Indian Budget

by Manshu on July 7, 2009

in Economy

The Indian budget was announced yesterday and looking at the sharp fall in the stock market, you would think that it was a total disaster.

The market fell because a lot of expectations were built up leading to the budget, and bold reforms were expected from the Congress, which didn’t deliver.

By now, all of you know about the 6.8% deficit number, lack of concrete measures, small reduction in personal income taxes, no disinvestment etc. etc.

So, I will not repeat that, and instead take a shot at analyzing the rationale of the budget and talk about the one number that’s been talked on more than any other — the 6.8% fiscal deficit.

But first: a little recessionary economics.

During recessions, private spending goes down, which means that people like you and I spend less than what we did in the boom. (I am sure all of us have noticed this in our personal life).

Now, remember, the money you spend is someone else’s income, so if you are not going to go to that restaurant every Saturday night, its earnings will go down.

If their earnings go down, they will have to lay-off some of their staff, and then those people will not be able to watch movies every Sunday night, and the theatre’s income will go down.

This is where the government comes in. If you and I are not going to spend money, then someone else has to do it, and that someone is the government.

Back to the budget

The most prominent number that has been floating around since yesterday is the fiscal deficit of 6.8% of GDP.

What this means is that the government has decided that this is the time for it to carry out spending and stimulus measures like never before.

Clearly, the government doesn’t think the economy is going to revive on its own any time soon. The global economy is still weak and there is not going to be much by way of export growth or private investment.

There are a couple of things that have been done in the budget to counter this.

The first one is the direct act of continuing tax incentives and sops to export oriented units, whether it is IT or Textiles.

The second and bigger measure is boosting infrastructure and rural spending. This may come across as a populist measure (and to some extent it is), but it is also a measure to boost domestic demand.

It is a step to reduce the dependency of GDP growth from exports and orient it more internally. In fact, one of the key factors because of which India remains relatively insulated from the global recession is that exports don’t form the majority of India’s GDP.

This is a step which extends that “decoupling” and aims to boost the GDP growth, despite the global recession.

And of course, we all welcome any improvement in infrastructure that we can get.

So far, we have seen only one side of the equation. The fun side and the spending side, but someone’s got to look at the difficult side too.

If you are a spoilsport, you may ask, where is the money going to come for all this spending?

The Finance Minister didn’t talk about disinvestment and he gave you a small tax break, so, where is the money for the spending going to come from?

Why, he will borrow of course.

The government has been borrowing heavily over the last couple of years and will continue to do it on top of the (already) huge public debt.

This is a risk and the willingness of the government to take this risk shows that it doesn’t believe that the private sector or exports can deliver the 9% growth the FM so badly wants.

But, all this debt has to be paid back, and for that, it is imperative that India has a few 9%plus growth years soon (and that too, without any stimulus spending).

If that doesn’t happen, all this spending will backfire. The deficit will soon become difficult to manage and it will trigger inflation and other problems like rupee or even sovereign devaluation.

Will all this pay off? No one knows for sure, but my opinion is that spending is the right thing to do at this time.

There will be plenty of time to save later and bring the deficit under control when the economy rebounds; this is not the right time to worry about deficits (It has always struck me odd, how a nation of savers can be so profligate collectively). Countries around the world are propping up their economies by passing stimulus packages and India has also joined that bandwagon. It is the right step, given the severity of this recession.

{ 4 comments… read them below or add one }

Biplab Das July 7, 2009 at 1:23 am

Market over reacted for sure. But what was wrong for FM to give a clear roadmap for divestment in the budget itself. He is now saying, it will happen but can’t have details as part of speech.

Knowing rural aspirations today I also feel FM might come out unscathed for his decision to increase spending. But NREGA has to be implemented properly. also why there was no talk of FDI?

Reply

Manshu July 7, 2009 at 3:17 am

The absence of anything to do with FDI was a real shocker to me too. My sense is that they saw what happened in the global financial markets as a result of deregulation and thought that they should wait some more time and let things stabilize before allowing FDI in Insurance and Banking.

Reply

Biplab Das July 8, 2009 at 1:43 am

did FM behave like a Keysian?? what is Keysian economics?

Reply

Manshu July 8, 2009 at 3:08 am

Yeah he did behave like a Keynesian. In this context Keynesian economics refers to government spending to stimulate demand and create jobs.
When private demand goes down, someone needs to fill in that demand or else a lot of people lose their jobs. This filling up is done by the government in the form of infra spending and other stimulus spending.

Reply

Cancel reply

Leave a Comment

Previous post:

Next post: