The Hindu Business Line : Pandora’s Box opened

The Budget has turned out to be a populist document of a government in election mode. The pre-Budget survey talked about the need to push ahead with reforms, resulting in protests from the Left. The interpretation is that the Government is prepared for withdrawal of support, and to face an election sooner than scheduled. This is reinforced by the measures announced for the vote bank.

Public memory is short. Past election results do not show any correlation between the budget and popular votes, especially when the intervals between the two are long. So, in order to quickly capitalise on the vote-catching features of the budget, the Government may be bold enough to taunt the Left further and announce an early election even if support is not withdrawn.

It may take place simultaneously with the elections to State Assemblies in big States like Madhya Pradesh. The Government’s persistence with negotiations on the 123 Agreement, despite the Leftist objections, is also a pointer in this direction.

Tough for RBI

Two populist measures that would create a problem of monetary management for the Reserve Bank of India (RBI) are the debt relief and waiver for farmers with holdings up to two hectares; and the steep changes in the exemption limits for various categories of income-tax assessees and slabs of rates. Around 4 crore farmers would benefit from debt relief to the extent of Rs 60,000 crore. Around 3 crore assesses would gain from the changes in the income-tax rates. The order of tax relief is high.

A quick estimate suggests the changed exemption limit and slabs would result in tax saving of more than Rs 50,000 for each person with income up to Rs 5 lakh. This is big money in a country with a large community of upper middle-class families. One can expect it to flow into the markets for consumer durables, including housing and automobiles, especially Nano. It will boost consumption demand, which showed some slackening recently due to high prices and interest rates.

Second, debt relief implies that money which in the normal course would have been recycled into fresh loans in the absence of over-dues now gets frozen as part of the core money supply, and new credit sanctions would add to it. This is not the first time that such a relief has been announced.

The moral hazard

The moral hazard problem is known. Apart from the damage inflicted on credit discipline it makes those who repaid loans in time feel foolish. If one recalls the procedure adopted in a similar case earlier, it is quite likely that the repayees would demand return of the money and the Government would oblige.

In a way it would, to some extent, tackle the moral hazard problem. For then the borrower would not hesitate to return the loan hereafter if he is conscious that any future loan waiver will benefit him also. So we may expect the total cost of debt relief to exceed Rs 60,000 crore.

There is also likely to be a demand for waivers from small and medium industries, as many of them have suffered from falling export orders due to the rupee appreciation. The Finance Minister has opened the Pandora’s Box in an election year. Money supply has already overtaken the desirable limits set by the central bank. It is likely to surge further ahead with the additional resources pumped into the system thanks to the Government largesse.

Inflation impact

As of now, one may rule out any relaxation in major policy ratios or rates. It is even possible that the policy may harden if prices flare up beyond 5 per cent. Certainly inflation expectations have been raised. Mindful of the impact of inflation on election results, the Government may not object to a hardening of RBI policy although its impact may not be immediately felt.

The claims on low revenue and fiscal deficits are to be taken with a pinch, nay a bag, of salt. The Finance Minister justified the exclusion of the compensatory bonds issued to oil-marketing companies and others on the ground that it was consistent with past practice and that he would ask the Finance Commission to look into the question of fiscal adjustment.

In any case, public finance experts and rating agencies take these outstanding bonds, cosmetically shown as off-balance sheet items under contingent liabilities, into account while evaluating the financial soundness of government. The Government is only fooling itself.

Now the question arises about compensation to banks for writing off farmer loans. Naturally it will be through a subvention from Government and will likely add to the so-called contingent liabilities through the issue of bonds. There is a view that the Government may not provide compensation to those banks that have already made provisions thereof. But it will not be level playing among banks.

(The author is a former officer-in-charge of the Department of Economic Analysis and Policy, RBI.)