Budget 2013 will be pragmatic, but not necessarily reformist

The events in the run-up to the Union Budget for 2013-14 to be tabled in Parliament in February are pointing towards a positive, pragmatic budget, and not a populist one. The government has realised that good economics is better for votes than bad economics.

The government has had it rough in the last two years and it is taking some corrective steps to stem the downside. The first step that the government has taken in the positive direction is recognising the problems plaguing the economy. In 2011-12, high inflation, fiscal deficit and current account deficit (CAD) - at 9 percent, 5.9 percent of GDP and 4.2 percent of GDP - required policy action. The RBI tightened monetary policy to bring down inflationary expectations while the government cut down on fiscal stimulus to bring down the fiscal deficit. While inflation is down to levels of 7.18 percent as of December 2012, the fiscal deficit is expected to be 5.3 percent of GDP for 2012-13.

[caption id=“attachment_588851” align=“alignleft” width=“380”]  The way the government will achieve a lower fiscal deficit will be through spending cuts and higher taxes[/caption]

The CAD is staying uncomfortably high at 4.6 percent of GDP for the first half of 2012-13 and this is keeping the rupee at lower levels of 54 against the dollar as of January 2013. The rupee is down over 20 percent against the dollar over the last one-and-half years. The high CAD and the weak rupee are forcing the government to take more corrective steps on the fiscal deficit to attract inflows.

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The government is expected to increase diesel and LPG prices by over 15 percent to bring them more in tune with crude oil price levels. The increase in railway fares this month (the first major hike since 2003) is seen as a positive step to improve the functioning of the railways.

International rating agencies are pressuring the government to cut down its deficits and there is a danger of the country losing its investment grade rating if the deficits are not checked. The government at this point of time is keen on boosting its image before international investors as it is dependent on capital flows to prevent the rupee from depreciating further. Liberalisation of debt limits and encouraging flows into equity are expected to bring in capital flows. These flows will be hit if India is downgraded to junk status.

Expectations from 2013-14 budget

Budget 2013-14 is likely to be more pragmatic than populist. Reform elements, however, will be low. The government, keen to show that its finances are in a better shape, is likely to budget a fiscal deficit of less than 5 percent of GDP for thenext financial year. The way the government will achieve a lower fiscal deficit will be through spending cuts and higher taxes. Subsidies as a percentage of GDP will be budgeted at lower than 2 percent of GDP. There is talk of the government raising taxes for the higher income brackets but that will be seen as anti-reformist and hopefully the government will raise more taxes by widening its net.

The government is hoping for a recovery in the global economy on the back of stabilising conditions in the eurozone. The RBI is also expected to lower policy rates as inflation is trending downward. This will lead to an improvement in consumption and investment activity in the economy.

The government will not be too ambitious in its GDP growth target for 2013-14 and will likely peg it around 6.7 percent against expected growth levels of 5.8 percent for 2012-13.

The markets will welcome a budget that is pragmatic and if global equities stay firm, Indian equities, bonds and the currency can see a strong rally after the budget.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors