Chinks in the Armour: Hindustan Times 4th March 2008

The important question to ask after viewing the provisions of the Union Budget for 2008-09 is as to what is wrong with it. We must look beyond the goodies and the answer must steer clear from the usual clichés that are heard such as non-reduction of certain taxes or surcharges or the introduction of new taxes. After all, if the FM has to garner revenue in some form or the other, somebody has to pay for it.

The significant observation on the Budget is that since this is a pre-Election one, the proposals are laced with propaganda on the success of the ruling UPA government. The problem issues have been tackled head-on, which is good. However, a very myopic view has been taken of things as a result of which five anomalies arise in this budget.

The first is the loan waiver scheme. This is analogous to the ‘loan mela’ schemes in the eighties where loans were perforce disbursed by banks on account of political considerations. Now, banks have to write-off loans to the tune of Rs 60,000 cr. The first issue here is that it sets a bad precedent for future defaults. Borrowers may be tempted to default every 5 years when Elections approach knowing fully well that the government will bail them out. The second is that we need to know as to who will bear this cost. The government has clarified that the burden will be spread over 3 years i.e. banks will be reimbursed by the government. However, the write-offs will take place this year itself. This means that these loans, which are around 2.7% of total bank credit, will be written off with the burden of adjustment also falling on banks. Assuming that Rs 20,000 cr is reimbursed every year, banks have to bear the opportunity cost of not having Rs 40,000 cr of funds to lend at the PLR of 11% which works out to Rs 4400 cr in the second year and Rs 2200 cr in the third year. While the act of saving the farmer is gracious, the result of banks’ losing out does not make banking sense. If the entire amount was reimbursed by the Budget at one shot, then it would have been okay.

The second problem with the Budget is the Pay Commission. The Report will be out by the end of March, and the proposals will then get incorporated. Clearly, there will be no compromise on the recommendations given that the class of government officials is very important elite which matters at the time of Elections. The fiscal numbers are bound to get distorted further and maybe when it comes for final discussion, these numbers will slip in when the Parliament meets.

Thirdly, there have been liberal doses of benefits for the farming community in terms of expenditure on water, soil etc. This is good enough to placate the farmers. However, while admitting that agricultural growth has been a stumbling block this year, the FM should have typically taken a longer term view of things and had concrete plans to raise productivity in wheat, oilseeds and pulses. But, this has not been done as the focus has been very short term. Therefore, the development aspects are missing from the Budget while catering to the immediate requirements.

The fourth problem has been the reaction to the commodity markets. The market, which is in a nascent stage is already faced with the problem of a ban on futures trading in 4 commodities. The FM has imposed the commodities transaction tax which will be a burden on the players. Their withdrawal from the market on account of this burden could mean that the price discovery process would be affected. Therefore, instead of growing this market, which is handicapped today with one single instrument and only retail and corporate participation, the tax will be a dampener.

Fifthly, there are liberal allocations for Bharat Nirman, rural roads, plantation industry etc. However, what would be more pertinent there is the administrative issues of implementation. This becomes important here because while monetary allocation targets are met in these cases, the same does not hold true here.

Now let us look at the pure economic variables. The FM has admitted that growth is lower this year, but the Budget has no clear strategy for spurring growth. In fact, it is assumed that growth will be there at 10%. The few changes in the excise and customs rates will not have a major impact on consumption to start a growth chain.

Further, inflation has been stated as being a concern. If one were serious on inflation, the agricultural plan should have been on, as mentioned earlier, as food along with oil prices have been mainly responsible for inflation in the last two years. The Budget has not addressed this issue. Besides, the Budget has implicitly assumed an inflation rate of 5% for the next year (15% growth in nominal GDP which will mean 10% in GDP and 5% inflation).

Lastly, the Budget gives confusing signals on interest rates. While the fiscal deficit is down, there will be less pressure on the available liquidity in the system. The government has implicitly assumed a marginally higher interest rate of 6.4% this year with interest payments (Rs 190,000 cr) well exceeding total borrowings (Rs 145,000 cr). This is indicative of the fact that notwithstanding the signals that will be given to the RBI, it may be difficult to lower interest rates in the coming year.