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Hard Choices

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The BW roundtable on Budget 2010 — the many expectations and the real possibilities. Excerpts: …

The BW roundtable on Budget 2010 — the many expectations and the real possibilities. Excerpts:


SHOWING THE WAY: (From left) Laveesh Bhandari, director of Indus Analytics; Omkar Goswami, chairman of CERG Advisory; Bibek Debroy, Centre For Policy Research; Pronab Sen, secretary and chief statistician of India, Ministry of Statistics and Programme Implementation; Abheek Barua, chief economist of HDFC Bank; and Prosenjit Datta, editor of Businessworld, and also the moderator of the discussion (BW pic by Tribhuwan Sharma)

Prosenjit Datta (moderator): What should we expect in Pranab Mukherjee’s sixth budget? Laveesh, why don’t you start? Laveesh Bhandari: It is essentially going to be a go-slow budget with minor steps towards withdrawal of the stimulus; the fiscal deficit will be somewhere about 5.5-6 per cent. There will be expansion of some of the social sector schemes. What it should do is accelerate the withdrawal of the stimulus and get at least the excise rate back to 12 per cent level. Omkar Goswami: I tend to agree. There are three or four things he (Pranab Mukherjee) is going to face. Over the next six months, if not longer, (there will be) serious hardening of crude oil prices. I told him this the last time we met so I am interested to see what call he takes — either before the budget or during the budget — on Kirit Parikh’s report. If he doesn’t take a call, the off-balance sheet items (oil bonds, etc.) are going to throw every thing out of gear. Also, if China continues to grow in double digits, I can’t see how food prices are going to remain under control. There are some things they are probably rethinking. One is the big disinvestment target. It’s not just what happened with NTPC. Going forward this calendar year, we will see very skittish global markets — not exactly a market where you can predict disinvestment revenues. 

“In terms of the politics of finance, the fact is that implications of reducing plan expenditure are much more powerful than of the taxes. Also, normally in our public expenditure plan, there is a huge amount of fat deliberately built in. In raising taxes, the political fallout is minimal. I think expenditure would not be curtailed.” PRONAB SEN “It is essentially going to be a go-slow budget with minor steps towards some withdrawal of the stimulus movement; and the fiscal deficit somewhere about 5.5-6 per cent. What it should do is have a more accelerated withdrawal of the stimulus and get at least the excise rate back to 12 per cent level.” LAVEESH BHANDARI “Don’t expect too much hair-raising reformist stuff. I don’t think Pranab babu is going to do it.” OMKAR GOSWAMI “Since 1991, we have equated the budget with spectacular policy announcements, which may or may not be implemented subsequently. But this finance minister’s style is not that. Therefore, this budget will essentially be a budget about numbers, and not spectacular policy announcements.” BIBEK DEBROY “The big problem really is the financing of the budget. The market simply cannot take that amount of bond issuance and we don’t have formats like open market operations.” ABHEEK BARUA

The second is his quest to reduce the deficit. Everybody wants the stimulus to continue. In the corporate sector, the average tax rate paid is about 22 per cent. No one is taking a call on how to bring that up to 30 per cent. He has certainly put off the direct tax code for the next year. Bibek Debroy: Let me begin with the deficit numbers. This year, the deficit was supposed to be 6.8 per cent of GDP. I suspect the numbers will look somewhat more respectable — probably around 6.3 per cent. I think it has largely happened because of disinvestment. The figure will be close to Rs 30,000 crore. But the finance minister is committed to a deficit figure of 5.5 per cent next year. So how is he going to do this? Obviously there will be some sleight of hand in the numbers. We do not yet know

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  • 1. Hard Choices Published: Business World The BW roundtable on Budget 2010 — the many expectations and the real possibilities. Excerpts: Indicus Analytics SHOWING THE WAY: (From left) Laveesh Bhandari, director of Indus Analytics ; Omkar Goswami, chairman of CERG Advisory; Bibek Debroy, Centre For Policy Research; Pronab Sen, secretary and chief statistician of India, Ministry of Statistics and Programme Implementation; Abheek Barua, chief economist of HDFC Bank; and Prosenjit Datta, editor of Businessworld, and also the moderator of the discussion (BW pic by Tribhuwan Sharma)
  • 2. Prosenjit Datta (moderator) : What should we expect in Pranab Mukherjee’s sixth budget? Laveesh, why don’t you start? Laveesh Bhandari:  It is essentially going to be a go-slow budget with minor steps towards withdrawal of the stimulus; the fiscal deficit will be somewhere about 5.5-6 per cent. There will be expansion of some of the social sector schemes. What it should do is accelerate the withdrawal of the stimulus and get at least the excise rate back to 12 per cent level. Omkar Goswami:  I tend to agree. There are three or four things he (Pranab Mukherjee) is going to face. Over the next six months, if not longer, (there will be) serious hardening of crude oil prices. I told him this the last time we met so I am interested to see what call he takes — either before the budget or during the budget — on Kirit Parikh’s report. If he doesn’t take a call, the off-balance sheet items (oil bonds, etc.) are going to throw every thing out of gear. Also, if China continues to grow in double digits, I can’t see how food prices are going to remain under control. There are some things they are probably rethinking. One is the big disinvestment target. It’s not just what happened with NTPC. Going forward this calendar year, we will see very skittish global markets — not exactly a market where you can predict disinvestment revenues. 
