India’s federal budget fails to instill fiscal discipline
India’s fiscal outlook has been precarious for awhile and the latest budget holds out little hope of instilling some discipline in a country that has missed its deficit target three times over the last ten years — the last failure being the biggest in three years.
On March 16, India presented a budget for the fiscal year starting April 1. The deficit target was set at 5.1% of the gross domestic product (GDP), the largest of all the major emerging-market nations.
In response, major credit agencies immediately warned that the budget could hurt the government’s profile — a warning that further weakened investor sentiment.
“India’s deficit in the next fiscal year is likely to remain high, and uncertainty surrounds the path to subsidy consolidation and to lowering fiscal vulnerability to volatile commodity prices,” said Standard & Poor’s.
The agency rates India at BBB-/Stable/A-3, the lowest investment grade for a country with a stable outlook. Any further downward rating would leave India with a speculative grade.
Analysts doubt the government can cap the deficit at the projected figure, given that the deficit in the current year is estimated to be 5.9% of GDP, a great deal above the 4.6% originally targeted.
In India, financial experts expressed greater disappointment in the budget’s failure to provide a road map to reduce the enormous subsidies on oil, fertilisers and food — an enormous drain on its economy.
The latest budget provides for subsidies worth 435.8 billion rupees (US$8 billion) for fuel, 777.94 billion rupees for fertilisers and 750 billion rupees for food.
“Unless subsidy cuts and fuel price increases are introduced in the next few months, expenditure targets will likely be exceeded yet again,” said ratings agency Moody’s, which rates India at Baa3.
The budget is proposing to cut the government subsidies to 2% of GDP this year, from about 2.5% now, and to 1.7% by 2015. In absolute terms, this would save the government about 600 billion rupees in the first year alone.
But the budget did not elaborate on how it plans to cap the spending on subsidies, said Moody’s. Analysts agree.
Prime Minister Manmohan Singh has talked about “biting the bullet” (read: increasing fuel prices) to address the ballooning deficit. For a good part of the last three months, the general belief in the country was that petrol price increases were being held in abeyance because of elections in Uttar Pradesh, the country’s largest state. But those elections have come and gone.
Given the government’s hesitancy in tweaking petrol prices, it is unlikely to be in a hurry to raise diesel and kerosene prices, which are more vulnerable to populist pressures.
Unfortunately for India, the problem is growing more complicated. Raising fuel prices would ease the budget deficit but could also lead to higher inflation. The budget did not venture anywhere close to offering solutions for the difficult scenario.
If the government had sidestepped the deficit issue, it seemed even less concerned about reining in public spending.
It plans to spend 18% more, with much of it going into education, healthcare and housing. Investment in agriculture, irrigation and the development of minority communities will all rise too. An ambitious plan to guarantee food to millions of Indians alone would cost 923 billion rupees.
Much of the spending is necessary from the perspective of social welfare in a country that is still largely poor but a part of it is also populist. The decision to raise to the income-tax exemption limit might win the government more support from the middle class but would also lose it nearly 51 billion rupees in revenue.
Importantly, electoral considerations have also submerged long standing demands for economic reforms related to foreign direct investment (FDI) in multi-brand retail industry, insurance and aviation.
As far back as in December, the government had been forced to shelve plans to allow foreign retailers like Wal-Mart into India amid political opposition. In the same month, the government had also dropped proposals to allow FDI in the pensions sector. The failure of the budget to introduce the above reforms was criticised by experts as the victory of a short-term populist agenda over India’s long-term economic development.
“In the absence of new policy initiatives, it will take a combination of improved economic growth, corporate profitability, lower global commodity prices and exchange rate stability to meet the fiscal deficit target in 2012-13,” Moody’s said.
With the 2014 federal elections looming, the next budget is likely to be primed solely at winning the favour of voters. This latest budget then, was very likely Finance Minister Pranab Mukherjee’s last chance to suggest a road map towards achieving fiscal discipline for India — a chance that many fear he has, quite simply, missed. AR