The farm-loan waiver will, inevitably, start a flurry of me-too announcements. Expect to see rival political parties engage in an auction of promises offering sops – free power, free rice, free televisions, free saris, free sandals – to their own target constituencies. The public finances, at the state and central level, can hardly support this largesse. Adding together state and central deficits, as well as off-budget subsidies, the fiscal hole is close to 7.5 per cent of GDP. At a time when inflation is climbing and India is struggling to raise the $500bn it plans to spend on its roads, railways, ports and power supply over the next four years, an extended period of pro-cyclical fiscal profligacy will jeopardise the sustainability of India’s growth story.
More worrying still is that the steady deterioration in the quality of public spending is correlated with the relentless fragmentation of the political system at the national level. The decline in the share of the single largest political party in the national assembly since the mid-1980s, when the Congress party still bestrode the political stage, has gone hand in hand with a steep decline in the proportion of government spending on development items. Although the headline data for central government expenditure indicates an improvement in the share of development spending, this has been more than offset by the growth in off-budget subsidies of oil, food and fertiliser.
The share of development expenditure in total government spending, including all off-budget items, has declined from about two-thirds in the mid-1980s to barely 50 per cent today, according to Morgan Stanley. At the same time, the single largest party’s share of parliamentary seats has fallen from about 80 per cent to just over a quarter. Since the continuing rise of regional and caste-based parties, at the expense of the Congress party and the Bharatiya Janata party, the two largest national parties, is a trend most analysts agree will continue for the foreseeable future, investors have reason to be even more concerned about the quality of future public spending.
Investors have for too long been ready to believe that recent high growth rates – averaging 8.8 per cent over the past five years – can be sustained in the absence of a single-minded government that is determined to drive forward the liberalisation of the economy. This week’s sharp stock market falls in the wake of the budget suggest that investors are once again inclined to punish poor policymaking by weak coalition governments, rather than to ignore or even reward it. One managing director at Goldman Sachs recently confided – only half-jokingly – that he had developed a crude rule of thumb for estimating the fair value of Mumbai’s Sensex share index in an era of coalition politics.
Take the number of seats in the 543-member parliament won by the single largest party, he advised, and multiply it by 100. Under this rough rule, the Congress party’s 145 MPs would suggest a value for the Sensex of 14,500. In the aftermath of the May 2004 election, when the Sensex fell below 5,000, this would have seemed absurdly optimistic; and on January 8 this year, when the market peaked at about 21,000, it would have looked ridiculously bearish.
It has, of course, obvious flaws as a valuation tool, but with the Sensex now down 20 per cent to well under 17,000, it looks quite conceivable that it may end up about right on election day.
India – Politics & Policy
When economics yields to politics
Published: March 3 2008 19:18 | Last updated: March 3 2008 19:18
The Indian government – which believes economic growth will slow to 8.7 per cent in the fiscal year to March 31 from 9.6 per cent the previous year – can argue that it remains fiscally prudent in spite of the stimulus provided by this budget. The official fiscal deficit for 2008-09 is forecast to fall to 2.5 per cent of gross domestic product from 3.1 per cent a year earlier.
Unfortunately, that is not the whole truth. The central fiscal deficit number is flawed because it excludes expensive subsidies for oil, food and fertiliser and does not take into account the deficits of the Indian states. Even the relatively modest official economic growth forecasts may prove too ambitious.
Just as it has shied away from necessary reforms to liberalise the labour market and the financial sector, so the Congress-led coalition has failed to invest heavily in the roads and schools that India desperately needs. Instead, the surging revenues arising from a period of rapid economic growth have been channelled into wasteful subsidies and make-work schemes and often skimmed off by corrupt officials.
India’s budget remains horribly skewed towards unproductive spending. It is true defence spending rose only 10 per cent, compared with a 20 per cent increase for education, but annual military expenditure of $27bn is still excessive in a country with so many poor.
The next shock to the fiscus is likely to be the outcome of the once-a-decade pay commission for the Indian public sector, which is due within weeks and tends to overwhelm the most prudent government’s budgetary defences for two or three years. With an election looming, things can only get worse.