Budget 2011: Finance minister's Houdini act shrinks expenditure

The budget does not make dramatic shifts in what has been government policy — one of benign negligence.

The minister used the opportunity to lay out the roadmap of the pending legislation to be introduced in Parliament. Here, as always, implementation remains key.

The market has been “trained” to look at fiscal deficit and total borrowing requirements of the government. The speech made pointed references to both these numbers, which, apparently, were well within expected range. As usual, the devil lies in the detail.

With no significant growth in revenues and a trendline increase in expenditure, one would expect to see the deficit widen. However, it has magically shrunk. The reason is the vanishing of several costs. Crude prices have to fall over 20% (not in the hands on the government) for the budget provision of fuel subsidy to hold. Clearly, this is a case of hope, not strategy.

Similar is the case with other subsidies — food and fertiliser. Direct transfer of subsidy to individuals is a laudable goal, but one where the modalities are yet to be outlined. The NREGA itself is ridden with holes and should have been implemented with a technology backbone to make leakage difficult. Instead, with a linkage to inflation, it will over time become a monster.

Government borrowing is very likely to overshoot budgets, not the least because assumptions underlying tax revenue growth are optimistic. The budget seems to imply that tax revenues will grow in the same proportion as the previous year. Judging by the reduced margins companies have already reported, this may not be a tenable assumption.

A praiseworthy initiative is the attempt to mobilise long-term money from foreigners, both for debt and equity. One hopes the plan to allow foreign investors (not only FIIs) to invest in mutual funds is a step in the direction of allowing foreign investors direct access to the Indian markets. The logic of allowing only “institutional” investors is weak at best, for KYC is best implemented when dealing with the final investor, not an intermediary (which is what the FIIs are).

Capital flows into India should also improve with a reduction in taxes on dividends from foreign subsidiaries. However, this provision is open to abuse.
The budget statement of having a fiscal policy that is counter-cyclical remains only an intent. Additionally, with inflation still higher than deposit rates, the mother-of-all stimuli — a negative real interest rate scenario — continues.

The banking sector remains a beneficiary, with further capital commitments from the government. Additionally, the removal of interest rate arbitrage between banks and money market funds, will put banks in a better position to retain CASA deposits. Money market funds — a substantial portion of which come from the corporate sector — will now find it more difficult to offer advantages to investors.

A measure that needs attention is the setting up of a regulator for real estate. While the government states that it wants to weed out unaccounted money, one of the key sources of its generation is real-estate transactions. Despite large parts of the saving of households tied up in real estate, there is no financial regulation. Every other financial intermediary handling client money is required to segregate owned funds from client money - not so the “developer”. Surprisingly, there seems to be no policy mention of the need to regulate this sector.

In essence, the budget fails to offer any solution to increase economic growth without raising inflationary expectations. The market indices witnessed some initial turbulence, but ended almost flat. Expect the pre-budget trends to continue.

Anand Tandon is CEO, JRG Group