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The day the Budget for 2012-13 was announced, the Sensex shed 209 points and another 193 points on the next day. Clearly, the markets were disapproving of the Budget. Why? The overshooting of the fiscal deficit target for 2011-12 had already been already priced in. Besides, the Budget has attempted to bring down the fiscal deficit from 5.9 per cent in 2011-12 (revised estimates) to 5.1 per cent in 2012-13 (budget estimates). Why were the markets less than convinced about the budgetary exercise?
Fiscal Consolidation
The fiscal consolidation effort, in fact, seems rather credible, as it is based on revenue mobilisation and not on expenditure compression (see table) . Both, revenue and expenditure are budgeted to grow, but the former at a much higher pace than the latter. In an economy which has seen growth compression, higher spending financed out of greater mobilisation of revenue is welcome. The additional positive feature is the thrust on Plan expenditure (see table) and capital spending.
For instance, the share of capital spending in total expenditure had declined from 13.5 per cent in 2010-11(RE) to 12.8 per cent in 2011-12 (BE) and 11.9 per cent in 2011-12 (RE). The share of capital expenditure in the 2012-13 Budget is up to 13.7 per cent. The Budget provides for a 30 per cent increase in capital expenditure in 2012-13 over the levels of 2011-12 (RE).
As the increase in revenue is premised on extending with scope of taxes on services and the withdrawal of fiscal concessions to industry, the revenue projections for 2012-13 would appear realistic, if growth in 2012-13 pans out as per Budget projections. The increase in non-tax revenue, which includes proceeds from disinvestment and spectrum auctions, is dependent upon the market scenario, political support and the interest shown by telecom players after the spectrum fiasco.
Markets' Reservations
The markets were, however, irked on three counts. The first reason was the absence of any big-bang announcement on reforms — like a specific time line for the introduction of DTC or GST, permission of FDI in multi-brand retail, decontrol of urea prices, measures to resolve the poor health of State Electricity Boards, and to expedite land acquisition/environmental clearances.
Second, the subsidies budgeted for 2012-13 are a cause for concern, in view of the elevated prices of crude in the international market. The markets are unconvinced of the government's ability to convince its allies on rationalising domestic prices of fuel products, in line with international prices.
This would need to be done, as India imports three-quarters of its crude requirement. Unless such price alignment takes place without much delay, the fiscal deficit numbers projected for 2012-13 can go topsy-turvy.
Third, the government has budgeted a ‘crowding out' of a larger share of resources from the private sector. Notwithstanding attempts at fiscal consolidation, the Budget placed the gross and net market borrowings for 2012-13 at Rs 5.69 lakh crore and Rs 4.79 lakh crore, respectively. The net borrowing was higher by Rs 43,000 crore, compared with that for 2011-12(RE). Markets were earlier expecting a Budgeted gross borrowing of Rs 5.25-5.50 lakh crore for 2012-13, against the actual Budgeted sum of Rs 5.69 lakh crore. The higher-than-expected market borrowing programme caused the benchmark bond yield to rise to its highest in two-and-a half months. The 10-year benchmark bond yield closed at 8.42 per cent, up 6 basis points from previous close and up 9 basis points from when the borrowing data in the Budget was released.
Monetary Policy
The RBI has made it clear that the timing and pace of rate easing would depend on the government's fiscal consolidation efforts. Headline inflation had been falling continuously from October 2011 through January 2012. The falling trend was reversed in February, with headline inflation inching up to 6.95 per cent in February 2012.
The spike in inflation was on account of primary products whose prices increased by 6.3 per cent in February 2012, compared with only 2.3 per cent in January 2012. The rise in primary products inflation was guided by the erosion of the base effect in seasonal fruits and vegetables.
More importantly, the non-food manufactured inflation or core inflation for February 2012 was seen at 5.7 per cent, after falling successively from the high levels of 8.4 per cent in November 11. The decline in core inflation should give some comfort to the RBI. Though the Budget has projected for a fiscal deficit of 5.1 per cent for 2012-13, its credibility would depend on its ability to bite the bullet on reducing subsidies.
The government seems more determined this time around, with the Finance Minister budgeting subsidies at a much lower 1.9 per cent of the GDP in 2012-13 (BE), compared with 2.4 per cent in 2011-12 (RE). He has also charted out a reduction in subsides as proportion of GDP to 1.75 per cent over the next three years.
With the next monetary policy review due on April 17, RBI should give the government a chance by beginning the easing process. Among other factors, growth of GDP will guide the fiscal consolidation in 2012-13.
(The author teaches Economics at the Xavier institute of Management, Bhubaneswar. Views are personal.)
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