  • 3.  “ In terms of the politics of finance, the fact is that implications of reducing plan expenditure are much more powerful than of the taxes. Also, normally in our public expenditure plan, there is a huge amount of fat deliberately built in. In raising taxes, the political fallout is minimal. I think expenditure would not be curtailed.” PRONAB SEN “It is essentially going to be a go-slow budget with minor steps towards some withdrawal of the stimulus movement; and the fiscal deficit somewhere about 5.5-6 per cent. What it should do is have a more accelerated withdrawal of the stimulus and get at least the excise rate back to 12 per cent level.” LAVEESH BHANDARI “Don’t expect too much hair-raising reformist stuff. I don’t think Pranab babu is going to do it.” OMKAR GOSWAMI “Since 1991, we have equated the budget with spectacular policy announcements, which may or may not be implemented subsequently. But this finance minister’s style is not that. Therefore, this budget will essentially be a budget about numbers, and not spectacular policy announcements.” BIBEK DEBROY “The big problem really is the financing of the budget. The market simply cannot take that amount of bond issuance and we don’t have formats like open market operations.” ABHEEK BARUA OVERALL VERDICT 
  • 4. The second is his quest to reduce the deficit. Everybody wants the stimulus to continue. In the corporate sector, the average tax rate paid is about 22 per cent. No one is taking a call on how to bring that up to 30 per cent. He has certainly put off the direct tax code for the next year. Bibek Debroy:  Let me begin with the deficit numbers. This year, the deficit was supposed to be 6.8 per cent of GDP. I suspect the numbers will look somewhat more respectable — probably around 6.3 per cent. I think it has largely happened because of disinvestment. The figure will be close to Rs 30,000 crore. But the finance minister is committed to a deficit figure of 5.5 per cent next year. So how is he going to do this? Obviously there will be some sleight of hand in the numbers. We do not yet know what the Finance Commission has said. But one of the things it seems to have said is that the off-budget items should explicitly be part of the deficit calculations. This will not happen because then the numbers won’t look respectable. There will also be greater public expenditure demands. The cost of Right to Education has not yet been incorporated into any budget calculations and we must remember that there is the right to food kind of legislation, which cannot be indefinitely postponed. The subsidy burden is certain to go up. There will also not be any reform on the administered price mechanism for petroleum products.
  • 5. On the stimulus, I think we should separate the components. The first is the monetary part. The second part is the three fiscal packages that happened after December 2008, and when one is saying withdrawal, one really means that. Every economist says that the excise should go up if we are going to have this unified goods and services tax (GST) target. But, clearly, that is not going to happen this year (the corporate sector is against it). The direct tax reform has effectively been postponed to the next year, so there is not going to be any removal of exemptions. In terms of limited stimulus, we may have a little bit of tinkering, but no more.  A more important element of the stimulus is the public expenditure, which kicked in before September 2008. That is what fundamentally led to an increase in the deficit. I see no signs of that being addressed. So a 5.5 per cent fiscal deficit will essentially be through disinvestment. I am not sure what the figure is going to be, but I would not be surprised with something like Rs 50,000 crore.  Goswami:  It would come close to the Rs 50,000 crore mark. But there is one more issue — the 3G auction. It will certainly happen in the course of the next fiscal. Now will it come in at the end as the revised estimates of fiscal 2010-11? Or, will it be factored in the budget?
