Don146;t be afraid, for now

How to battle our fears was the theme of the unusually 8212; and for us journalists 8212; almost schizophrenia-inducing hectic news cycle ...

How to battle our fears was the theme of the unusually 8212; and for us journalists 8212; almost schizophrenia-inducing hectic news cycle preceding the budget. Fear of birds carrying the flu, fear of George Bush going back without a deal, fear of bar killers getting away perhaps we should add to this list the fear of actually having to listen to the Amar Singh CD. With so much to be scared of, the budget could not retain its traditional top-of-the-mind slot. That8217;s a little sad. Because, as is clear from Monday8217;s the Economic Survey, the battle with our fears is the smartest way to understand the context of today8217;s budget.

We used to be scared of deficits 8212; internal and external. Much of economic policy was a battle against them. But the Economic Survey data suggests we needn8217;t be so afraid. That has crucial implications for the budget. But we can8217;t appreciate the message unless we tackle some hard economic facts first. Since economic commentators are routinely 8212; and most of the time 8212; justifiably accused of assuming that the fiscal and current account deficits are a normal dinner table topic of conversation, I will try to give the most easily comprehensible indicators.

To see why our fear of internal deficits can be tempered, consider that the central government will borrow around Rs 8,000 crore less from the market than it had planned to. Governments borrow from the market for the same reason as any one else 8212; to bridge the gap between earning and expenditure. If at the beginning of 2005-2006, the government had planned to borrow around Rs 1,41,000 crore, and if the financial year ends with borrowings of around Rs 1,33,000 crore, anyone can guess that the gap between earning and expenditure must have narrowed.

Remarkably, the same thing is happening with states, for long considered more spendthrift than the Centre. The easiest way to see this is to note that state governments have been buying central government debt 8212; specifically, they have been buying something called short dated treasury bills. If states didn8217;t have some elbow room vis-a-vis their finances, they wouldn8217;t be financing the Centre8217;s borrowing. Central deficits have come down because tax collections have improved with growth. Manufacturing and services are growing at a fast clip. Many tax experts are saying tax compliance has also improved. For states, value added tax, or VAT, has made a big difference. So has debt relief programmes 8212; simply put, states have been allowed over the last three years to exchange high interest debt for low interest ones. The combined effect of improving central and state finances is that the overall internal deficit Centre8217;s plus states8217; will be at most eight per cent of the GDP by the end of 2005-2006. It was 10 per cent in 2001-2002. That order of reduction 8212; here you have to take the economists8217; word for it 8212; is really a pretty big deal. It means we can begin to fear internal deficits less.

We can begin to be less afraid of external deficits for a different reason 8212; they are good for us. India8217;s current account 8212; the difference between what we earn and what we spend in a year by selling things abroad and buying from abroad, and also the net of remittances and investment income 8212; is likely to be close to 2.9 per cent of GDP this financial year. That 8212; and again you have to take economists8217; word for this 8212; would have been a big and scary deal, say, 10 years back. In fact, the current account was in the surplus only two years ago.

The reason why a biggish current account deficit is not scary is that we have, as of now, no problems financing it 8212; foreigners are putting their money in and on India. In fact, since these capital flows are a little over four per cent of GDP, they fund the current account, which is 2.9 per cent of GDP, and still have something left over for us to deal with the RBI deals with foreign exchange inflows.

What all this means for the budget is this: Finance Minister P. Chidambaram can start the process of changing the language of India8217;s economic policy. Assume reasonably that the current situation of high growth, relatively low interest and inflation rates continues; also reasonably assume policies continue to make India an attractive bet for foreigners8217; money, then if the internal deficit keeps falling, we can run current account deficits merrily running up both the deficits at the same time means serious trouble. This provides absolutely radical flexibility to economic management.

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The big short-term question is whether the raft of state elections, in which UPA constituents8217; fortunes may or may not take a beating, will impose a political premium on policy reversal. If that is the case, higher government expenditure-led pressure on the internal deficit will start the process of slowly bringing back our fears of deficits.

Till then, your fears should be more optimally allocated to birds, to Bush, and to bar killers.