"A Budget to Transform", 'The Hindu', February 14, 2015

A budget to transform

Over the past eight months this government has issued some strong  statements on the economy and taken some bold steps aimed at  transforming it. As it prepares to present its first real budget we may reflect upon the direction that it should take.

First, we would expect a budget with a focus, one that resists the temptation to spread either allocations or interventions too thin. If quickening growth is the objective, and the government has stated that it is, the budget should address this objective squarely by increasing the allocation for capital formation. We know that the trajectory of the economy over the past decade is related to the path of public capital formation, notably in infrastructure. To be effective in the context of a significant slowing of growth, however, a substantial hike in public investment would be necessary. This will come up against the programme of fiscal consolidation being pursued. I do not consider it vital to stick to the 4.1 percent fiscal-deficit target announced for this year. Reports are that this target may have been breached already. But there is a more substantial argument. In the present state of the economy - when there is excess capacity in manufacturing, adequate stocks of foodgrain and the inflation rate is trending downwards - we have an opportune moment for a public investment-centred fiscal expansion. Tax revenues will rise following the resulting expansion in output and the increased debt incurred to fund the expansion is thereby financed. This dividend has been termed, cheekily but surely, a ‘fiscal free lunch’. It also suggests that when there is a feed-forward impulse present in the economy, i.e., its current state casts a shadow on its future, fiscal abstinence when the economy is sluggish could actually lead to a worsened fiscal balance in terms of the debt-GDP ratio, for growth would have been lower. Nothing said here detracts from sticking to fiscal consolidation as a desirable long-term objective. It only suggests that its pace must not be forced, but instead calibrated  to the state of the economy. Right now a rigid adherence to a targeted fiscal deficit is not optimal. To borrow from Keynes, “the boom is the time for austerity”. However, fear is that government may currently be practicing the reverse of this maxim. There are newspaper reports that faced with the prospect of overshooting the target of 4.1 percent for the fiscal deficit in the current fiscal year the Ministry of Finance has advised a reduction of plan expenditure. To do so would be foolhardy. Note that what is being called for is only a temporary deviation from the target for the fiscal deficit. Any fiscal expansion may be reversed as its beneficial effects occur and the economy expands. However, this may take upto three years or so given that growth has slowed for about twice as long.

The argument thus far is based on considerations of aggregate demand deficiency. But there are also significant supply-side gains to be had from public capital formation. These supply-side gains feed into one of the government’s major initiatives and also one that is lacking even as it is very important for the country. The first is the idea of Make in India. The second is agriculture, which has so far received less attention from this government than it deserves given its importance.     

There is a perception that the Make in India initiative is pitched towards foreign firms. FDI is important both as a source of funds, foreign exchange and technology, and conditions must be created for favourable entry of foreign firms, but we can hardly ignore India’s entrepreneurs if we are interested in the wide-spreading of prosperity. And, while Indian firms rightly expect a predictable tax regime and freedom from Inspector Raj, they are also hobbled by the lack of adequate infrastructure. This only the government can provide, though not the central government alone. There is a major role for the state governments in this regard. So long as we are interested not only in economic growth but also in the participation in it by individuals, publicly-provided infrastructure is what is going to make the difference. While SEZs can be useful, especially for raising exports, and large corporates may push for them, I have in mind the infrastructure needed to service the segment of Indian manufacturing dubbed as ‘unorganised’. More recently termed the MSME - medium, small and micro enterprises – sector, it sector produces close to half the manufacturing output, comprises the largest number of production units, employs the largest number of workers, and generates a significant share of exports. What its firms need most is producer services. These range from electricity to waste disposal and assured water supply. These smaller producers do not have the wherewithal to supply these services themselves. On the other hand they would be willing to pay for them. For Make in India to progress beyond promise more than mere legislation is required. An attractive investment climate is made up not only by favourable laws but also by enabling producer services. Among these are also information and advice. There is a strong case for something akin to the agricultural extension service for the MSME sector. It could be housed in the District Industries Centres, which were instituted some forty years ago but have remained dormant.

A sector of the economy that has not so far received even token  attention from the government is agriculture and rural India in general, though technically speaking Make in India can be said to include rural industry. It is not sufficiently well known that in the past decade the real price of food has risen by 25 percent. This is completely out of line with the experience of the richer economies of the world where the price of food has shown a secular decline. Take China, the share of food in the household budget there is on average much lower than it is in India. As less need be spent on it now, cheaper food expands the demand for manufactures. The general approach in India has been to increase the production of food, but the point actually is to also lower its cost of production. Public capital formation in agriculture has been on the downward trend for about twenty five years now, preventing the yield increase necessary for keeping price increase in check. The trend needs to be reversed. Whether in industry or in agriculture, expansion of the economy’s infrastructural base increases productivity, driving growth and enhancing the tax revenue needed to finance the public debt. But more so, infrastructure empowers people more than do consumption subsidies.    

Having made a case for greater public capital formation, the issue of which projects to undertake is a real one. There is no question that the choice of projects should be done carefully and the implementation rigourous. The Pradhan Mantri Gram Sadak Yojana initiated some ten years ago would be an ideal vehicle for investment. After all, roads are needed across the country, rural India would be targeted and the overall outlay will be substantial. Only, given India’s diverse geographies a flexible approach should be adopted and the states taken on board. Nothing is gained by insisting on one-size-fits–all solutions, a feature that has plagued central schemes historically.

The suggestion that the budget be used as the vehicle for expanding the capital base of the country ought also to be seen from the point of view of the mode of financing. The much-vaunted PPT model for expanding infrastructure, in vogue for a decade, has broken down. Also, public sector commercial banks are now under-capitalised having been pressured to lend to long-gestation projects which they are not suited to do. Once again, some perspective is to be gained from the experience of China where the infrastructure has been built by the state. In general, the importance of public capital in the form of infrastructure for economic growth, not to mention well-being, has been underrated in the discourse on the future of India.

          Greater public capital formation would have to be financed. As already argued we may expect at least some part of the increased debt due to the fiscal expansion to finance itself. Two other possibilities are for funds from consumption subsidies to be channeled into public infrastructure and for proceeds from disinvestment to be earmarked similarly. Consumption subsidies other than on food for the poor should be reviewed. The slide in growth after 2008 began as the government chose to privilege consumption subsidies over investment. Do we really need a subsidy for cooking gas which we know to be regressive? The kerosene subsidy is known to abet criminality as the stock is diverted to adulterate transportation fuel. The food subsidy could be trimmed if the PDS is linked to Aadhaar and the buffer stock reduced substantially. Increasing the foodstock beyond what is necessary is not only costly but also raises the market price, leaving the poor without access to the PDS worse off, thus defeating the very purpose of government intervention. Mr. Modi had promised maximum governance. Fortune, it is said, favours the brave and the budget would be a good place to start.