Is not, and should not be , a full budget

Financial Express, 17 February 2009

With elections around the corner, fairness demands that the government desist from making announcements that will target narrow constituencies. The UPA government has correctly announced nothing of importance in the `Interim Budget 2009-10' speech. While we live in an exceptional macroeconomic environment, fairness in elections is even more important than macroeconomic stabilisation. The UPA can and should chip away at economic policy reform - but only in areas that are invisible to voters.

Fairness in elections

Governments in power have an incentive to do short-sighted things, as elections approach, to woo voters. There is a greater risk of sectarian programs that target marginal constituencies. The international experience has shown that when the legislature controls the central bank, monetary policy is likely to ease in the period before elections, triggering off inflation after elections.

A sound institutional architecture requires appropriate checks and balances. As an example, central banks worldwide have been reformulated around the principles of independence, accountability and transparency so as to get away from election cycles. In India, one element of these checks and balances is the notion that when elections are around the corner, there is a shut period where the government is not allowed to make announcements.

In recent weeks, the media tried to hype up the speech of 16 February as being a `budget announcement' or even a `mini-budget announcement'. However, any serious effort at formulating economic policy would have been improper. In early 2004, the NDA government had refrained from making announcements after mid-January. In similar fashion, the UPA government has been fair in avoiding any announcements. This is as it should be.

Some argue that we live in exceptional macroeconomic conditions, which require exceptional actions by the government. It is argued that the desperate need of the hour is a massive fiscal stimulus, such as announcing large programs of infrastructure expenditure and/or tax cuts. Even if this were true, fairness in elections is more important than macroeconomic stabilisation. The UPA government has done the right thing by eschewing any adventures of this nature. Fairness in elections requires that any decisions that can influence the thinking of an ordinary voter should not be announced. On a large fraction of issues in economic policy, then, we will get back to the normal rhythm of policy debates and announcements only after the next cabinet is in place.

Progressing with economic policy that's invisible to voters

The only things that the UPA government can work on from here on are the areas of work which are invisible to voters. There is a long list of areas where such attention is merited.

We are indeed in the midst of an unprecedented macroeconomic environment. Fiscal policy in India has limited capabilities, owing to debilitating fiscal weakness, and in any case fiscal policy is now out of the picture owing to impending elections. Monetary policy has done many things right in recent months, but monetary policy in India is quite feeble. RBI commands little influence over the economy by changing the short-term interest rate, owing to the malfunctioning `monetary policy transmission'. When the RBI cuts rates, not much happens to the economy.

As a consequence, we in India are in the midst of a business cycle downturn that is not ameliorated by properly structured fiscal policy and monetary policy frameworks. In a downturn, firms suffer from adverse shocks to cashflow. In the short term, many firms are suffering from operating losses. Bluntly, they are spending more than they are earning. The only away to sustain this for any period of time is to bring in new financing. This emphasises the role of finance as a tool for coping with the business cycle. Firms that have little access to debt or equity capital are more likely to fold up, thus exacerbating the downturn. Firms which are able to buy time by the injection of a `breath of life' of equity and/or debt capital are able to stay alive and bide their time waiting for conditions to improve.

Financial sector policy is thus of critical importance in combating a downturn. There is an urgent need for financial sector reforms in India, so as to improve access to financing for myriad firms, large and small, spread across the country. Interestingly enough, these reforms are feasible even today, because financial sector reforms are not concerns of voters. Whether FIIs are permitted to trade in currency futures or not; whether banks are permitted to give loans against corporate bonds as collateral or not; whether RBI or SEBI regulates the bond market: these kinds of questions matter to the economy as a whole but will not be seen by the election commission (or the opposition) as unfairness in elections.

The UPA government has mapped out this space through four committee reports: the R. H. Patil report on the corporate bond market; the Percy Mistry report on international finance; the Raghuram Rajan report on domestic finance and the Jahangir Aziz report on debt management. Even today, it must act on these recommendations.

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