Populist budget paves way for darker days

Had this been a normal year, had the GDP been growing at 8 per  cent and the government’s tax revenues at 25 per cent a year, one could have given the budget for 2009-10 a cautious welcome. For as in every year since 2005, the UPA government has concentrated on streamlining the tax system, simplifying payment procedures and relying upon the spontaneous growth of tax revenues to cover a truly massive increase in social spending.

Unfortunately, this is not a normal year. By the CSO’s preliminary estimates, the growth rate has fallen from 9 per cent in 2007-8 to 6.7 per cent. Based on predictions that growth could rise marginally to over 7 per cent in 2009-10 and signs of life in a few sectors of industry, the government has assumed that the worst is over and it can go back to business as usual once more. Nothing could be further from the truth.

To begin with, the 6.7 per cent figure is hugely misleading. Fully, 1.9 per cent out of it is accounted for by a 13.5 per cent spurt in  ‘community, social and personal services’, which is no more than the increase in the salaries,  pensions and arrears paid out to civil servants after the implementation of the sixth pay commission’s report. Only a quirk in the way the UN system of national accounts was set up in 1948, allows us to count an increase in the salaries of civil servants as a real increase in the national income. If we deduct this to make the 2008-9 estimate comparable with those of previous years, then growth has slipped from 9 per cent to 4.8 per cent.

The outlook for this year is even bleaker. Growth fell in the second half of the year to 5.8 per cent. But this is also the period in which all of the salaries and arrears that pushed up GDP in the services sector were paid out. Thus the true growth rate from October 2008 has been not 5.8 but a shade over 2 per cent (with 1.6 per cent growth in agriculture and 2.4 per cent in industry, this should not be too surprising).  With industrial growth at close to nil in the first two months of the current year and agriculture headed for a sharp decline, even the World Bank’s projection of 4 per cent growth this year could turn out to be too rosy.

The sharp fall in production last year has led to an even sharper decline in rate of growth of the Central government’s revenues. Against an annual increase of 20 per cent a year during the previous four years revenues grew by a paltry 3.7 per cent in 2008-9.
The government has therefore financed its entire fiscal stimulus package by borrowing from the commercial banking system.

As a result against a budgeted Rs 133, 287 crore it floated bonds for sale in the money market worth Rs 326,515 crore. The huge flow of ready money to civil servants and farmers has stimulated demand, but the parallel flood of government bonds into the money market has crowded out private borrowing by keeping interest rates high. As a result the growth of credit extended by the commercial banks has shrunk by ten percent of the GDP from 25 per cent in 2007-8 to 15 per cent in 2008-9. What is more there has been almost no increase in aggregate lending after November.

It is in these circumstances that Pranab Mukherjee has presented a business-as-usual budget. Under the pretext of stimulating the economy he has presented one of the most populist budgets that the country has ever known. Every head of social expenditure has seen
increases in outlays of 40 to 144 per cent! But even by the government’s own roseate expectations, revenues will not rise by more than 9 per cent. The government again intends to finance its fiscal deficit, now scheduled to rise by another 0.8 per cent to 6.8 per cent, by issuing still more bonds.

Thus its total borrowing is scheduled to rise further from Rs 326,515 crore to Rs 400,996 crore. If anything is needed to make sure that interest rates do not fall this year and investment stagnates, it is this. But the fillip that the government’s social sector spending will give to consumer demand will combine with the revival of speculation in commodities abroad and the decline in agricultural output within the country to push up inflation in the coming months. What Mukherjee has unwittingly written out, therefore, is the perfect recipe for stagflation. Is it any surprise that the Sensex fell by 730 points within minutes of the end of his speech?

The budget does contain a silver lining, but it is political, not economic: after 42 long years, the government has restored the tax exemption on corporate donations to political parties. No single act by any government had done such incalculable harm to the Indian political system as Indira Gandhi’s decision as prime minister to first tax and then altogether ban such donations. By not simultaneously setting up a state funding system she opened the doors first for criminal finances and then for criminals to enter the political system.

The restoration of the tax exemption will not repair all the damage that has been done in the past four decades because the rot has sunk  too deep. But by opening the way for transparent and honest financing of politics once again it will make it possible for  people to enter  politics who have stayed  out so far because of their unwillingness to make the personal compromises that were needed to finance  their elections.

The writer is a commentator on economic affairs