Lower budgeted expenditure will help douse inflation

The expenditure policy of the government has a direct correlation to inflation. High unproductive expenditure leads to high inflation as there isn’t sufficient investment in capacities to meet the artificial demand caused by unproductive spending.

The budget for 2011-12 is expected to be anti-inflationary in nature and the focus of the market will be on the expenditure policies of the government. Lower budgeted expenditure on unproductive items will enthuse the market on inflation and inflation expectations can come down. Falling inflation expectations means lower interest rates and better prospects for economic growth.

The main areas of non-productive expenditure are interest payments and subsidies.
The government has to pay interest on its borrowings, which include market loans and other internal and external liabilities. Interest expenditure cannot be avoided or reduced and it forms a significant part —- around 25% of the total government expenditure. Interest liabilities for last year amounted to Rs249,000 crore.

The government keeps adding to its debt liabilities every year as it is a net borrower. Interest payments are affected by both a rise in stock of debt and a rise in interest costs. Investors will have to keenly study the net borrowing figure of the government and the levels of yields of government bonds to estimate future interest costs.

Interest payment will go up by at least Rs30,000 crore from last year to this year, amounting to Rs280,000 crore, given that the government has to service existing debt plus new debt added during 2010-11.

Subsidies are the biggest contributor to wasteful expenditure. Apart from the fact that subsidies do not reach the intended audience, it paints a wrong picture on inflation, leading to monetary actions to counteract the hidden inflation.

The government spends on food and fertiliser subsidies.

Food subsidies arise from the difference between cost of procurement of food grains and the sale price through the public distribution system (PDS). The government consistently raises the price of food grains (minimum support price) as it benefits farmers. The food grains are stored in warehouses for distribution.

Usually, the warehouses get filled up due to the weak PDS and the grains rot. The food subsidy bill for 2010-11 was Rs55,000 crore and investors should keenly watch this figure in the budget for judging the government’s prudence.

Fertiliser subsidies account for another Rs50,000 crore of non-productive expenditure. The difference in production costs and selling costs of fertilisers are accounted in the form of fertiliser subsidy. The subsidy bill has a direct correlation to fuel prices and higher the price of crude and natural gas, the higher the subsidy bill.

The bill has gone up to Rs100,000 crore from the budgeted Rs50,000 crore due to rise in fuel prices and this year’s fertiliser subsidy will have an impact on the government’s finances. The only respite for fertiliser subsidy is the availability of gas from within the country and this may bring down the bill over a period of time.

Fuel subsidies are another cause of deep holes in the government’s coffers and lead to inflation being understated. The fuel subsidy was budgeted at Rs3,500 crore last year and with oil prices going up by over 25% over the year, the bill is touching Rs100,000 crore. The government will be pressured to rationalise fuel subsidies to bring down the subsidy bill.

The other big spend of the government is the rural employment scheme. The government had budgeted Rs40,000 crore for rural employment where there is guaranteed employment for rural population. A rise in this expenditure is inflationary in nature as the higher wages does not lead to higher production of goods and services.

Investors will have to look out for the rise in non-productive expenditure. High budgeted expenditure impacts both finances as well as inflation and is not good for the economy. On the other hand, rational expenditure is good for the economy as it has a positive impact on finances and inflation.
arjun@arjunparthasarathy.com