People's Democracy

Budget 2004-05: Backsliding On CMP

Prabhat Patnaik

THERE are two and only two possible trajectories of economic policy in the contemporary world: either to open up to global capital and commodity flows and let the domestic economy adjust to their consequences over which the government has little control; or to mould the domestic economy according to certain social objectives, in which case its openness to global capital and commodity flows must be restricted. This is why “liberalisation with a human face” is an impossibility. If the “human face” is to be preserved then restrictions have to be put on “liberalisation”. On the other hand if “liberalisation” is to be persisted with, then one has to forget about the “human face”, as the country has been doing for the last thirteen years. This is why there is a fundamental contradiction between the central thrust of the Common Minimum Programme with all its limitations (since it promises employment guarantee etc.) and neo-liberal economic policies.

BACKSLIDE ON THE CMP

The 2004-05 budget acquired importance in this context: which way is the UPA government going to move? And the answer is clear: it has chosen to persist with neo-liberal policies and backslide on the Common Minimum Programme.

Ironically, the budget has been hailed as being “pro-poor” and “pro-farmer”, and “having a vision for agriculture, irrigation and rural development”. Nothing could be farther from the truth. The outlay for the Department of Agriculture and Co-operation remains at the same level as the NDA’s interim budget, Rs 3014 crore. There is no additional outlay over what the interim budget had provided for the food-for work programme; and the extension of coverage from 1.5 crore to 2 crore families under the Antyodaya Anna Yojana had also figured already in the NDA’s interim budget.

Indeed, paradoxically, for a government committed to Rural Employment Guarantee, there is a marked decline in Central Plan outlay on rural employment compared to 2003-04 (RE), from Rs 9,640 crore to Rs 4,590 crore. True, the outlay for 2003-04 was inflated because several rural areas were declared “calamity-affected”, and the finance minister has promised financial assistance upon request this year too; but even if we remove this special component from both years’ figures the outlay actually decreases from Rs 4,751.25 crore to Rs 4,310 crore. If we take the outlay for the Department of Rural Development as a whole, again excluding the “calamity relief” component, the increase is meagre, from Rs 10,612 crore to Rs 11,437 crore. No doubt there are off-budget measures promised, such as the Rural Infrastructure Development Fund, and the doubling of credit to agriculture over three years, but the budget itself is extraordinarily niggardly towards agriculture and rural development, contrary to the promise of the National Common Minimum Programme.

The budget does bow in the direction of the Common Minimum Programme by raising the amount of budgetary support for the Plan by Rs 10,000 crore over the provisions of the interim budget. Of this however a significant amount of Rs 4,910 crore according to the Receipts Budget, which is financed by the two per cent cess levied on five taxes, should go for education. The remainder is too small to make much difference. By contrast, defence expenditure has gone up by Rs 11,000 crore over and above the sum provided by even the interim budget of the BJP-led government. Questioning the need for such an enormous jump in defence expenditure may not be de rigeur, but the contrast between the attitudes to defence and to rural development is quite striking, more characteristic of the NDA than of the UPA. It comes as no surprise that the NDA’s former finance minister Yashwant Sinha has expressed “satisfaction” over the increase in defence outlay while calling the education cess, perhaps the most positive feature of the budget, a “mindless act”!

What is dubious about the budget is not just its commitment to the Common Minimum Programme, but also its macroeconomics. The relentless pursuit of neo-liberalism, especially during the NDA years, had imposed a drastic deflation on the economy, compressing aggregate demand, and giving rise to a combination of unutilised industrial capacity, unsold foodstocks, and increased unemployment. Boosting domestic demand through increased government expenditure, and doing so via increased outlays in rural India, was the obvious need of the hour. The budget not only does not raise outlays in rural India significantly, it does not even give much boost, as it stands, to aggregate demand in the economy. This is so for two reasons: first, the fiscal deficit is supposed to come down from 4.8 per cent of the GDP in 2003-04 (RE) to 4.4 per cent in 2004-05, which is contractionary per se; and secondly, since a large chunk of defence expenditure would go for equipment imports, representing a demand leakage from the economy, the 27.7 per cent increase in defence expenditure, which significantly alters the composition of public expenditure, would have a further contractionary effect. In short, the budget as it stands does not free the economy from the scourge of deflation.