  • 6. Abheek Barua:  My estimate is that they will have a relatively conservative number for disinvestment, something like Rs 1,200 crore, and then pat themselves on the back if the market improves and they have a higher number. He (the FM) was asked a couple of months back how he is going to bring the deficit down to 5.5 per cent. He gave broad calculations, and this has been corroborated by people like Subir Gokarn (deputy governor of the Reserve Bank of India). He doesn’t have to pay the arrears from the Pay Commission payouts; about 0.3 per cent of GDP. The debt waiver plan is about 0.6 per cent; and 0.6 per cent is the stimulus due to plan expenditure increasing. That is a little over 1 percentage point, and some tax changes and a little bit of disinvestment or from 3G. So the arithmetic seems credible even without large disinvestment numbers. If you look at the trend of planned expenditure, it is roughly about 4.5 per cent of GDP. This year, it went up to about 5.8 per cent of GDP. So by making large allocations to some sectors and cutting back on others, some of these programmes can be fitted in without necessarily increasing the deficit substantially or banking on the disinvestment. I am just reflecting Pranab babu’s arithmetic (smiling). Pronab Sen:  Let me tackle Bibek’s fear about the Right to Education and the Right to Food. The experience has been that in the first couple of years, it is simply re-dressing a whole bunch of current programmes, with not even a single naya paisa increase in the allocation. 
  • 7. I agree that the arithmetic is such that you will have to rely on the 3G and the disinvestments. Now the real question is disinvestment. What you are really talking about is the government switching from a debt financing of its budget to equity financing. And that has to be seen in the context of our larger financial markets. The equity market today is depressed. And as we have not yet seen a substantive revival in investment in new projects, is this a good time for the government to go into the equity market because that particular kind of crowding out is more damaging than the crowding out that takes place through the debt market? If equity is not available you kill the project at source. Barua:  I disagree with the fundamental premise that there should be accelerated withdrawal of the stimulus. Things are still uncertain globally. So, the withdrawal should be gradual.  The big problem really is the financing of the budget. The bond market, in fact, is very concerned about the liquidity situation. From what the RBI has said, the net government borrowing this year will be the same as last year, and the gross borrowings will be much larger this year because of the redemptions. The market simply cannot take that amount of bond issuance (necessitated by the existing fiscal deficit) and we don’t have formats like open market operations. I would rather go for very gradual withdrawal of stimulus, and get the RBI to help in financing. I do not think we should fall into the trap of decoupling our policies from the G7 world and rebonding with a sort of emerged market strategy.
  • 8. Sen:  I agree that this recession is not going to go away in a hurry. At the moment, people have been living with it. But they will not put up with it for very long. Even with a very good crop, we will still be looking at inflation in the 8-10 per cent range. You can’t just ignore it.  Bhandari: There is crowding out. We know from the 2008-09 investment numbers that the manufacturing investment has taken a big hit. And it is not just an inflation issue. There is an investment issue here as well.  Goswami:  I sit on the board of several companies and see how investment decisions are actually taken. The 2008-09 reduction in growth and the absolute reduction in manufacturing investment was not a case of crowding out. It was straight forward; the management had said, “Yes, we need it, but let’s wait it out.” I think manufacturing is averse to the kind of gearing that was there till 1993-94. They don’t want it.  For investment to come back to the kind of levels you saw before Lehman will need another year of solid growth, possibility of excess demand and strengthening cash flow. It’s not crowding out. Datta:  What can be done about inflation? Bhandari:  There is a whole range of issues that  should have been taken care of six months, a year back. At the very least, we need to start stabilisation of prices, whether the Food Corporation of India does it or some other entity. But I also think we need to withdraw the stimulus. Government expenditure is feeding inflation.
