Memo to FM: Ignore critics; this is the time to spend better

The finance minister and the Reserve Bank of India (RBI) governor are definitely the two most powerful names in the world of business as they set the rules of the game. The former was more in the limelight in the past, but ever since the RBI began increasing the frequency of monetary policy statements, the markets watch the governor’s lips more than the FM’s.

However, with the budget due on 16 March, the spotlight is going to temporarily shift to the FM, especially since more is expected of him while we all know what to expect from the RBI. To use market phraseology, the RBI’s stance has been discounted already.

The pre-budget exercises are hyped-up events and more of a ‘demand mela’. There are the ubiquitous meetings with the FM. Everyone who is important gets a chance to meet the FM and express his or her views, through industry associations, product groups, banks, or economists. The repetitive nature of these views is significant because the advice given is almost always the same.

Everyone wants the fiscal deficit ratio to come down. We want the government to spend less on subsidies and NREGA, but more on infrastructure, so that industry can be given a fillip. Taxes should come down even though the goods and services tax (GST) and the direct taxes code (DTC) have set the broad contours. Industries using inputs want tariffs lowered, while the producers of these inputs want a level playing field.

In short, these bromides are repeated every year. Bankers want good fiscal discipline so that interest rates come down and business can borrow more and grow. The media is in the fray, obtaining the views of all who matter, who speak within this framework through round tables and panel discussions. Everything is quite predictable because it is politically right to speak the same language.

The view here is actually quite different. We should consider the budget as a means to meeting certain objectives based on the current economic environment, which is quite tenuous. Today the economy has slowed down due to low investment demand and consumption in the face of declining export growth.

The question to be asked is whether or not the budget can address this issue. The direction must be expansionary for it to deliver and there is admittedly a definite tradeoff here in the form of fiscal numbers going awry. But, in case it does work, it should automatically bring things back on rails.

This means we should admit that the government was a bit too hasty last year when it was decided to rollback the stimulus without taking into account the possibility of global economic conditions changing drastically.

One must remember what Keynes had said - when the facts change, I change my mind. The global conditions changed when the euro nations went down. We should have taken the hint then and not gotten into a comfort zone of feeling that we are different. Other countries have not done so and are still running high fiscal deficits.

Therefore, we should start with the assumption that a high fiscal deficit is not bad and at times when economic growth is sluggish, a Keynesian solution is quite okay. (For the uninitiated, Keynes was an economist who had suggested at the time of the Great Depression of the 1930s that when demand conditions are slack, government spending helps.)

This policy has been behind the stimulus followed in the west to get over Crisis 1.0 in 2008 and 2009. This means that we should not be too critical of the subsidy payments or NREGA which will put more money in the hands of low income groups. Add to this aggressive project expenditure by the government using public-private-partnerships (PPPs) and we can forge strong backward linkages with other sectors and bring about growth.

More money in the hands of people will spur consumption that will lead to higher demand for investment which, in turn, will run in parallel with the government’s efforts. The repercussions here are widespread criticism from critics and multilateral agencies. We will be chided for such profligacy. But in the medium run we can also see tax collections increase which will offset this growth in expenditure. This will be a tough call for the government to take considering that it is already blowing hot and cold on its own performance.

But what will be important is to stick to the expenditure targets and not waver along the way. We have invariably seen that when the deficit widens, there is a tendency for the government to cut back on development expenditure, because that is under its control. The result is that expenditure which is demand stimulating is compromised time and again, making the entire impact of the government weaker. This should not happen for the stimulus to be effective.

Simultaneously, the government has to work to stimulate investment. This can be done through tax breaks because, from the fiscal side, this is a fairly effective tool. A reintroduction of investment allowance would be in order where profits not distributed but invested will be exempted from taxation. By keeping this open for a specified time period, companies will be incentivised to plough more of their profits to investment. And when they are aware of the demand building up through the expenditure route, it would make sense to expedite the same.

The budget ideology should be firm and bold if it has to make a difference. Or else it will end up being ineffective, with feeble attempts to placate various groups and fix not-so-good fiscal numbers. In that case we will be back to the initial condition of fiscal numbers going awry with no significant impact on the economy. We do need a kick-start and in the absence of a fiscal stimulus, will be left struggling to find the right pedal to press.

Madan Sabnavis is Chief Economist, Care Ratings. These views are personal