Obfuscating official language is something we have all got used to. Typically such language is not intentional but just a matter of habit that keeps the public guessing. Such guessing games were not consequential when market participants were few belonging to the same boys club. But things have changed. Today these guessing games can end dangerously. Yesterday’s market mayhem of a drop of nearly 900 points was such an example. A completely avoidable event brought on by a Budget that neither elaborated its intentions and implications nor spoke plainly. True, the market was expecting everything from this Budget, including perhaps world peace, but there was little in the Budget that warranted this outsized reaction. Instead, poor management of market expectations and shoddily communicated messages turned a reasonably well constructed Budget (under the circumstances) into pushing the market into a tail spin.
Let’s begin with the numbers. We had expected a deficit of 6.6 percent of GDP, so the announced target of 6.8 percent was not surprising, especially since it was entirely on account of divestment. We had assumed around Rs 15,000 crore, while the budget had virtually nothing. Ministry officials spent the better part of yesterday’s afternoon trying to explain why even though the President’s speech, the Economic Survey, and the Budget itself had clearly stated the government’s intention to divest up to 49% of its holdings in listed public sector companies and even undertake IPOs, the Budget contained no target or estimate for divestment.
The government plans to use around Rs 33,000 crore from the previously issued MSS bonds in financing this year’s budget, which it is accounting as market borrowing. That’s the right thing to do.
But including this number in the overall net borrowing number without alerting the reader gives the impression that all of the announced Rs 390,000 crore borrowing will be done anew. The MSS funds had been raised two years ago! Excluding the MSS and any reasonable assumption about divestment would put the net borrowing number closer to Rs 350,000 crore without changing the fiscal deficit target. The market reaction to this number would have been far less vicious.
We did not expect anything significant in terms of revenue measures. And on the face of it the revenue measures look like nickels and dimes except for the elimination of the fringe benefit tax and the increased income tax deduction. But a careful reading would suggest otherwise.
For example, pension trusts would be exempt from income tax, STT, and dividend distribution tax. This is important to spur the private pension market, which could turn out to be key in intermediating savings in India. But these trusts will come into being only after the PFRD Act is passed, which my guess is that the government will do soon. But the budget just glosses over these tax cuts without elaborating their import.
On the expenditure front, we did not expect any new large infrastructure initiative just expanded outlays on existing flagship programmes such as Bharat Nirman. The budget was broadly in line with this. As before, infrastructure spending will continue to be pushed through PSUs and PPPs. We had, however, expected increased refinancing for infrastructure projects. This amount was not explicitly increased, but the government’s refinancing arm, IIFCL, can now refinance 60 percent of bank loans to critical PPPs.
Although there are signs of economic recovery in India, they remain very tentative. Given this, the government could not turn away from providing further stimulus. However, it was important to frame this stimulus within a medium-term framework of fiscal consolidation. Key elements of such a framework, in our view, would have been the introduction of a nationwide GST; reforming the oil and fertiliser subsidy programmes, continued divestment, and a return to FRBM targets. The Budget mentions all this, including subsidy reforms which will likely be politically difficult. But much of the language in the Budget is terse to the point of saying almost nothing. In sharp contrast, when Ministry officials were asked about medium-term deficit targets they quite openly provided specific numbers, 5.5 percent of GDP in FY11 and 4 percent of GDP in FY12. Many of the market’s fears and concerns emanating from this year’s large fiscal deficit would have been calmed if these explicit targets were mentioned and elaborated in the Budget document. By now the government should know that no one really considers the Budget numbers to be cast in stone. They are missed. All that the public wants is an explanation as to why that happened.
The market was expecting way too much out of this Budget. But even with such runaway expectations, yesterday’s market mayhem could have been avoided if the government had decided to speak plainly, elaborating its plans and intentions with numbers. Speaking plainly is important because it limits the space for interpretations and reduces unwarranted uncertainty. Numbers are important because they anchor market expectations. By doing neither the government added more uncertainty exactly when the market was looking towards the Budget for clarity and guidance. In times of uncertainty the government needs to provide assurance, not add to it through dangling thoughts and obfuscating language.
It could well turn out that divestment is substantial, market borrowing less than budgeted, and significant reforms are rolled out in the next few months as the government apparently intends. The equity market would then rally, the rupee strengthen, and bond yields decline. But in the interim we will have to contend with unwarranted uncertainty brought about by market cynicism and doubts.
The author is chief economist for India, JP Morgan Chase. These are his personal views