  • 9.   The finance minister has publicly committed to a deficit figure of 5.5 per cent next year. How  is he going to do this? Obviously there will be  some sleight of hand in the numbers. —BIBEK DEBROY He (the finance minister) does not have to pay  the arrears from Pay Commission payouts.  That is about 0.3 per cent of GDP. The debt  waiver tranche is not there. So that is another  0.3 per cent of GDP and 0.6 per cent is the  stimulus due to plan expenditure increasing  over long-term trends. That is a little over  1 percentage point from these sources, and  some tax changes and a little bit of disinvestment  or from 3G. The arithmetic seems credible even  without large disinvestment numbers. —ABHEEK BARUA TAMING THE DEFICIT  What it [the budget] should do is have an accelerated withdrawal of the stimulus  package. It should not be too slow. —LAVEESH BHANDARI I basically disagree with the fundamental  premise that there should be accelerated  withdrawal of the stimulus. Things are still  very uncertain at the global level. So it’s  good to be careful next year. Let’s go in  for a more staggered, calibrated withdrawal. —ABHEEK BARUA The direct tax reform has effectively been  postponed to the next year. All the removal of exemptions etc., is not going to happen.  In terms of limited stimulus, we may have a  little bit of tinkering, but no more. —BIBEK DEBROY SIGNS FOR THE STIMULUS
  • 10. Debroy:  Let’s take the food price inflation first. This is not just drought; it is not just seasonal elements because this has been happening over the last several years. The fundamental issue is simple. The supply curve is completely inelastic because the necessary agro reforms have not been introduced. Now superimpose an increasing demand on it. Part of it because of income growth and changes in consumption caused by the farmers’ debt relief, the National Rural Employment Guarantee Scheme… all of that. And we don’t need to discuss agro reforms because we have been discussing it since 1991.  The question to ask is what can the Centre do because fundamentally these are state government subjects. I think the Ministry of Agriculture could have done a lot more to trigger and catalyse those reforms.  The second conceptual issue is again something that every economist will agree on, but no government since 1991 has been able to do. Let us agree that not everyone in the country can be subsidised. Let us identify, in some fashion, who are the poor and subsidise only those.  So far what has been happening is that all of that is in abeyance. Let’s wait till Nandan Nilekani actually delivers his numbers.
  • 11. Sen:  Accept this simple fact — in terms of agriculture production per capita, we have been  stuck at the same level for the last 10 years. But, you take every other item of consumption, there have been very substantial increases in production. Does it come as any surprise that the relative agriculture prices have gone up? So why are we getting so shocked about it?  Then, there is the wage-price link that’s happening and there have been large changes in the wage demands that have been coming through. The government has helped it along by having the Sixth Pay Commission award, by having fairly generous dearness allowance policies, so you are actually pushing the wage spiral up.  But more importantly, I think we are seeing the emergence of a point of view which says that we are in an inflationary environment and if we actually raise prices nobody is going to get hurt.  Goswami:  I have a simple point to make, again at the micro level. Every FMCG player is waiting for Hindustan Unilever’s move. Somewhere in the next month or two, they are going to make their price moves because the general call today is that upcountry India sales are buoyant. They didn’t raise prices earlier because they were worried about demand. Similarly, for a company like Nestlé.
  • 12. Datta:  Pronab, you track consumption quite closely; do you think upcountry India can absorb a price rise?  Sen:  Yes. In fact, all this leads to a very good case for raising excise. Before those guys raise prices to take advantage of the willingness to pay, tap that willingness and get better revenues. But, on the other hand, today I am not in a position where I can say that consumption  demand will remain buoyant.  Bhandari:  There is no way food inflation over a whole range of commodities can be sustained.  Sen:  We have been through an unusual year. You have had the global crash and one of the worst droughts. To be sanguine about demand is being excessively optimistic.  Goswami:  There is not a single serious guy in the FMCG sector who has the slightest doubt about pushing for higher prices. In their view, the market will absorb it. Debroy:  Some factors pushing inflation are not going to go away. The shift to the rural sector is not going away. The National Rural Employment Guarantee Scheme will continue. If at all, it will be implemented in even more districts. The wage rates will probably go up even further.
  • 13. In addition, exports are showing signs of some recovery now. So, a whole lot of programmes will continue to happen under Bharat Nirman. The Pay Commission effects are now going to kick in at the state government, local body and the quasi-government levels.  So, it is one thing to say that they are not clear about what is going to be the rate of growth in demand, and it is a completely different thing to say that demand is not going to grow at all.  Sen:  I have no doubt that demand is increasing. But is it increasing at a rate that will support 7-8 per cent growth without faltering? If it isn’t, then we better be very careful because you can tip it back very, very quickly.  Barua:  There is still quite a bit of uncertainty in the system with regards to the rate of growth and demand. In this situation, my limited submission was that the RBI should perhaps not be as contractionary or aggressive in tightening. So, I would go with a relatively easy fiscal policy and a gradual withdrawal of stimulus, supported perhaps by a somewhat accommodative monetary policy, which does not mean no change in policy rates. You will see an increase in short-term rate of about 125 basis points.  What is likely to happen though is that, as Dr Subbarao (RBI governor) indicated in his conference call which spooked the market, you are looking at a very large government bond issuance which automatically sort of has a sterilising effect because liquidity gets mopped up. So both the fiscal and the monetary authority will have to be careful in executing the recovery. Goswami:  I don’t expect any hair-raising reformist stuff in the budget. I don’t think Pranab babu is going to do it. It is not the nature of this man to do drama. Many have convinced him, I think wrongly, that concessions are the only things that stand between our survival and our doom. And people have convinced him that next year, between 3G and disinvestments, he will be fine.
