Jul 09, 2014

    Budget comes first for Modi, not thanking voters

    IN INDIA, a new government's first post-election budget is usually a time to hand out rewards - freebies and tax cuts for the ruling party's loyal supporters.

    This might seem like good politics as well as good manners. But if Indian Prime Minister Narendra Modi wants to meet the high expectations that markets have set for him, he needs to take a different path when he presents his budget tomorrow.

    At between 7 and 9 per cent, the combined fiscal deficit of the central and state governments has been unsustainably high for years.

    The then ruling coalition had slashed taxes in 2008 to combat a fiscal crisis, and it decided to go slow in rolling these back. It increased subsidies for oil, fertilisers and food. It announced big increases in government support prices for crops, helping farmers but stoking food inflation.

    At first, this spending spree stimulated the economy. But a slowdown followed, exacerbated by a global downturn.

    The central bank raised interest rates, but these hit production without curbing prices. Rating agencies threatened to downgrade the country's debt, and the government responded with savage cuts in capital spending. At the same time, the threat of corruption investigations paralysed decision-making, so project approvals froze.

    Result: Gross domestic product (GDP) growth was almost halved, to 4.6 and 4.7 per cent, respectively, in the Congress party's last two years in power before Mr Modi's blowout victory.

    The lesson for him is clear: If you start with soft budgets, you will win only temporary popularity.

    Mr Modi is enjoying a honeymoon with voters and political supporters. Cutting it short could be the best antidote against a divorce down the line. This means disappointing all sorts of constituencies that contributed to the win.

    One of his allies in the southern state of Seemandhra, for instance, promised during the campaign to waive repayment of bank loans made to farmers and self-help groups. The local party now wants him to help pay for its foolish pledge.

    The Prime Minister should refuse. His own budget is under strain. Besides, such brazen favouritism to one state would explode all his claims to good governance. Loan waivers reward defaulters and make honest repayers look foolish.

    The core support for his party comes from the Indian middle class. So, the news media is full of speculation that Arun Jaitley, his finance minister, will reward these voters by raising the income-tax exemption limit to 500,000 rupees (S$10,390) per year from 200,000 rupees.

    This would be fiscal suicide. Instead, the new government should focus on plugging loopholes, reducing the huge array of existing tax exemptions and exceptions and improving tax administration.

    Fuel subsidies account for almost 1.5 per cent of GDP. They are not even targeted at the poor or the needy, benefiting mostly big farmers, the middle class and owners of luxury diesel cars.

    Mr Modi needs to raise the government-designated price of oil products such as diesel and kerosene immediately and phase out price controls completely within two years.

    His election platform promised massive new spending on infrastructure and health. Where will all this money come from? Private infrastructure companies cannot be the solution: Most are deep in the red, unable to pay their bank debts.

    State-owned banks, which account for 70 per cent of all banking, need almost 6 trillion rupees of fresh capital by 2018 to meet the new Basel norms. But New Delhi lacks cash for recapitalisation.

    In sum, the situation calls for tough decisions and stringent budget discipline. This must be accompanied by good policies and a slashing of red tape to revive economic growth.

    Only then should Mr Modi embark on his promised infrastructure spending spree. This approach will disappoint his gung-ho supporters in the short run. But it will yield dividends when he has to face the voters again.