Last chance for prudence

The only two Gs that matter today are growth and governance. On February 7, the Central Statistical Organisation released its estimate of 5 per cent GDP growth in 2012-13 — the lowest in a decade. This came as a shocker for eternal optimists. About a week earlier, a prescient RBI governor, Duvvuri Subbarao, had finally leaned on the side of growth, cutting the key policy rate by 25 basis points, even though there had been no significant respite from consumer price inflation. He took great risks in doing so, and he must expect Finance Minister P. Chidambaram to guard the budget deficit. While it is anticipated that the finance minister will do everything possible tomorrow to rev up growth, improving governance, we all reckon, is a much more onerous task. This will remain a work-in-progress for a long time. When Chidambaram rises to present his budget, the stock markets will be scanning for measures that boost growth, and economic pundits for moves to improve governance, even if the budget is just about fiscal governance. I will focus on three key assumptions that Chidambaram makes and one particular action that he takes in the budget. These will determine if the finance minister is rooted in reality as he takes measures to boost the economy.

The first assumption is to do with the nominal GDP growth rate for 2013-14. Every finance minister is tempted to be ambitious about this estimate, since a higher nominal growth rate is all that it takes for him to project a robust estimate of revenue collection. This, in turn, helps in presenting a rosy picture of the fiscal deficit — the difference between total receipts and total expenditure of the government. The deficit for the current financial year is estimated at 5.3 per cent of the GDP. Chidambaram has kept the expenditure on a tight leash so far. So he will rein in the deficit and keep it below the estimate. But next year is an election year. A nominal growth rate of over 13-14 per cent will raise eyebrows. A real growth rate of 6.5 per cent and inflation of 6.5 per cent is the best case scenario for next year. Disinvestment proceeds should add a chunk to total receipts, and for that the finance minister has to ensure that there is enough to attract foreign investors.

The budget also assumes a certain rupee-to-dollar exchange rate. In the expenditure projections for the full year, this number is implicit — how many rupees will fetch you a dollar. This is because India's imports are significant, the biggest item being crude and then, of course, gold. We have to pay for our imports in dollars. The government, we know, does not pass off the entire cost of importing global crude oil while pricing petrol, diesel and cooking oil domestically, and bears part of it. A very modest exchange rate of 50-51 to a dollar will understate the oil subsidy burden of the government. Almost throughout the 2012-13 fiscal so far, the rupee has hovered over 52 to a dollar. It was lowest last June, at 57.15, and currently stands at over 54. A recovery in growth will generally bring with it higher oil consumption. Given the size of our current account deficit, estimated at 4.2 per cent of GDP for the full year, a very modest rupee-dollar exchange rate assumption will make the budget look good immediately. But it could turn ugly as the year progresses if growth does indeed pick up, fuelling oil consumption in the process.

Related to this is the level of global crude prices that Chidambaram assumes while projecting his expenditure. Till January this fiscal, the country imported crude oil to the tune of $140 billion, 11.5 per cent higher than the corresponding period last financial year. The monthly average crude oil spot price, between April 2012 and January 2013, was about $102 a barrel. The International Monetary Fund projects a small uptick in global growth in 2013, 3.5 per cent from 3.2 per cent in 2012. Oil prices depend on too many factors, but going purely by the growth impulse, it will be disappointing if it is assumed at a lower level than $90 a barrel. Lower oil price will again understate expenditure and the government's subsidy bill.

That's about the three assumptions. The only action to watch out for is on the expenditure front. Chidambaram, one believes, will not succumb to the normal pre-election sentiment of splurging on populist schemes. He may make some real expenditure cuts in some of the schemes whose merits have been widely questioned. This includes the employment guarantee scheme. Also, he will be eagerly watched for any incremental spends, such as those required for food security. Given the precarious situation that India's economy is in — high current account and fiscal deficits — no finance minister can afford mistakes.

Chidambaram knows that there is a very real danger India's ratings can turn junk if we fritter away any opportunity to demonstrate prudence. Poor growth, with no respect for the need to curb the deficit, is a sure recipe for disaster. Clearly, growth is critical, but temporary puff-ups will not help. The economy's fundamentals need to be sorted out first so that growth is sustainable. The budget must attract foreign capital flows, not just to ensure that the rupee remains anchored, but also to finance the bloated current account deficit. It must be sober, credible and austere, all three.

The writer is editor, Mumbai; pv.iyer@expressindia.com

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