With the JPC issue now seemingly resolved, the chances of a normal Budget session look much brighter. This is indeed good news, as it is critical that the session is used for a thorough debate on the challenges facing the economy. There is a natural tendency for us to gloss over our problems and believe that ‘all is well.' This is further reinforced by the prospect of 8.5 per cent GDP growth in 2010-11 and a similar rate of growth in the coming year.
A serious debate on the possible challenges and risks to economic growth would help dispel the complacency that seems to have overtaken large parts of the policymaking establishment. This complacency is holding up progress on much-needed reforms.
CURRENT ACCOUNT DEFICIT
Several emerging trends and features should warrant against complacency. First, inflation at around 8.5 per cent and food inflation stubbornly at around 13 per cent are still a major worry. Going forward, even the optimists do not see inflation coming down below 7 per cent by the end of the fiscal year.
This is well above the comfort zone of 4-5 per cent. Moreover, events in West Asia may raise global oil prices. The prospect of bad global agriculture performance in 2011, with the threat of a severe drought looming over China, will put upward pressure on food, cotton and other agro-input prices.
So, inflation may remain sticky, requiring the RBI to raise interest rates to levels where they will begin to hurt investment intentions. We could see a repeat of the situation in 1997-98 when inflation was quelled only by sacrificing growth, which plunged to below 5 per cent.
Second, on the external front too, we are faced with a rather large current account deficit of 3.5-4 per cent of GDP. This would not cause concern, except for the fact that foreign direct investment (FDI) flows have sharply declined by 31 per cent during April-November 2010 over the same period in 2009.
That this is not due to external factors is borne out by the fact that FDI flows in most other major emerging economies like Indonesia, Malaysia and Singapore have increased by 122-400 per cent during the same period, while Brazil and China have seen an increase of FDI inflows by 16 per cent and 6 per cent, respectively.
Clearly, foreign investors are turning away from India because of perceived and real difficulties in the investment environment. The implication of this sharp decline in FDI flows is that our current account deficit is being increasingly financed by either volatile portfolio inflows or external commercial borrowings, both of which make us more vulnerable on the external account.
Third, the index of industrial production (IIP) has been on a declining trend and tanked to a mere 1.6 per cent in December 2010. While the anaemic IIP figure in December was clearly a result of the very high base of December 2009, the general declining trend should be a major cause of worry. It would aggravate the inflationary situation, with supplies unable to keep pace with rising demand. That does not augur well for overall economic growth.
Fourth, credit off-take by the conventional manufacturing sector from scheduled commercial banks has sharply slackened, with a mere 10 per cent of the total non-food credit off-take from a major public sector bank reportedly going for capacity expansion in the manufacturing or industrial sector. The remaining 90 per cent is for infrastructure projects undertaken in the PPP framework, where a minimum return is quasi-guaranteed by the government through the use of viability gap funding.
Given the risks facing the Indian economy, complacency is hardly justified. Even a minor external or internal shock, like a sustained spike in crude oil prices or domestic political instability, could land the economy in a situation where high inflation may co-exist with tepid economic growth and relatively high interest rates.
Therefore, it is essential that this Budget demonstrates the government's commitment to making the economy more resilient by restoring macro-economic stability. The most important step in this direction would be to rein in the fiscal deficit which at about 5.8 per cent is well above the FRBM ceiling.
The Finance Minister would be well advised to use his buoyant tax receipts (which have increased by 20 per cent for direct taxes and 40 per cent for indirect taxes) to reduce the fiscal deficit rather than once again splurge on subsidies, social security schemes and direct transfers for improving the lot of the aam aadmi . Restoring fiscal discipline and rapidly wiping out the revenue deficit, in particular, should be the most important objective of the coming Budget.
FARM SECTOR REFORMS
The Budget should also include some incentives for the states to abolish the pernicious APMC Act, allow free movement of agro-products across their borders and encourage competition in agriculture markets. States should at least be encouraged to de-list perishables from Schedule I of the APMC Act, as this results in cartelisation of licensed traders in wholesale fruits and vegetable markets to the detriment of both farmers and consumers. The agriculture sector is a laggard, and is unable to meet rising domestic demand. The Budget could include substantial outlays on building new irrigation projects and resurrecting agriculture extension services that have virtually collapsed over the years.
A Budget announcement liberalising the entry of FDI in multi-brand retail will not only improve investment opportunities for FDI but, more importantly, start the process of agriculture sector modernisation, with the large, modern retailing houses creating modern supply chains between the farmgate and consumer and investing in warehouses and cold-chains for the delivery of perishables.
They could become the conduits for new farm technology and agriculture practices. Restoring macro-stability and modernising the agriculture sector are clearly among the two top priorities for the country today. Let us hope the Budget delivers on these two counts.
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