Tuesday, July 15, 2014

Some late thoughts on the budget

I was travelling, so didn't have a chance to comment on the budget (not a bad thing, considering the deluge to which hapless readers and TV reviewers are subjected on budget day and thereafter).

Well, the budget is a tribute of sorts to the UPA government. I don't mean this a criticism of the present finance minister or the government. They may have been vociferous in their criticism of the UPA when they were in opposition. Now, having assumed office, they are better placed to appreciate the constraints, both political and economic, very well. So, there is very little of the "second generation" reforms in the budget. The unwillingness to tackle subsidies is glaring. I also noted the reference to maintaining the "public sector character" of banks. That means the NDA government will not allow government shareholding to fall below 51%; the PJ Nayak committee report on bank governance has been ignored.

The budget is mostly an attempt to balance the books and keep the fiscal deficit under control so as not to rattle the credit agencies and the markets. Has the finance minister done a good job of that? Will the fiscal deficit target of 4.1% be met? The task is difficult, chances are that the deficit will end up at around 4.5%, but it's not impossible, seeing what Chidambaram did in FY 2014-14- ruthlessly cut expenditure in order to meet the target.

I guess Jaitley will do likewise if the revenues he expects don't materialise. There is, of course, a price to pay. The combination of fiscal and  monetary compression will mean that growth will be the casualty and growth in 2014-15 will end up 5-5.5% rather than 5.5-5.9% as projected. What astonishes me is that most of the media criticism has been mild; a budget such as this coming from the UPA would have been savaged. Not that the media would be right in doing so. My own reading, as I said, is that both the UPA and the NDA governments have read the political economy correctly. There is only so much that can be done in the present environment without seriously antagonising the electorate.

Let me now turn to the infrastructure sector on which the FM has lavished a lot of attention. The broad trend in recent years is for the government to reduce its own role in investment and to leave it to the private sector to drive infrastructure through the mechanism of public private partnerships (PPPs). Jaitely's budget seeks to accentuate this trend. According to one estimate, central government investment (directly and through support to the state plans) in infrastructure will be only 15% of the total. The rest is left to the private sector.

That's a tall order. For two reasons. First, in all of the developed world and in China, infrastructure development has been largely the domain the state. The FM mentioned that India has the highest number of PPPs in the world today, 900. How come we lead in this one respect while lagging behind in so many others? Could it be that the world has understood that PPPs are the not the best way to develop infrastructure?

Secondly, the PPP model we have used thus far is broke. Every component has to be reworked: the bidding norms, the concession terms, dispute resolution etc. There are issues extraneous to the model that need to be fixed: land acquisition, environment clearances, fuel supply linkages etc. In other words, there are major institutional issues that need to be addressed in order to get PPPs going again. This won't happen in a hurry.

The budget overlooks these realities and instead expects that private investment will be lured by improving returns at the margin through various means:

  • Investment infrastructure trusts whose interest income will be exempted from tax\
  • Tax holiday upto 2017 for power companies
  • Less onerous CRR, SLR and priority sector norms for banks that raise long-term funds for infrastructure which will help banks lend at lower rates
All these will help improve returns. But the problem today is not the level of returns. It is variability in returns or risk. And that requires fixing the issues mentioned above. Once the demand side is taken care, supply of finance can be tackled.

I have serious reservations about the way bank finance for infrastructure is sought to be made cheaper. Lowering statutory requirements raises issues of risk management. A simpler way to reduce lending rates for infrastructure would have been been to allow banks to issue tax-free bonds. (Or simply revive development finance institutions with access to concessional finance). I also doubt that the level of bank recapitalisation budgeted, around Rs 11000 crore, suffices to give banks the confidence to increase loans to infrastructure in a big way.

There is one other issue in infrastructure today which cannot be ignored. Many of the leading companies are neck deep in debt. Their loans have to be restructured, they need to monetise their assets. Only then will banks will confident enough to lend. The bottomline: I can't see the infrastructure sector reviving in the near future.

Two people will be greatly disappointed with this budget, the BJP's mentors Jagdish Bhagwati and Arvind Panagariya. Wonder what they have to say. 

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