Governance Diaries 2009: Budget 2009 and Indian Economy

The anticipated event for this month is the Budget 2009 – there has been an interim budget already earlier in the year that was presented by the then acting Finance Minister, Pranab Mukherjee, so this July 2009 budget will make it the second time in this year that we will wait with bated breath for ‘THE BUDGET’.

Predictably and staying on script, the media is the one that’s most enjoying this second shot at a budget – with the usual cast of characters being heading out to various studios and editorials to discuss budget expectations! In my experience and observations, these so called ‘expectations’ haven’t changed a bit since the dawn of this concept of expectation broadcasting! It’s mainly about this tax break or that excise duty reduction, i.e. micro issues with a casual statement here and there about the macro structural issues.

So it’s not unusual to have ‘expectations’ like ‘XYZ’ Sector should be exempt from all taxes because XYZ sector creates so many jobs/is important to the GDP/is vital for nation’ etc.. I suppose this implies that every other sector should be taxed because they are not creating jobs/are unimportant to GDP/are not vital to the nation etc. So these expectations tend to range from the sublime with the ridiculous with an occasional anchor and analyst attempting to pierce through this very average discussion to make some good points.

Personally, I have long since learned to ignore pre-budget hype and read/watch the expectation drama only if I have very little else to do or am struggling for a cure of temporary sleep deprivation!

As I have already written this is a Government that has been voted into office in these elections on two fundamental premises – A promise of a new approach to Government (with all the elements that make up that point) and a Government that has a strong mandate and therefore no excuses to not perform and so cutting through the hype – This budget is an important one. – not so much for the tax and excise duty and other SOPs for respective lobbies, but for the direction that it will take the Economy and the institutions of Government over the next five years.

In my opinion the government finds itself in a very peculiar and challenging situation vis-a-vis the economy. Let’s understand where our economy is at currently – Our economy has for the last several years grown on the back of sustained investment flows (Equity, Credit) and a surging services/export sector, which has resulted in a downstream consumption economy that creates a further spiking of growth. Over the last several months and looking forward, it is safe to make some assumptions –Given the global credit crisis, Foreign Investment flows have moderated and will show little signs of reversing (except for short term phenomenon of funds playing the arbitrage game between markets) – leaving the domestic sources of capital as prime driver of investments. Even assuming that liquidity in Indian credit and equity markets remain high, the problem is that, with the increasing fiscal deficit and increased borrowing needs of the Government, the chances of Private sector and investment requirements being crowded out by the Governments own financing needs are very high. Simply put, the capacity of the domestic markets to finance the ambitious investment requirements of our economy are limited and if foreign investment flows don’t materialize and in significant numbers, the investment side of the equation of our economy could falter. China is using investments to pump-prime its domestic economy and brace itself against the global downturn. Given our fiscal situation, its unlikely we will be able to do this on our own, without external sources!

Pressing this point further, if investment flows falter as they have in the last 8 months, then the economy could be vulnerable – given that the second leg of our economy (i.e. exports and services like IT, BPO) is weak because of its linkages to the global downturn and is already plateauing or declining (Manufactured exports are very hit!).

It follows from this, that the derived consumption economy is also sputtering as is obvious from the results of the retail companies and retail sector in general! This sputtering so far has been gradual and not been sharp – which could either mean that things aren’t as bad or about to get worse!
Given this background, you can understand the challenges for economic strategy and policy making for this Government and the somewhat self made predicament it finds itself in –
a) It has a significant Political spending program which it has to finance and
b) The economy needs a significant investment program to kick-start or pump-prime!
c) Both these objectives will compete for capital – increasingly limited to domestic banking and capital markets.

Knowing as we all do that the Finance Minister cannot compromise the governments spending programs, the budget therefore will have to lay out bold, decisive, clear policy and administrative measures that can be put into place to:
a) Accelerate external capital flow and other sources of capital into the investment programs of the private and public sector (including domestic savings, FDI, FII, ECBs)
b) Reform the Governments own finances primarily by focussing on delivery of Government spending, to ensure that Government requirements for its political programs don’t increase and cause more financing pressure!

More than tax breaks and other interesting points that characterizes the budget normally, this time around look for aspects that address the above! This time around, the larger financial and economic strategy will be far more important than ever before - So look for that and I hope there is plenty of that in this budget.
At the end of the last five years, Government could be described as having a TAX/BORROW AND SPEND FISCAL STRATEGY –It has obviously worked politically for it. But India today needs a TAX/BORROW and INVEST ECONOMIC ARCHITECTURE and we should all hope this budget takes us there. Let’s touch base post election and exchange notes on if the budget does achieve this!