has simply heightened expectations that the government is saving bold policy-reform announcements for the budget, making it a vision document for the next five years. The expectations from the budget have boundlessly increased. Many of them are internally inconsistent, others are not even under the purview of the ministry of finance and several are just bewildering.
One problem has been that the market and analysts alike (including this writer) are basing their policy and reform expectations on what they believe the government’s worldview is. The government hasn’t articulated that. If the dysfunctional decision-making of the previous government was the only reason why the economy has languished, then, by inference, one should expect much of the same of what was dished out during the last decade, except that the policies and reforms would be better executed. The previous government’s specific choices of macroeconomic policies and reforms reflected its worldview. It is not clear whether the electorate rejected that worldview, or just the disappointing outcome of the associated policies because of poor implementation and governance. Equally, it is unclear whether better implementation of those policies and reforms can help India break out of the current low-growth quagmire in a substantial way. More efficient governance can clearly increase productivity and investment, but one wonders whether that is all that India needs to get back on a higher growth path.
For one, the global economy has changed markedly in the last few years. The easy solution of plugging into global trade and riding the globalisation wave to high domestic growth is over. After recovering from the 2008 crisis, global trade has been stagnant for the last three years, reflecting slow-moving structural changes such as ageing populations in developed markets and economic rebalancing in China. At the same time, globally, the cost of risk capital has increased substantially because of regulatory changes and, chances are, these changes are not over yet. This has increased the cost of taking risks, slowing inflows into local currency products in emerging markets. As a result, dependence on domestic demand drivers and internal capital markets will likely increase, not lessen, over the next decade.This implies that the nationwide GST, which has now been on the agenda for more than a decade, acquires increased importance, not just as a way of improving tax efficiency and revenue, but also as a way of unifying India’s internal consumer markets.
Liberalising domestic capital markets and the banking system is critical to garner sufficient funding for India’s large, necessary infrastructure investment. Foreign capital will be needed, but it is unlikely to be a substitute for domestic funds. In this context, the rise in leverage among infrastructure companies is disconcerting and could hold back investment, even if the government clears the administrative hurdles. Resolving the problem ultimately requires recapitalising banks, though there is virtually no fiscal space to do so. Privatisation is the natural solution, especially given current equity valuations. In its previous avatar, the NDA was clearly not averse to selling state assets. But this time around, it would mean reducing the government’s shareholding to minority status, which has been sacrosanct since the bank nationalisation of the 1970s, making the decision difficult.
There has been much handwringing over India’s ballooning subsidy bill, and rightly so. A plethora of solutions has been proffered by all and sundry. But it is unclear how the government views subsidies. Is it against such subsidies on principle, or is it forced to cut back due to fiscal constraints? Policy choices will vary widely depending on the answer. One gets a sense that the government believes that some subsidies are necessary, but that they need to be better targeted. Ergo, changes are likely to be slow moving, with gradual alterations to the parameters of the subsidy programmes and better targeting through direct cash transfers, much like what the previous government did in its last two years.
But these policy priorities may not be shared by the government. Hopefully, the budget will articulate the government’s worldview, priorities and the policy agenda for the next five years. Without minimising the importance of the budget, articulating the government’s vision for the next five years is far more necessary at this point.
And this finally brings me to the 2014-15 budget per se. There is a widely accepted belief that it needs to be “pro-growth”, with higher capital spending and increased privatisation, “technically” ensuring that the fiscal deficit does not blow up. This would be a mistake. Privatisation is simply an exchange of assets between the public and private sectors and, therefore, needs to be netted out to compute the underlying fiscal stance. So, if the government raises 0.8 per cent of the GDP in assets sales this year, as seems likely, but the deficit is only reduced by 0.2 per cent of the GDP compared to last year, then the underlying fiscal stance has actually been eased. And an easing in the underlying fiscal stance has almost always been inflationary in India. There is a preponderance of cross-country evidence garnered over the last 25 years covering almost all economies that shows that once inflation breaches a threshold (around 4 to 5 per cent for India), higher inflation lowers growth, it doesn’t increase it. That’s what happened in India when the previous government did not roll back the Lehman stimulus sufficiently early and paid for it dearly with three years of high inflation, high interest rates, plummeting corporate investment, widening current account deficit, falling rupee and languishing growth. Some will argue that inflation isn’t India’s burning problem, creating jobs for the vast millions of new workers is the priority. Perhaps, but history suggests that pushing growth through a higher fiscal deficit, however camouflaged through asset sales, doesn’t work. Reforms do and one hopes that this week’s budget will be mindful of this.
The writer is chief Asia economist, J.P. Morgan. Views are personal