Making the Budget matter

The negative fallout from sustained inflation, and the nationwide yearning for better governance last year, should provide clear signals to good politicians who are quick to sense what the majority wants.

The forthcoming Budget would be a political success if it addresses the two issues, which are connected: For, governance failure vitiates supply-side response that is the best way to contain inflation.

Neither the macroeconomic policy that remained stimulative for longer than necessary after 2008 nor the subsequent excessive monetary tightening were able to moderate inflation by increasing supply or reducing demand. It remained high as long as food prices ruled high. Fiscal policy was loose, but it supported consumption, not investment. In the end, growth was itself hurt.

For the Budget to credibly improve governance, three tough filters have to be applied to every decision. First, select expenditures that create capacity, defined broadly to include human resources capacity. Second, select those expenditures that deliver the biggest impact for each rupee spent. Third, remove distorting interventions. These are the best ways to sustainably deliver the stated objective of inclusion.

ACTIVE INCLUSION

As high growth and some tax reform raised its revenues over 2003-08, it seemed that the Government could continue defining equity to mean using resources from growth to spend on multiple welfare schemes, even if they did not really reach the poor. But moderation of growth, return of high deficits, and persistent inflation suggest that this status quo is not sustainable.

Opportunities from decent growth, however, make alternatives politically feasible. India is uniquely positioned to define inclusive growth not as a mere redistribution from a productive section to the rest, but as creating conditions for the masses to become productive and contribute to and participate in growth itself.

Examples of expenditures meeting these criteria are those going towards improving infrastructure, health, education, technologies that the poor use, and public services delivery. The rewards to hard work, then, increase. Successes with conditional cash transfers — made in technology-enabled, leak-proof ways as in Brazil — show subsidising activities that improve human capital, induce participation from the very poor. They compensate for market failures that exclude the poor.

AGRICULTURE

Since food price inflation was critical in pushing up wages and general inflation, agriculture must get more attention. The current too sharp price crash can also cause future problems. It is not a coincidence that China's successful industrial transition — relevant to our country that has similar population levels — was preceded by a sharp rise in agricultural productivity. Given past failures, a new approach that strengthens local institutions and creates new options for farmers is required.

Agricultural production and distribution are now on the concurrent list. But that cannot be an excuse for doing nothing. The Centre can legislate on the movement of goods and on creating a national market. The Lokpal Bill debate may have shown it not to have the numbers to push through a new bill. But two or more States can pass a resolution on goods movement under Article 252 of the Constitution.

The Budget can motivate these States by making key allocations conditional upon reforms of their existing Agricultural Produce Marketing Committee laws. Once a few States do so and start showing positive results, others will follow suit. Also, more local change agents have to be introduced, which is the key argument favouring foreign direct investment in retail. The Government must procure more if it has to — but in competitive markets without artificial divisions.

Similarly, if allocations for MGNREGA expenditure are made conditional on the creation of rural assets, employment would be provided as a by-product, while increased productivity would absorb higher wages without creating inflation. Experience with recent Finance Commissions and the Jawaharlal Nehru Urban Renewal Mission programme show that incentives work with States, if they are not subject to political renegotiation. They should be structured so accordingly.

IMPLEMENTATION

The 2008 global financial crisis justified bypassing of fiscal consolidation targets mandated under the Fiscal Responsibility and Budget Management (FRBM) legislation. But farm loan waivers and other measures had already done the damage even earlier. The 13th Finance Commission was asked to lay a new roadmap, and set the fiscal deficit (FD) at 4.8 per cent of GDP for 2011-12 against the original target of 4 per cent. If the fiscal deficit rises above 4.8, it would further undermine the FRBM.

Clearly, laws alone are inadequate without structures that create incentives for implementation. Revenue buoyancy from growth can help consolidation as long as revenues are not wasted. Decentralised spending decisions, favouring different groups, with taxes determined separately result in overspending. Since the tax-pool is common, each group internalises only a fraction of the social cost of tax increase. Binding limits on allocations from a disinterested source and linking spending more clearly to funding would, therefore, help. Subsidies must not be left uncovered, and committed spending should be kept below revenues to leave room for cyclical adjustment.

Any new programme must have a clear source of funding. Who bears the cost must be made transparent. Populism gives a gift but hides a cost. If energy subsidies are to fall as food subsidies rise, would the poor be happy with free grains if they have to pay more to cook them? Also, they may not want them, as their diets have diversified.

The Budget could start taxing diesel cars to attack pollution, corruption and diversion that poorly designed subsidies have encouraged. The annual implementation report should also have a section on measures to induce better governance.

(The author is Professor, Indira Gandhi Institute of Development Research, Mumbai. blfeedback@thehindu.co.in)