Why the foreigners are not impressed with Budget 2013

P-CHIDAMBARAMThe foreigners aren’t impressed with the budget presented by Finance Minister P Chidambaram yesterday. These include the rating agencies as well as investors who pour money into the Indian stock market.
As Ruchir Sharma, head of the Emerging Markets Equity team at Morgan Stanley Investment Management and the author of Breakout Nations told NDTV in a discussion yesterday: “On the fiscal side..a lot of the assumptions are being torn apart when people are analysing this budget.”
Government income is essentially categorised into two parts. Revenue receipts and capital receipts. Revenue receipts include regular forms of income which the government earns every year like income tax, corporate tax, excise duty, customs duty, service tax and so on.
Capital receipts include money earned through sale of shares in government-owned companies, telecom spectrum, etc. Capital receipts are essentially earned by selling things that the government owns.  Once something is sold it can’t be sold again and that is an important point to remember. Borrowing by the government, which is not an income, is also comes under capital receipts.
Revenue receipts for the year 2013-2014 are expected to be at Rs 10,56,331 crore. For the year 2012-2013 revenue receipts were budgeted to be at Rs 9,35,685 crore when the last budget was presented. This number has now been revised to Rs 8,71,828 crore. Hence, the government expects the revenue receipts to grow by 21.2 percent in 2013-2014. This projection has been made in an environment where the government is unlikely to meet its original revenue receipts target for the year. Also the revenue receipts this year will grow by 16 percent in comparison to last year.
So a 21 percent growth in revenue receipts is a fairly optimistic assumption to make. So if revenues collected are lower during the course of the year and the expenditure continues at the same rate, the fiscal deficit will be higher than it has been projected to be. Or expenditure will have to be cut, like it has been done this year. And that is not always a good sign.
Another point that this writer made yesterday was on the side of subsidies. For the year 2012-2013 subsidies were expected to be at Rs 1,90,015 crore. This has been revised to Rs 2,57,654 crore, which is almost 36 percent higher. This makes it very difficult to believe next year’s subsidy target of Rs 2,31,084 crore, especially when more subsidies/sops are likely to be announced during the course of the next financial year in view of the 2014 Lok Sabha elections.
As I said in the piece, the understating of subsidies has not been a one-off thing and has happened every year during the second term of the Congress-led United Progressive Alliance (UPA) government. So higher subsidies than budgeted might again mean a higher fiscal deficit or a cut in expenditure.
Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management, in a report titled The Art of Balancing, make an interesting point. They feel that the finance minister by projecting a fiscal deficit of 5.2 percent of GDP for this financial year and 4.8% of GDP might be giving an impression of fiscal prudence, but a closer look at the math reveals a different story.
As they write: “As trained accountants, we have learnt that sale of assets from the balance-sheet are one-off or non-recurring items. It is interesting that if we add back the estimates from sale of (telecom) spectrum and divestment of government companies (both non-recurring in our view), the ‘real’ fiscal deficit/GDP ratio for financial year 2014 shows no improvement over financial year 2013.”
The table below sourced from the Morgan Stanley report gives the complete story.

Table from Morgan Stanley
Table from Morgan Stanley

Once we take away capital receipts like divestment of shares and sale of telecom spectrum, which are essentially one-off sources of income from the equation, the real fiscal deficit  to GDP ratio comes in at a more realistic 5.6 percent of the GDP and not 4.8 percent or 5.2 percent that it has been projected to be. The point is that people aren’t buying the numbers put out in Chidambaram’s budget.
There is also very little acknowledgement of the mistakes that have made by the government over the past few years.
Ruchir Sharma, in his discussion on NDTV, put up a very interesting slide. The slide shows that India has consistently held rank 24-26 among 150 emerging market countries when it comes to economic growth over the last three decades. We thought we were growing at a very fast rate over the last few years, but so was everyone else. As Sharma put it: “The last decade we thought we had moved to a higher normal and it was all about us. Every single emerging market in the world boomed and the rising tide lifted all boats, including us.”

India's growth has remained consistent in the last three years
India’s growth has remained consistent in the last three decades

But now that we are not growing as fast as we were in the past, it is because of the slowing down of the global economy. As Chidambaram put it in his budget speech “We are not unaffected by what happens in the rest of the world and our economy too has slowed after 2010-11.”
Sharma pointed out the self-serving nature of this argument thus: “When the downturn happens it is about the global economy. When we do well it’s about us.” This is a disconnect that still persists, as is evident from Chidambaram’s statement.

India in the last four years was fed with artifuical fiscal stiumal, which led to high inflation
India in the last four years was fed with artificial fiscal stimulas, which led to high inflation

Another slide put up by Sharma makes for a very interesting reading. “Between 2008 and 2010 we implemented a massive stimulus, both fiscal and monetary, and that artificially inflated our growth rate to 13th in emerging market (as is evident from the slide). We were thrilled about it. It led to a massive increase in inflation and now this is payback time. Between 2010-2012, we fell to the 40th position,” said Sharma. So as more money was pumped into the economy, it chased the same number of goods and services, which led to higher prices or inflation.
So the massive spending by the government came back to haunt us. Inflation went through the roof. India’s rank among emerging markets when it came to inflation used to be around 60th. In the last few years it has fallen to the 118-119th position.

Chart:Morgan Stanley
As Sharma puts it: “This is the problem that India has today. India does not have an explicit inflation target. Most emerging markets and central banks work with explicit inflation targets. We have gotten away with it. I think the time is coming now for a more rules-based system. If we had an inflation target I doubt if we would have allowed inflation to increase at such a rapid pace”

Nations which have grown in the past at rapid rates have never had consistently high inflation. “And whenever inflation persisted over a period of time it always meant that the economy was headed for a major slowdown,” said Sharma. High inflation continues to be a major reason for worry in India.
Inflation in India has been a manifestation of a rapid increase in government spending. The total expenditure of the government in 2006-2007 was at Rs 5,81,637 crore. For the year 2013-2014, the total expenditure is expected to be at Rs 16,65,297 crore. The expenditure thus has nearly tripled (actually it’s gone up 2.9 times). During the same period the revenue receipts of the government have gone up only 2.5 times. The difference, as we all know, has been made up by borrowing leading to a burgeoning fiscal deficit. The next slide tells you how hopeless the situation really is.

Chart:Morgan Stanley
So India is really at the bottom when it comes to the fiscal deficit.

The point is very basic. We don’t earn all the money that we want to spend. As Chidambaram admitted to in the budget speech: “In 2011-12, the tax GDP ratio was 5.5 percent for direct taxes and 4.4 percent for indirect taxes.  These ratios are one of the lowest for any large developing country and will not garner adequate resources for inclusive and sustainable development.  I may recall that in 2007-08, the tax GDP ratio touched a peak of 11.9 percent.”
And this budget highlighted very little on how the government plans to increase its revenue receipts. In fact, Chidambaram even admitted that only 42,800 individuals admitted to having taxable incomes of greater than Rs 1 crore in India. This is a situation that needs to be set right. More Indians need to be made to pay income tax.
To conclude, let me say that the foreigners are worried and so should we.
The aritcle originally appeared on www.firstpost.com on March 1, 2013.
Vivek Kaul is a writer. He tweets @kaul_vivek