UNREALISTIC REVENUE ESTIMATES

But, as almost everyone recognises, the revenue estimates of the budget are grossly unrealistic. Income tax revenue is budgeted to rise by 26.5 per cent over the revised estimates of 2003-04, despite the fact that as many as 14 million tax payers out of a total number of 27 million tax assessees, are being taken out of the tax net. (This measure incidentally has to be rectified since in its present form it introduces anomalies such that people with higher pre-tax incomes end up having lower post-tax incomes in absolute terms compared to those with lower pre-tax incomes). Corporation tax revenue is expected to grow at an even more phenomenal rate, 40.4 per cent. The budget has of course increased the rate of service tax from 8 to 10 per cent and extended its coverage. It has also introduced an extremely innovative tax on stock market transactions, though it has removed the tax on long-term capital gains, entirely without any justification. (Interestingly, the introduction of a stock market transactions tax, in addition of course to capital gains taxation, and larger service sector taxation had been advocated by a Convention of economists, organised by Social Scientist and Sahmat, in Delhi on July 5). But a major assumption behind the revenue estimates is that a “tidy sum” would be fetched from all tax arrears, which is rather sanguine.

If, in the likely event of tax revenues falling short of budget estimates, the government cuts back on expenditures in order to meet the fiscal deficit target, then the deflationary scourge on the economy would persist and the Common Minimum Programme would remain even more of a chimera. But if the revenue shortfall gets covered by a larger fiscal deficit, then aggregate demand would receive a boost, and the Common Minimum Programme targets would appear less remote. True, even in such a case, we would not have used the best means of boosting aggregate demand, viz. through rural development expenditure; we would have essentially boosted demand through tax-cuts on middle income groups and some increase in Plan outlays (apart from the limited stimulus of defence expenditure). But at least there would have been some escape from the scourge of deflation.

FRBM ACT AN ABSURD APPROACH

It is important therefore that the finance minister should stick to his expenditure targets even in the event of a revenue shortfall. Such a course would no doubt be contrary to the Fiscal Responsibility and Budget Management Act, but that is a piece of legislation with which the government must not tie itself down. Inspired by Right-wing American ideologues like Buchanan, and meant to appease finance capital which is always opposed to State activism in matters of expenditure, this Act constitutes an insult to intelligence: “Thou shalt not have a fiscal deficit exceeding a certain proportion of GDP from now to eternity” cannot possibly be accepted as an immutable value-judgement. In the EU where there is a limit on fiscal deficits under the Maastricht Treaty, as part of the currency unification process, France and Germany have recently been violating the limit. In the US where the preachings on fiscal orthodoxy originate, the recent boom has been stimulated by a substantial expansion of the fiscal deficit under Bush. And yet in India the NDA has tied everybody’s hands by enacting this law which is theoretically absurd. In a demand-constrained system harping on keeping down the fiscal deficit is bad economics, apart from being socially retrograde; and this is all the more so when the expenditure financed by the fiscal deficit creates demand within the public sector itself and hence gives rise to larger public sector profits. (These theoretical arguments are discussed in my paper “The Humbug of Finance” in Frontline, February 4, 2000).

But quite apart from general theoretical considerations, there is a further specific reason why this Act is absurd at the present juncture. We have had huge foreign exchange inflows through FIIs. The RBI quite rightly has prevented the rupee from appreciating too much (and thereby precipitating a domestic de-industrialisation) by holding on to reserves which currently exceed 120 billion dollars. The high-powered money created as a consequence has boosted bank reserves even though the demand for bank credit from quarters which the banks consider creditworthy (which unfortunately excludes the peasantry and petty producers) has been limited. To support banks’ profitability the RBI has been putting government securities into their portfolios (in what are misleadingly called “sterilisation” operations). In the process however the RBI’s own holding of government securities has gone down dramatically, and with it the RBI’s own profitability.

This decline in RBI’s profitability is significant not only in itself but also for an additional reason, namely that much of the finance for rural credit through NABARD comes from the RBI’s profits. With the drying up of the RBI’s profits there has been a drying up of such funds for rural credit as well. It is extremely urgent that additional government securities be put into the RBI’s portfolio. For the government to refuse to do so because its hands are tied by the Fiscal Responsibility Act is folly beyond belief. In short, to have a Fiscal Responsibility Act that limits the size of the fiscal deficit when there are no controls over the inflow of finance from abroad is plain illogical. This bit of absurdity inherited from the NDA government must be done away with. At any rate the finance minister, if he is serious about his commitment to the Common Minimum Programme, should pay little heed to it.

