The Congress Party was re-elected in May on a promise of economic populism that the country can't afford. On 6th July the government delivered on that promise. This is bad news for India, and especially for its poorest citizens. The budget outlines three priorities: 9% economic growth, "inclusive development" and better public services. It would achieve these outcomes by boosting spending by 36% to 10.2 trillion rupees ($211 billion), mostly on handouts and infrastructure. No major public-sector rationalization or private-sector liberalization were announced.
This is in effect a revival of India's socialist past and a rejection of the 1990s reforms that gave India the best kind of "inclusiveness": economic growth. The Govt thinks that creating more 'yojanas'(schemes) and throwing money at them will eliminate poverty. Infact statistics show the exact opposite. More people were lifted out of poverty in the last 18 years(1991 to 2009) than in the previous 44 years(1947 to 1990).
Going back to 70's economic formula - government spending, large deficits and high interest rates will stifle economic growth and increase poverty. The 9% growth achieved in the last 4 years(2004-2008) was due to India's private sector. Mr. Mukherjee seems to understand some of these ideas, at least in principle. Yesterday he said private investment was "the principal growth driver" of India's boom years. Yet he did nothing to ease private industry's tax burden, cut regulatory red tape or liberalize the country's restrictive foreign direct investment regime. He also praised Indira Gandhi's 1969 bank nationalization as "wise and visionary" and "an inspiration".
The 9% growth achieved in the last 4 years was powered by foreign capital inflows(FDI, FII, Private equity, Venture Capital). These flows have slowed due the credit crisis. The main reason why Indian industry is dependent on foreign money is that the Government swallows a large portion of the domestic savings to finance its fiscal deficit. Things on this front do not look encouraging. In the financial year 2007-08 (i.e. between April 1, 2007 and March 31, 2008) the government spent Rs 1,26,912 crore more than what it earned. For the financial year 2009-10 (i.e. between April 1, 2009 and March 31, 2010), the government plans to spend a whopping Rs 4,00,996 crore more than what it earns.
When the government spends more than what it earns, it borrows by issuing financial securities known as treasury bills and bonds or government securities. So in the year 2007-08 the government borrowed Rs 1,26,912 crore to service its deficit. And in the year 2009-10, it will have to borrow Rs 4,00,996 crore to fund its deficit. Large Government borrowings are already leading to an increase in interest rates. The yield on the 10 year Gilt is already at 7% and could rise to 7.5%. The increase in the cost of borrowing could dampen investment and consumer demand.
Pranab Mukherjee's Budget wallows in the optimism that "something will turn up" and restore the Indian economy to high growth while miraculously restoring a sense of balance to the mounting fiscal deficit. Apart from making some ritual genuflections to fiscal responsibility -- he remarked that it was important to return to fiscal deficit targets "at the earliest possible opportunity" and that "reforms were required" to curb the fiscal shortfall -- he offered nothing concrete. The very real risk of a sub-par monsoon this year could upset all hopes of a sustained recovery.
If Pranabda is counting on a developmental Deus ex machina to save the day, I would bet against him.
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