The Union Budget 2011-12: Consolidation of a Pernicious Trend

April 3, 2011

By Sanhati Collective

Introduction

It is a truism that statistics can as much hide as reveal the phenomenon under study. For the presentation of Indian Budget, of course, the concealment is not accidental, it is by design. Behind the pronouncement that MGNREGS wages will be inflation-indexed, for instance, is the unsaid fact that total allocation under the scheme is being reduced. Behind the announcement of an additional 400 crore rupees for spreading the green revolution in eastern India is the unstated fact of fund cuts for agricultural sector. But how much is 400 crores rupees anyway? Recall that last year the revenue loss to the exchequer, courtesy the bonanza given to software technology parks in corporate tax exemptions, was eleven and half thousand crores. For Special Economic Zones, the notional revenue loss was a little over five thousand crores. So much for the 400 crore rupees financial boost to spread green revolution in eastern India!

Continuing in this vein of stripping the emperor of his expensive clothes, layer by layer, in what follows, we would like to point to some key features of the budget that allows us to examine what lies beneath the facade. But first a brief sketch of our argument.

The central thrust of the budget is to work out a strategy to reduce the fiscal deficit. One purported aim is to contain inflation [1]. If the government goes ahead – as it will – and slashes expenditure to reduce fiscal deficit three results are likely. First, since the diagnosis of inflation is erroneous to begin with, it will continue unabated even if the fiscal deficit is reduced. Second, the state of the poor would deteriorate because expenditure cuts will reduce social sector spendings related to health care, nutrition, poverty alleviation, primary education. Third, and perhaps paradoxically, the target of fiscal deficit reduction will not be met. But that does not mean that the whole exercise is pointless. By cutting government expenditure the aam admi’s protection against vicissitudes of the open market is further eroded and the social safety net dismantled a little more. In the process, wider fields are cleared for big capital to operate in, monopolize and thrive. Isn’t this the enclosure movement in a different garb? The enclosure movement under neoliberalism?

Fiscal deficit

The fiscal deficit is targeted to go down to 4.6% of GDP next year from 5.1% in 2010-11. How will this be achieved? By slashing expenditure in real terms even as it announces an increase in nominal terms! The nominal aggregate government expenditure is slated to go up by 3.4%. Is this normal? To put this number in perspective, recall that last year aggregate government expenditure increased by 18.7%; and this was happening in a context where Pranab Babu was rolling back the fiscal stimulus necessitated by the global economic recession. Thus, a 3.4% rise is way below what can be considered normal, and with inflation hovering around 10%, this would mean a decline of 6.6% in real terms [2].

Before examining implications of the cut let us scrutinize the merit of the oft-repeated argument that inflation can be tackled through reducing the fiscal deficit. It is true that high, and rising, deficits may lead to price rise if the economy is at full employment, or if there are sectors in the economy which are facing supply constraints. The argument runs as follows. When the government spends beyond its means it may finance the same through ‘deficit financing’ – either borrowing from the capital markets or printing more money (let us assume the latter). With more money in circulation (and the velocity of circulation remaining unchanged), if supply of goods cannot be raised, prices may rise. But supply will be inelastic if the means to produce goods are already fully used up. If not, i.e., if there is unused capacity – be it of machine or man – supply may very well rise when money supply rises. Moreover, if the velocity at which money circulates , i.e., the speed at which money facilitates transactions of goods and services, changes then the link between deficit spending and inflation becomes even more difficult to establish. In short, the cause and effect chain which many seek to draw between deficit and inflation is based on assumptions which will not be satisfied in an economy with excess supply of labour. It is true however that high and rising aggregate demand, with unresponsive supplies in some sectors, may cause prices of those products to rise [3]. So, freeing the supply side rigidities in those sectors might be advisable. Cutting back government expenditure to deal with supply rigidities dashes the hopes of a robust revival [4].

That excess demand has not been the primary reason behind the current spurt in inflation can be deduced from the fact that inflation has been strong in the last three years, precisely the years during which demand had dampened due to global recession. Note that during the recent high inflationary phase prices of agricultural commodities rose at a high rate. This is important because the agricultural sector meets many of the conditions of a supply constrained sector. Consider the following factors: due to neglect of public investment in recent years, aggregate investment has been lacklustre in agriculture, thereby eroding production capacities. There are institutional rigidities as well, such as inability of poor farmers to access inputs, credits, etc. or lack of security of tenure for tenant farmers. These suggest that a sensible policy to contain food price rise would attempt to remove the supply side hurdles in the agricultural sector, and not harp on reducing fiscal deficits. In fact, what the government would achieve through its deflationary measures (i.e., reducing aggregate expenditures) is just the opposite.

