Budget 2011-12 to focus on inflation and growth
The Union Budget 2011 will be presented by the Finance Minister, Pranab Mukherjee, in the midst of rising global commodity prices, which can increase inflationary pressure. Even though the Government is likely to stress on growth as well as economic reforms, it will have to adress the key issue of inflation in the first place. As the Economic Survey has also warned, food inflation has been in double digits for 76 weeks since June 5, 2009. “The inflationary pressures on the domestic front are likely to be exacerbated by the higher levels of global commodity prices,” said the Finance Minister while tabling the Economic Survey for 2010-11 in Parliament on Friday prior to his Budget presentation today (Monday).
Further, the easy money policy being followed by developed nations and the political turmoil in the Middle East will have a bearing on headline inflation at home.
The Bombay Stock Exchange benchmark 30-share index, Sensex, lost 8.2 per cent since the Reserve Bank of India (RBI) hiked interest rates and revised upwards its inflation estimate. With the increases announced on January 25, the RBI has cumulatively increased the repo rate by 175 basis points and the reverse repo rate by 225 basis points since mid-March 2010. Additionally, the cash reserve ratio (CRR) was increased by 100 basis points.
The Survey has also mentioned the projections of the International Monetary Fund (IMF) of continued pressure on commodity and non-commodity prices. The Middle East turmoil has already taken global oil prices to a two-year high of around $120 a barrel. Even though the government has already said that it expects inflation to moderate to around 5 per cent by June-July and its policy makers like Planning Commission Vice-Chairman Montek Singh Ahluwalia gyrates the topic of inflation by saying “it will come down soon”, inflation and inflationary pressures are continuing unabated making common man's life miserable. Though the Government favours a higher growth rate even at the cost of rising inflation, markets believe that high inflation would endanger an ambitious growth expectation.
“Primary articles inflation has been an issue due to surging demand and supply shortage,” said K. Ramanathan, Chief Investment Officer-Single Manager Investments, ING Investment Management India. He said more focus needs to be there on increasing acreage/arable land and productivity in agriculture. Focus should also be there in reducing risks due to poor monsoon. While manufacturing inflation has been benign so far increasing global commodity, especially oil, prices have the potential to derail economic growth. Reduction in import duty on crude and excise duty on petrol and diesel would also reduce inflationary pressures to some extent.
“The formulation of this budget against the current challenging macroeconomic backdrop is likely to be a difficult task for the government. Given upcoming State elections, drastic expenditure reforms are unlikely in the 2011-12 budget,” said Anubhuti Sahay, Economist, Standard Chartered Bank.
Also, the growing perception that government policies, or a lack thereof, have worsened the fiscal situation leaves little room for a significant deviation from the fiscal consolidation path, at least in the initial budget announcement. Investor sentiment has already been dented by downside risks to growth and upside risks to inflation. While announcing a fiscal deficit of 5.1 per cent of gross domestic product (GDP) for 2011-12 on the heels of a 5.2 per cent deficit in 2010-11 might be seen as a positive step towards deficit reduction, the inability to meet the 4.8 per cent target set in the government's fiscal consolidation plan is likely to weigh on market sentiment.
“We are not convinced that the government can do much in the short-term on inflation and growth,” stated a report of Nomura Financial Advisors and Securities (India) Private Ltd. Furthermore, the report states that the budget could entail the risk of a rise in excise duties, which would put further pressure on existing margin pressures and inflation. “We do not see much respite for interest rates which we expect to remain elevated amidst ongoing systemic liquidity shortages and a high level of expected market borrowings.” Fiscal imperatives and a limited ability to hike expenditure could further cap upside to systemic liquidity.
The current bout of inflation in India is primarily being driven by rising global commodity and domestic food prices. Management of inflation and inflationary expectations is the domain of the central bank which can, at best, tweak short-term rates in the hope of reining in aggregate demand. The global commodity cycle, the key determinant of manufacturing and fuel inflation, constituting about 80 per cent of the WPI index, is exogenous to the government.
Food inflation is now morphing into a structural feature and is being driven by rising food demand in a fast-growing economy plagued by a creaky food supply chain, endemic inefficiencies and poor infrastructure in the critical agricultural sector. “This year, inflation seems to be driven by demand factors, despite higher supply levels,” the Survey said. This is in contrast to the fact that in the last fiscal, inflation was mostly driven by a deficient monsoon, leading to scarcity of certain food products like pulses, cereals and sugar.
“We expect the budget to be a tight rope balance on the fiscal deficit side,” said Mr. Ramanathan. As per the fiscal deficit reduction road map, the deficit is to be cut to 4.8 per cent of GDP.
Higher claims on subsidies (food, fertilizer and oil), pressures to increase social spending in the background of several State elections and absence of one-offs like the 3G bounty (which accounted for almost 1.3 per cent of GDP in 2011) would be the challenges the finance minister has to contend with.
One way of increasing revenue would be to normalise the reduction in excise duty and service tax to pre-crises levels. Possible increase of 2 per cent in both these accounts can be expected in the budget. Another source of increased revenue would be increasing MAT rates to align with the 20 per cent rate proposed in the Direct Taxes Code Bill, 2010. Buoyancy in tax revenue would continue due to sharp increase in nominal GDP growth. Given that this would be the last year of the current five-year Plan, there would be limited room for pruning Plan expenditure growth.
On the non-Plan expenditure side, interest payments and defence expenditure account for around 50 per cent and scope for reduction here is limited. Given the high global commodity prices and rising oil prices, the subsidy bill also would be substantially higher next year. In this backdrop, containing fiscal deficit to 4.8 per cent of GDP would be an arduous task.
The speed of the reforms process has perceivably slowed down in the recent past. Market participants would look for measures that indicate the government's resolve to continue with the reforms process. One such measure that could boost the market, according to Mr. Ramanathan, could be allowing FDI in multi-brand retail, defence (up to 49 per cent) and in insurance. Other measures that would give market confidence would be the passage of several pending bills like the Mines and Minerals Bill and Land Acquisition (Amendment Bill). Fiscal deficit number of 4.8 per cent as well as reemphasising commitment to increase investments in infrastructure, sort out policy and procedural delays in sectors like power and road transport would be other measures that could boost the market.
OOMMEN A. NINAN
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