Last chance, Mr FM

Dear Mr Finance Minister,

The backdrop to this year’s Union budget is high inflation, low growth, high fiscal deficit and an alarmingly high current account deficit. Additionally, this is the last full-fledged budget before next year’s general elections. Hence, you will need to balance populism and fiscal discipline.

The global backdrop continues to be a gloomy outlook, although the International Monetary Fund claims that 2013 will be better than last year. That’s little comfort for our export prospects next year. Let’s examine each backdrop factor in some detail.

High inflation is not merely due to high oil prices, which are beyond your control. It is also because of double-digit food price inflation, which feeds into a wage price spiral. Minimum support prices have risen faster than the GDP, and stagnant productivity in agriculture is causing a supply bottleneck. The coexistence of high food inflation and record stocks in granaries is not merely a puzzle, but also an embarrassment.

A continuous increase in administered prices such as linkage coal, railway freight, electricity tariff, and road tolls, all contribute to headline inflation.

We hope that you will send a strong anti-inflationary signal in your budget, through a combination of expenditure compression and price rationalisation. Please limit the growth in spending well below revenues, and the projected GDP. The low growth is manifested mostly in the manufacturing sector, which has been totally flat — it has had zero growth.

The lack of investment in manufacturing means we run into capacity bottlenecks, causing us to import larger quantities, making the current account deficit worse, leading to job losses and inflationary conditions. The national ambition is to raise the share of manufacturing from 15% to 25% of the GDP. This calls for a ‘Project Tiger’ approach to this sector. India’s global rank in ease of doing business is a lowly 132, even behind Pakistan and Nepal.

The two things that hinder investments in manufacturing the most are delays in approvals and clearances, and the stability of contract enforcement. The former can be enabled with parallel (that is, non-sequential) processing of applications and a streamlined genuine single window approach. The latter needs to be strengthened and complemented with quasi-judicial out-of-court dispute settlement mechanisms. India’s 5% growth is simply not adequate to address the need for massive job creation and poverty alleviation.

The third backdrop factor is fiscal deficit. Please note that in the past nine years, the deficit (and also the government’s borrowing) is up by almost 500%, whereas the real GDP is up just about 85%. This is the surest sign of fiscal profligacy, even though the intervening fiscal stimulus of 2009 was necessary and well-timed, and helped the economy weather the post-Lehman global crisis.

The single biggest item in your spending side is payment of interest. That is close to 40% of all your revenue. Even a token reduction of 0.25% in interest rates can reduce interest burden by Rs17,000 crore.

Of course, not all of this benefit is in cash flow, since some benefit of lower interest goes to banks. But 75% of banking is in the public sector and needs capital infusion from you. Lower interest payment, and lower deficit also decrease the tremendous preemptive pressure on the borrowing system. It also frees loanable funds for the industrial sector (both public and private) at lower rates. Of course, interest rates are set by the Reserve Bank of India (RBI), but expenditure compression from your side will enable it to have room for a rate cut.

Oh, please resist the temptation of decreasing the fiscal deficit by a new super-rich tax. As you know, 63% of personal income tax is paid by only 1.3% of the taxpayers. So, you have limited mileage in milking this source. Instead, there is more mileage in widening the tax net, given that the tax administration system is able to cross-check and triangulate many high value transactions, such as those in real estate.

This is also your last pre-election budget. Hence, there are strong indications that you may include a loan waiver and the Food Security Bill (FSB) in your speech. Please note that a loan waiver creates perverse incentives and punishes the farmer who struggled to repay his loan. Loan restructuring could be a better and viable option.

As for the FSB, whose goal is to provide grain at a low cost to 70% of the population, we request you to budget for this explicitly. Please note that moving the grain to these families will need additional spending on the already choked railways, on storage and on reducing leakage. It would be best if the FSB is combined with the public distribution system (PDS) in a way that eliminates overlaps.

Lastly, on the widening current account deficit, please note that high import of gold is a consequence of inflation hedging. Hence, lowering inflation and interest rates is a surer way to reduce gold import rather than merely raising duties, and inviting smuggling. Imports have also increased because India’s modest growth is being harvested by other countries, with huge idle capacities. These cheap, often below cost, imports also undermine our industrial production and investment.

In summary, here are the key requests: expenditure compression and fiscal consolidation, high priority to improving investment climate, widen tax net not increase rates, desist from loan waiver, use synergy between FSB and PDS, create condition to enable RBI to cut rates. 

Oh, one more thing. Can you please project your GDP growth clearly upfront, instead of in footnotes, as has been the practice?

With best wishes, and may you have Dhoni’s pluck and luck on February 28.