To understand this better, let us take a look at the wide-ranging deflationary measures that have been proposed in the current budget and the specific heads under which expenditures are going to be cut.

Subsidy Cuts

The aggregate subsidy bill is to go down by 13% in nominal terms. In real terms, therefore, nearly a one-fourth cut has been planned. The food subsidy bill is going to be cut marginally; the fertiliser subsidy is slated to go up, again marginally (both in nominal terms). The steepest cut is to take place in petroleum subsidy: 38%. Recall that last year petrol prices have been decontrolled. But that does not seem to be enough. Kaushik Basu, the Chief Economic Advisor at the Ministry of Finance, has been making remarks on the merits of decontrolling diesel prices too. Since there are fears that international crude price will be high in the near future, this will all add up to a heavy burden on consumers and farmers.

How exactly will the cut in subsidies take place? For food and fuel there are proposals to switch to direct cash transfers. The move towards subsidy through cash rather than in kind has often been criticised, especially in the case of food. The reasons are not difficult to understand. First, there is no certainty that the money being paid would be used in buying the goods it was intended for. One might argue that the beneficiary should be allowed to decide how she wants to spend her subsidy. Why should we force her to consume food if there are better uses of equivalent sums of money? Such an argument negates the very purpose of a food subsidy. It also assumes that decision making units are homogeneous, that they are free, and that there is no element of coercion involved. The fact is that there are disparities and exploitation within a family. In a patriarchal society where males control the cash, while women run the kitchen, subsidies paid in cash rather than in kind may mean loss of food entitlement for the family.

Second, one needs shops which sell food so that the cash subsidy can be exchanged for food. As has been reported in the press recently, remote rural areas in the country often do not have them (for example, this article on Tehelka).

Third, with cash subsidies it is difficult to ensure that the real worth, or rather the food worth, of the cash remains unchanged. Keeping its value intact would involve layers of bureaucratic exercise, and probably a lag in adjustment, which would reduce food entitlement.

Finally, when the need to provide food directly ends, the requirement to collect food disappears also. Thus the whole paraphernalia of food procurement and the public distribution system (PDS) could be conveniently dismantled. The result would be not only to erode food security of the urban and rural poor but also to render farmers vulnerable to the vagaries of the market.

Shrinking Allocation for Agriculture

Given that the agricultural sector still employs more than half the Indian workforce, one is naturally interested in how the allocation to this sector has fared in this budget. Table 1 shows the remarkable fact that the allocation of agriculture and rural development funds has been reduced. Note that these are aggregate figures, which clubs together both plan and non-plan expenditures. As Table 1 shows, the allocation has been nominally reduced. After accounting for the impact of price rise, the decline would be larger in real terms.

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Table 1: Changing allocations under different ministries (in crores of rupees)

The big song and dance surrounding the pronouncement that wages in MGNREGS will be linked to inflation has to be set against the reality that total allocation under the scheme has in fact gone down from 40,100 crores in 2010-11 to 40,000 in 2011-12. Even if the government keeps the real wage of workers constant at 100 rupees a day, which is in fact less that the minimum wage rate in many states, this would mean a drastic decline in the number of workers that can be accommodated under the scheme. It is also noteworthy that allocation under the scheme had only increased nominally last year. This is clear indication that the budget is not serious about addressing the rigidities present on the supply side.

But production of goods is only one part of the story, the other and equally important component of supply is distribution. Over the years the government has been procuring food, but its delivery has been shoddy. Musing over the paradox of rising stocks of grain and widespread hunger, Kaushik Basu informs us in a recent article (Economic and Political Weekly, Vol. 46., No. 13., 29 Jan, 2011) that the stock with the government in recent times has been about twice the size of the minimum buffer norm. Carrying over of huge stocks, apart from raising the obvious question as to why the government is not distributing grains at a lower price (if the price is perceived to be too high by beneficiaries) or not raising the allocation norm of beneficiaries, has been causing serious public relations embarrassment for the government. Reports of grain rotting in godowns, or in open spaces, have surfaced in the press. Revamping supply chains would not be unnatural to expect in these conditions. The finance minister has told the parliament that there is shortage of food grain storage facilities (as reported in The Hindu, March 25 2011). Yet the budget cuts funds under the head food, storage and warehousing (see Frontline, March 2011).

