Dream Budget, Hard Reality

The facts are clear. The economy has slowed to about a 4-5 per cent growth, a steep decline from the above-6.5 per cent growth in each of the last three years. While there is some nonsense talk of a recession, it is more accurate to term it a growth recession—a decline in growth below its normal trend. The inflation rate has also declined—something that most commentators have noted, but not analysed. The wholesale price inflation is at a 20-year low of about 3.5 per cent—a decline of 3 per cent over the last year. Consumer price inflation has declined by over 4 per cent in the last year and is now hovering around 4-5 per cent.

The fact that the economy is growing at less than 5 per cent has precious little to do with the 'dream' budget. Indeed, one can reasonably argue that if it had not been for the expansionary budget, growth would have been lower. This, unfortunately, is in the nature of what economists call a 'counter-factual' statement. One does not know what would have happened had taxes not been lowered, but given other policies (more of which later), it is a safe bet that growth would have been lower had the dream budget not occurred.

But economists cannot be let off that easily. How can one 'prove' that the budget was actually a good budget? Since the economy isn't growing faster, isn't that proof that such tax-cutting policies do not work? Not so, because there can be other factors which affect the growth path of the economy. Let's look at four such determinants:

Interest Rates: The impression conveyed by the RBI that interest rates have declined is only a half-truth. The glass-is-half-empty version states that real interest rates have actually gone up in the last year. This is based on simple arithmetic. The prime lending rate last year was 14.5 per cent and inflation 9 per cent (consumer price index) to yield a real interest rate of 5.5 per cent; at present, consumer price inflation is less than 5 per cent while the prime lending rate has declined to only 13 per cent, yielding a real interest rate of 8 per cent. The mirage of a half-full glass is the assertion that interest rates have declined; the reality is that the real cost to borrowers has gone up. Any wonder then that growth rate is declining and there is over-investment in government securities?

The Rupee: One thing has changed since the halcyon days of July 1997 and before—everybody is an expert on the rupee. And not just the chattering classes or their representatives writing pieces with a learned air. After all, if the RBI, with all of its experts, does not know what the real value of the rupee should be, why should a stockbroker's guess about the economics of the exchange rate be any worse? This democracy on the rupee is heartening and suggests that it won't be long before the control-wonks give up their stranglehold on determining, by fiat, an all-important price.

For the moment (years), however, the damage is done and continuing. By achieving the impossible—the second strongest currency in the world and that too in a poor country—the authorities have also ensured that trade does not become an important handmaiden of growth. With our competitors cheaper by 20 to 40 per cent, is it any wonder then that India is in the grips of a growth recession? What can a dream budget do when there is the continuing nightmare of the rupee as "the strongest currency"?

East Asian Crisis: This has provided the seemingly perfect excuse for wrong monetary and exchange rate policies. How can India grow when the world around is collapsing? Good point, but wrong. India's growth recession was well under way prior to this crisis. This excuse should be reserved for use by the next government!

Political Uncertainty: In Casablanca, police chief Claude Rains orders his underlings to "round up the usual suspects" for a murder his friend Humphrey Bogart has just committed. The refrain, "political uncertainty caused the crisis", is not much different and equally hilarious. What's not funny is when serious analysts offer this excuse. Have these wannabe experts considered the reality that most reforms, and high economic growth, have been achieved in India in times of political uncertainty? And the obverse—slowdown of reforms and growth—when there is political certainty? The '97 dream budget and the major reforms of '91 occurred amidst considerable political uncertainty; while a brake on reforms occurred when Narasimha Rao had managed a Lok Sabha majority and there was full certainty of him continuing for another three years.

 So do not look far, or look for complicated excuses, to decipher what went wrong with the dream budget. It was very good policy then and remains so today. What went wrong was good old monetary and exchange rate policy. But there is hope for the future as interest rates are being deregulated and the exchange rate policy is moving towards enlightenment.