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Economy Feb 25, 2013

Rot began in 2008: Why Chidu’s Budget 2013 is a mea culpa

By R Jagannathan

In many ways, Palaniappan Chidambaram's 2013-14 budget will have to be a sort of mea culpa for his 2008-09 budget, which set the country on the path to high inflation and low growth. We have a tendency to blame Pranab Mukherjee for the slide, but the rot began with Chidambaram's 2008-09 budget, which set us on the path to disaster. Mukherjee merely compounded the errors introduced in Chidambaram's last budget of UPA-1.

So when the Finance Minister talks of presenting a "responsible" budget this time, we should see it in the context of the gross irresponsibility of the last budget he presented five years ago.

The budget of 2008-09, presented in the context of the looming 2009 general elections, was triumphalist in every way. Consider what Chidambaram said and did then.

Chidambaram said in 2008: "The four years to 2007-08 have been the best years so far but, may I say with humility, that the best is yet to come." (Read the full budget speech here)

We are still waiting for the best that is yet to come, and even the "humility" wasn't very visible as Chidambaram went on to claim, "If 1984 and 1991 were turning points in the history of India's economy, 2004 was another turning point."

How was 1984 a turning point for the Indian economy, unless Chidambaram wants to say that the Indian economy started the build-up to the 1991 crisis during Rajiv Gandhi's regime?

There was more self-congratulatory nonsense: "The India growth story, so far, has been an absorbing and inspiring tale. Beginning January 1, 2005, the economy has recorded a growth rate of over 8 percent in 12 successive quarters up to December 31, 2007...but if you ask me 'can we do better?', my answer would be 'we can and we should.' Budget 2008-09 is about raising our sights and doing more and doing better."

PTI

The economy is now doomed without short-term capital inflows, and in a slowing economy, the country is having to raise oil prices and abandon taxes for foreigners (GAAR) to continue growing. What a fall! PTI

Quite apart from the point that the revival in growth rates began in 2003-04, the last year of the NDA, what the budget of 2008 actually did was put Indian economy on the path to long-term slowdown, with higher vulnerability to external shocks and higher inflation. Budget 2008 did not raise Chidambaram's "sights" beyond the 2009 elections, for all he did was announce a huge farm loan waiver - ultimate cost: Rs 72,000 crore - coupled with some of the biggest increases in support prices for rice, wheat and other foodgrains (which came outside the budget), which made India's food inflation structural.

There were more pipedreams in the 2008 speech. Chidambaram said: "Mr Speaker, Sir, once upon a time India, together with China, accounted for 50 percent of the world's output. We must regain our position and it is within our capacity to do so."

Chidambaram's claims in that budget speech look so unreal today because he wrongly assumed that four years of good growth made India immune to what was happening in the rest of the world.

He said: "Since 2005-06, there has been an unmistakable boom in investment. Two indicators tell the story. The saving rate and the investment rate in 2003-04 were 29.8 percent and 28.2 percent, respectively. According to estimates made by the Economic Advisory Council to the Prime Minister, they will be 35.6 percent and 36.3 percent, respectively, by the end of 2007-08."

Well, savings rates are now down to NDA levels at just over 30 percent.

The problems Chidambaram imagined for the Indian economy were ones of plenty - plenty of capital inflows. He said then: "We have also witnessed capital inflows that are far in excess of the current account deficit (CAD). This poses a challenge to monetary management. The solution lies in increasing the absorptive capacity of the economy in the medium term."

Today's problem is the exact reverse. The economy is now doomed without short-term capital inflows, and in a slowing economy, the country is having to raise oil prices and abandon taxes for foreigners (GAAR) to continue growing. What a fall!

Chidambaram also gave himself lots of pats for revenue buoyancy - which was largely the result of high growth built on buoyant global growth and huge liquidity.

He said: "Many people are surprised by the buoyancy in tax revenues, especially in direct taxes. I am not. I have always maintained that moderate and stable tax rates coupled with a tax administration that shows no fear or favour will bring high revenues to the exchequer."

It did not take long for revenue growth to level off and expenditure to bloat out of control. The budget deficit - and especially the revenue deficit - was about to go out of control, but the FM was on cloud nine in 2008. This is when he indulged in his prime folly and decided to abandon the Fiscal Responsibility and Budget Management (FRBM) Act just because the going was temporarily good.

He said: "The fiscal deficit is estimated at Rs 133,287 crore which is 2.5 percent of GDP. Honourable Members will note that not only will I achieve the target for fiscal deficit under the FRBM Act, I have also left for myself some headroom. In the case of revenue deficit, I will meet the target of annual reduction of 0.5 per cent. However, because of the conscious shift in expenditure in favour of health, education and the social sector, we may need one more year to eliminate the revenue deficit. In my view, this is an entirely acceptable deferment."

He explicitly abandoned fiscal rectitude in an election year, and tore up the FRBM Act in the interests of political expediency. We are still paying the price for that.

But it isn't as if Chidambaram was meeting his fiscal deficit targets till then either. The FRBM targets were being met by sleight-of-hand. And he acknowledged it for the first time in that budget.

"I acknowledge that significant liabilities of the government on account of oil, food and fertiliser bonds are currently below the line. This accounting arrangement is consistent with past practice. Nevertheless, our fiscal and revenue deficits are understated to that extent. There is a need to bring these liabilities into our fiscal accounting. As a first step, I have shown these liabilities clearly in 'Budget at a Glance'. After the obligations on account of the Sixth Central Pay Commission become clear, I intend to request the Thirteenth Finance Commission to revisit the roadmap for fiscal adjustment and suggest a suitably revised roadmap."

Even while acknowledging the wrong accounting, Chidambaram could not bring himself to do the right thing and show a higher fiscal deficit. Mukherjee was the one who corrected it.

In 2004, Chidambaram tore up the FRBM roadmap once; in 2008 he did so again; and in 2012, he gave us yet another fiscal roadmap. What is the point in a roadmap if you are anyway going to go where you feel like?

With hindsight, it is clear that Chidambaram highly underestimated the dangers of giving up fiscal prudence and the scourge of inflation. He noted the "downside risks" thus: "World prices of crude oil, commodities and foodgrains have risen sharply in the period April 2007 to January 2008...Among commodities, the prices of iron ore, copper, lead, tin, urea etc are elevated. The prices of wheat and rice have increased in the world market by 88 percent and 15 percent, respectively. All these trends are inflationary, and there is pressure on domestic prices, especially on the prices of food articles. Consequently, the management of the supply side of food articles will be the most crucial task in the ensuing year."

But within months, the UPA government announced the biggest increases in food procurement prices, pouring fuel over raging inflation.

By August 2008, wholesale price inflation was hitting 12.63 percent, and interest rates were soaring. It took the global financial crisis of September 2008 to lower inflation in the year after that.

But by then Pranab Mukherjee was trying to boost the Indian economy with injections of steroids - three consecutive stimulus packages, that were not withdrawn for two more years.

Mukherjee ensured that inflation would stay high for at least two more years, and bring growth down subsequently.

A Reserve Bank of India study shows that whenever inflation crosses 5.5 percent, it inevitably impacts growth.

Chidambaram's irresponsible 2008 budget set the stage for that. And Mukherjee fanned the fires.

This is why Budget 2013 has to be a mea culpa for 2008. It has to reverse the damage that Chidambaram inflicted in 2008.

by R Jagannathan

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