  • 14.   A respectable 5.5 per cent fiscal deficit  will essentially be through disinvestment.  I would not be surprised if the target for  disinvestment is something like  Rs 50,000 crore (including the 3G auction). —BIBEK DEBROY What you are really talking about is the  government switching from a debt financing  of its budget to equity financing. —PRONAB SEN They will have a relatively conservative number  for disinvestment, something like Rs 1,200 crore,  and then pat themselves on the back if the  market improves and they have a higher number. —ABHEEK BARUA DISINVESTMENT DILEMMA There will also be greater public  expenditure demands. The subsidy  burden is certain to go up. The shift to the rural sector is not going to go away.  The National Rural Employment Guarantee  Scheme will continue. If at all, it will be  implemented in even more districts. The  wage rates will probably go up even further  under that. On the tax part, despite what all of  us had said about industry lobbying, I won’t be  surprised if excise actually goes up a little bit. —BIBEK DEBROY The difficulty is that everybody wants a tax exemption. How can you justify an average corporate tax rate of 22 per cent? For a  country with about 300 million poor, you  need social sector expenditure. —OMKAR GOSWAMI EARNING AND SPENDING
  • 15. The only consumption items that got significantly affected were those that were routed through the financial system, which were affected by credit. The agricultural ups and downs are very much in line with the long-term trends. If we cannot do anything right now, then next year again we have the Greece problem coming… Something will always come up.  Debroy:  Since 1991, we have equated the budget with spectacular policy announcements which may or may not be implemented subsequently. But this FM’s style is not that. So, this budget will essentially be about the numbers, and not spectacular policy announcements. However, to repeat what I said, he will somehow show a 5.5 per cent deficit. The reason I am using ‘somehow’ is because he has more or less committed that next year it is going to be 4 per cent. Now that is a hell of a dip. I don’t think we have ever accomplished that, and the year after it is 3 per cent. Now a 1 percentage point drop in fiscal deficit as a share of GDP is doable, but 1.5 percentage point is close to impossible.  Datta:  A question on disinvestment; you were worried about the market’s ability to absorb it? Sen:  We are seeing a putative recovery in investments. They haven’t dropped as much as was feared; but most of it is really what was put on hold before and has been brought back on track. The real question is about new investments, which are booking three or four years forward. These show investor confidence in the economy. We are not seeing a whole lot of it.  If the risk capital market gets tight, you may end up aborting that process. Debt capital is only a question of numbers. How much capital is available and how much of it can you take? 
  • 16. Barua:  It is very much a function of the risk appetite in the system, and the way it has deteriorated over the last three or four days has been very dramatic. I think it is a play on the news from China, sovereign debt default in Europe, the Volcker plan... The limited point is that if risk appetite is negative for the emerging market equities, then it is likely to remain so for a while.  Datta:  Assuming that there is some withdrawal of the stimulus, would you rather see it through an increase in the indirect taxes or through a cut in public expenditure? Debroy:  I think all of us would like to see the reduction in public expenditure and more efficient public expenditure. But that is not going to happen. On the tax part, despite what all of us had said about industry lobbying, I won’t be surprised if excise actually goes up a little bit.  Omkar:  I would have a clear preference for reversing some of the tax concessions. The longer the tax concessions remain, the more solidly entrenched they get. The difficulty is that everybody wants tax exemptions claiming that they are infrastructure, that they are part of nation building. How can you justify an average corporate tax rate of 22 per cent? For a country that has 300 million poor at least, you need money for social sector expenditure. Sen:  In terms of the politics, the fact is that implications of reducing plan expenditure are much more powerful than of the taxes. Number two, normally in our public expenditure plan there is a huge amount of fat deliberately built in. Keep your expenditure high, and at the end of the year say we had targeted 5.5 and did 5.3. And all will be utterly delighted over it and the rating agencies will fall over themselves to raise your ratings. In raising taxes, the political fallout is minimal. I think expenditure would not be curtailed.

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