INCREASING THE ROLE OF GLOBALISED FINANCE

Such commitment also requires a degree of control over capital flows into and out of the country, a pre-condition, as everybody must recognise after the Asian currency crisis, for overcoming thraldom to the caprices of globalised finance. Unfortunately, the budget not only shows no recognition of this, but has even taken a few limited steps towards increasing the role of globalised finance in our economy, such as raising the investment ceiling for FIIs in debt-funds from 1 billion to 1.75 billion dollars, and allowing banks, including foreign banks, greater latitude in the capital market. Indeed while the RBI governor had spoken recently with legitimate concern about “India becoming a parking place for dollars”, the finance minister in contrast wants to make the Indian capital market “attractive” for globalised finance.

Likewise his decision to raise the FDI cap in telecommunications, civil aviation and insurance is a thoroughly unwarranted step. His claim that the insurance sector meets the Common Minimum Programme criteria for FDI defies logic. The government-owned insurance companies in India have far greater experience, far larger reach, far greater social commitment, far greater expertise, and a far better record of honouring claims than foreign companies. To induct the latter into the economy serves no other purpose than gratuitously handing over a chunk of the lucrative Indian market to them. Raising the FDI cap in telecommunications hands over a strategic area to foreign investors, and in the process goes beyond what even the NDA had dared to do. And raising the cap in civil aviation amounts to giving foreign companies, again quite gratuitously, a share of the profitable Indian market at a time when the global industry continues to be in crisis.

The budget does of course put forward proposals to strengthen the healthy public sector enterprises with equity support of Rs 14 194 crore and to set up a Board for Reconstruction of Public Sector Enterprises to advise the government on the measures to restructure ailing Public Sector Enterprises. But, this healthy concern for the public sector is belied by the plan to disinvest in NTPC.

DOMINATION OF BAD ECONOMICS

An intellectual Gresham’s Law is operating in economics these days whereby bad economics drives out good economics. A completely erroneous proposition, namely that a fiscal deficit can be “closed” through disinvestment proceeds, has become “acceptable” and underlies the NTPC-disinvestment. But since those buying such equity do so not by skimping on their flow expenditures on consumption or even investment (surely even the government itself does not want private investment going down for financing the purchase of equity), covering a fiscal deficit through disinvestment proceeds is different from covering it through taxes, which do curtail flow expenditures. In fact, since the whole rationale for covering a fiscal deficit at all arises from the presumed need to ensure that the economy does not face excess demand pressures, “covering” a fiscal deficit through disinvestment is no “covering” at all. It merely constitutes an unnecessary and unwarranted transfer of public assets to the private sector.

The implementation of the Common Minimum Programme requires a strengthening of state government finances, which are in a crisis for no fault of theirs. The two main reasons for this crisis are: the implementation of the Fifth Pay Commission recommendations in line with the centre, which the states could not possibly avoid doing; and the exorbitant interest rates charged on central loans to the states. While the budget does reduce interest rates on fresh central loans to nine per cent, it is silent on the issue of debt write-off, which even the NDA government’s Planning Commission had proposed for non-Small Savings debt. And the eagerness to introduce VAT when there has been no study whatsoever of its consequences and when the centre’s promise of full compensation to states extends only to one year, is completely unjustified. (The case of Haryana which has made a revenue gain from the introduction of VAT cannot be cited to other states since Haryana is a virtually metropolitan state). The introduction of VAT has the potential to inflict great damage on state government finances, and hence should be eschewed until its consequences are better understood.

I began by saying that “liberalisation with a human face” is an impossibility, that the immanent logic of “liberalisation” pushes governments, no matter what their political complexion, into bowing to the caprices of globalised finance, and hence necessarily having to sacrifice welfare objectives (whose achievement therefore requires abandoning the neo-liberal path). But, of course the outlook of the UPA leaders is different. They believe that a reconciliation of “liberalisation” with the welfare of the masses is possible. The 2004-05 budget would have been the means for them to show how such reconciliation is possible. What we have instead is little of “the human face”, but a continuation, perhaps in a less brazen manner than the NDA, of “liberalisation”.