But it would be unjust to infer that the government is unaware of supply side difficulties. In the Economic Survey, in the above mentioned article of Kaushik Basu, in the budget speech, concerns have been raised [5]. But not many suggestions have been offered as to how to address those problems. One wonders if the government is gradually building a case for foreign direct investment in multi-brand retailing [6]? Time will tell.

Unwillingness to Earn

The other significant proposals in the budget include a near stagnant allocation for social services (which includes health, education, family welfare etc.), rising dependence on indirect taxes (a regressive step as the indirect taxes hit the poor harder; for more on this see this article on the 2010 budget by Debarshi Das on Sanhati), sale of public assets to the tune of 40000 crores rupees (to ensure ‘people’s ownership’ of public assets), huge tax concessions on account of corporate tax, income tax, excise and customs duties.

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Table 2: Tax revenue forgone (in crores of rupees)

This last point is crucial. Keeping with neoliberal precepts, a low tax regime, especially for the rich, is being foisted. Reluctance to tax the well-off, however, directly contradicts the fiscal deficit target the government has set for itself. A more ruthless set of deflationary measures would have to be deployed to carry out the job. But there are limits to fiscal fundamentalism. The present budget has probably reached a point very near to that barrier. On the earnings side, there isn’t any prospect of raising money through sale of 3G spectrum this year either; optimism over tax buoyancy can prove to be misplaced as the economy is already growing at 8.6%. In sum, the 4.6% fiscal deficit might prove to be unachievable, as we have indicated above.

The budget has underlined the chronic fragility of India’s external sector. The recent trend of low FDI and FII inflows – in fact there have been substantial outflows – has been causing concerns. This is because the current account deficit has no prospect of closing in the medium term (see Figure 1). Of course, to encourage foreign investment to meet this gap, norms have been relaxed. For instance, FIIs in mutual funds have been allowed under Know Your Client clause, sans registration. The relative insularity of domestic economy which has been crucial to ward off global recession is thereby being eroded. When the next round of financial crises sweeps over the global economy, India might be badly hit.

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Figure 1: India’s Current Account Balance

Conclusion:

That the present regime is pursuing a neoliberal trajectory is not news. It is also commonplace that interests of the ruling classes have to be served through policy instruments of the State. Yet the present budget will be notable in that it snubbed its nose at electoral democracy. With three years still to go before the next general elections perhaps the ruling alliance can afford this audacity.

An earlier draft of the article was presented at the “Budget Analysis” session organized by the MA Development Studies students of IIT Guwahati. We thank the participants for comments, questions.

Notes

1. Budget documents are silent over why fiscal deficit reduction is important. Therefore we go by an earlier Reserve Bank of India (RBI) announcement that Fiscal Responsibility and Budget Management (FRBM) Act, which guides these reductions, would help in controlling inflation.

2. Last year CPI (consumer price index) rose at 11%. We assume optimistically that it would come down to 10%.

3. See this (http://www.macroscan.org/eco/aug02/print/prnt170802Fiscal_Deficit.htm) for a detailed exposition.

4. By identifying rising incomes as a reason for food price inflation in the budget speech the finance minister has provided credence to two flawed narratives. One, demand is the chief reason for inflation. Two, although prices are on the rise, one need not worry too much, these are the signs of prosperity. He is echoing a similar and bizzare analysis much in circulation among upper circles of officialdom (for instance see, http://www.hindu.com/2011/01/12/stories/2011011259040100.htm).

5. “Despite improvement in the availability of most food items, consumers were denied the benefit of seasonal fall in prices normally seen in winter months. These developments revealed shortcomings in distribution and marketing systems, which are getting accentuated due to growing demand for these food items with rising income levels. The huge differences between wholesale and retail prices and between markets in different parts of the country are just not acceptable. These are at the expense of remunerative prices for farmers and competitive prices for consumers.” (Budget Speech, 2011-12).

6. The recent Frontline editorial emphasises the same point (http://www.frontlineonnet.com/fl2806/stories/20110325280600600.htm).

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