After a decisive election victory in mid-May, a visionary president speech in parliament, and a reform-filled Economic Survey, the first budget of the new government came somewhat as an anticlimax. Many analysts have criticized it as lacking in direction,   low in reform and having the potential to lead to a fiscal crisis. The stock market crashed on the day of the budget and the government bond yield rose.

The salient message from the budget is this: India’s growth is affected by the global crisis and there is very less likelihood of the global economy recovering soon and the way to revive high growth for India is through boosting domestic demand for which a large dose of government spending is necessary. The government has taken courage from the earlier fiscal stimulus packages which are believed to have prevented a sharper slowdown of the economy in the second half of 2008-09.

In 2008-09 the spending by the central government went up by a massive 33 per cent whereas its revenue receipts rose by a meagre 3.7 per cent (Table 1). This is due to a number of factors like the hefty rise in government salaries, large debt waiver for farmers, substantial rise in expenditure under the national rural employment guarantee (NREGA) scheme, reduction in excise duties, and reduction in petroleum taxes. This led to a sharp rise in revenue and fiscal deficits in 2008-09 to 4.5 per cent  and 6.1 per cent of GDP respectively from 1.1 per cent and 2.7 per cent of GDP respectively in 2007-08.

In this budget, the rise in total government spending is estimated at a moderate 13.3 per cent for 2009-10. Some of the major items of expenditure rise have been in NREGA (30.3%); Jawaharlal Nehru National Urban Renewal Mission, JNNURM (21.6%); National Rural Health Mission, NRHM (17.8%); food subsidy (20.3%); defence (23.6%); police (22.6%); and interest payments (17%). Revenue receipts are estimated to rise by 9.3 per cent and this growth is not due to tax receipts (which are estimated to grow by just 2 %) but a huge rise of 45.8 per cent in non-tax receipts. The main items of non-tax receipts which are shown to rise sharply in 2009-10 are dividends/ surplus from RBI, public sector banks and financial institutions ( a rise of 58.1%); and the receipts from the auction of 3G spectrum (Rs. 35,000 crore). While corporate taxes are estimated to rise by a healthy 15.6 per cent, all other tax receipts are estimated to fall except service tax which will have no growth as its rate was reduced by 2 per cent in March 2009. All these will result in a rise in revenue and fiscal deficits to unprecedented levels of 4.8 per cent and 6.8 per cent of GDP respectively.

Table 2 below calculates the emerging fiscal deficit situation. Including the deficits of states and off-budget items, the fiscal deficit of the country rose from about 5.4 per cent of GDP in 2007-08 to a record high of 11.4 per cent in 2008-09 and is set to remain at the level of 11 per cent in 2009-10. This would mean a rise of total public debt from 77.3 per cent of GDP at the end of 2007-08 to 80 per cent at the end of 2008-09 to a record high of 83.7 per cent of GDP by the end of 2009-10.

Table 2: The State of Fiscal Deficit (as % of GDP)

The budget may be accused of being lopsided in pushing just the demand side up in a pure Keyesian way. However, the lack of fiscal space available compelled the government in doing only so much that its impact on growth will be limited. This is in striking contrast to the strategy in 1991-92 when India confronted with its worst economic crisis. That time government tried to contract demand through reducing fiscal deficit but pushed the supply side through a series of structural reform measures. In 1991-92 as well India faced an external shock; it lost its biggest export market of Soviet Union and experienced an outflow of capital. Nevertheless, Indian economy recovered swiftly and strongly in 2002-03.

It is true that the budget speech contained a few reform ideas like the introduction of GST, direct-tax code, fertilizer subsidy reform, and “take out financing” by IIFCL for infrastructure projects. But they were not credible enough and could not obviate the fact that there was no reform thrust in the budget.

The huge fiscal deficit, the second one in succession, has scared the financial markets. The suggestion that half of it will be absorbed through RBI open market operations is a continuation of what is already happening and is not likely to ease interest rates. Bankers have already ruled out the possibility of any further reduction in lending rates and have indicated the possibility of hardening rates. There is now no rationale for the central bank in reducing its policy rates particularly at a time when there is already excess liquidity.

In short, the budget has failed in restoring confidence the lack of which is what is behind the current economic slowdown. The policy of continued demand stimulus without tackling the huge supply side problems through a “reform stimulus” is likely to fail in stimulating the economy.

*Mathew Joseph

*Mathew Joseph, Senior Consultant, ICRIER, New Delhi. Views are personal.