The Union Budget faces significant challenges in the form of a weak investment activity, supply constraints in infrastructure and farm sectors and twin deficits.
The Union Budget faces significant challenges in the form of a weak investment activity, supply constraints in infrastructure and farm sectors and twin deficits. Widening current account deficit (CAD) is now emerging as a major risk to the economy by putting pressure on the already weakened rupee. The foremost agenda of the Budget should, therefore, be to ensure an investment revival and curbing both the fiscal deficit and the CAD.
For this, the finance minister would look to create a more enabling environment for the financial sector to support the capacity expansion in the economy and to attract greater foreign capital of stable nature. On a macro level, curtailing the size of government borrowings and committing to a timebound reduction in fiscal deficit would allow for interest rates to ease and for banks to push credit.
The Budget should also look to reverse the recent trend of rising share of physical savings of households, particularly in gold, as against financial savings. Financial savings of the households fell from 10.4% in fiscal 2011 of GDP to 8% in fiscal 2012, while savings in physical assets increased from 13.1% to 14.3%.
Increasing financial savings would enhance the access to the formal financial sector, particularly banking services through financial inclusion initiatives. The other option would be to look at ways to monetise the gold holdings in the country or reduce gold imports. With $38 billion in first nine months of this fiscal, gold imports are one of the main drivers of the high CAD.
Suggestions made by an RBI group on gold-backed financial products, which could include allowing banks to offer gold deposits in demat form and developing the gold loan market, could be the way forward.
Introduction of inflation-linked bonds can also help in curtailing the gold demand.
Considering that the investment needs of the economy are large in comparison to the existing financing capacity of the banking and non-banking sectors, combined with greater capital requirements for banks under Basel III norms, there is a need for more capital into the banking system.
Since the banking system is largely dominated by public sector banks, the central government would have to continue infusing more capital into them. The finance minister should also encourage merging some of the smaller public sector banks with the larger ones in order to allow consolidation. Financing infrastructure requires long-term savings which are captured through pension and insurance sectors. Therefore, measures to strengthen these two sectors would help in channelising long-term savings into infrastructure projects.
The writer is senior economist, Royal Bank of Scotland NV Views are personal.
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