Budget 2013: UPA's fiscal mismanagement has weakened India's economy

What's his excuse? Manmohan Singh is India's third longest serving prime minister after Jawaharlal Nehru and Indira Gandhi. Unlike them, Singh, an economist by training, did not inherit a wobbly economy. In 2004, Singh assumed office with the economy growing at 8.1 per cent, the fastest in 14 years. In 2012/13, on the eve of his government's last full Budget before general elections, the economy is forecast to grow at five per cent, the slowest in a decade.

Only four times since Singh presented his landmark Budget as finance minister in June 1991 has the economy grown slower than five per cent a year. Now, he sometimes contextualises policy decisions by using 1991 as a reference point. Back then, Reserve Bank of India (RBI) had to pledge the country's gold abroad to deal with a crisis.

"The last time we faced this problem was in 1991," Singh said last September, during an address to the nation, justifying a diesel price increase. "We are not in that situation today, but we must act before people lose confidence in our economy," he added.

But the dramatic loss of momentum is hard to ignore. In 2010/11, the economy grew 9.3 per cent - the fourth fastest growth rate in the last 60 years - according to reworked government data released in January 2013. Analysts' gloom suddenly seemed misplaced, but not for long. Later in January, the central bank announced that India could, at best, grow seven per cent without triggering another debilitating round of inflation.

The anxiety increasingly articulated in key economic ministries keeps getting framed in the same chilling context: every year, at least 10 million young Indians enter the workforce, probably the largest in the world. With so many hunting for jobs, society can ill afford an economy running out of steam.

The disquiet, not expressed publicly, centres on how long it will be before things look up again. It could be a pretty long haul. D.K. Srivastava, chief of policy at Ernst & Young and former Finance Commission member, says: "It will take six to seven years to restore growth." And what kind of growth? "Potential growth of 8.5 per cent," he says.

Singapore-based Manoj Vohra, Director, Asia Pacific Economist Intelligence Unit (EIU), says: "The Budget is largely an exercise of putting together numbers to give an overall sense of direction."

Over nine years of the United Progressive Alliance (UPA), that direction has largely been South, partly because of mismanagement and partly because of the global economic slowdown.

According to the International Monetary Fund (IMF), India's problems are largely of its own making. The slowdown is "mainly led by falling infrastructure and corporate investment," the Fund concluded in its assessment of the economy, published this month.

IMF's conclusion echoes complaints from Indian industry about the glacial pace of decision-making. In December 2012, Ratan Tata, the outgoing chairman of Tata Group told the Financial Times that problems in India made other countries seem more attractive destinations. Tata's views reflect the incongruity of India's economic policy. The following month, Finance Minister P. Chidambaram stepped away from his Budget-making duties to travel abroad, hardselling India as an investment destination.

Could it be a coincidence that his tour came just a month after the head of a conglomerate with revenues of Rs 4.75 trillion in 2011/12 (which make it bigger than Karnataka's economy) seemed to find other parts of the world more inviting? (A trillion is 100,000 crore.) The answer to why the Indian economy has fallen off a cliff this decade lies in the UPA's 10 Budgets (including an interim one), beginning 2004.

The first Budget was built on high growth and a stable balance of payments. In 2003/04 - the preceding government's last year in office - the economy grew at 8.1 per cent, the fastest in 14 years. Besides, money from the developed world was chasing assets in India and other emerging markets, and the RBI grappled with the rather unfamiliar problem of plenty.

Things went from good to better. Between 2004 and early 2008, tax collection surged as the economy grew at over nine per cent for three years running. Tax collections as a percentage of gross domestic product (GDP) rose from 9.41 per cent in 2004/05 to a peak of 11.89 per cent in 2007/08, thanks mainly to the escalating profits of companies.

During this period, Chidambaram also introduced new taxes, such as the Fringe Benefits Tax and Securities Transactions Tax, and raised effective rates on the existing taxes. Parthasarathi Shome, adviser to Chidambaram at that time (and again since December 2012), wistfully referred to those years as a "golden age of tax reform" at a meeting in November 2012.

This "golden age" also saw an increase in spending. In 2005, a legislative framework on entitlementbased spending such as the rural employment guarantee programme was introduced. In 2009, finance minister Pranab Mukherjee would note that this kind of spending was unimaginable in the more frugal era of early 1980s, when he first became finance minister.

This was also the phase when the first warning signs on subsidies emerged. The government swept them off the balance sheet by introducing oil and fertiliser bonds. As it turned out, that was like skating on thin ice.

By 2008, signs of fiscal stress began to appear. The economy lost some of its momentum in the wake of the global financial crisis. By now, the UPA had begun to fritter away the gains of its early years. The 2008/09 Budget included a Rs 65,000-crore farm loan waiver. That year, three stimulus packages - spending and tax cuts totalling Rs 1.86 trillion or 3.5 per cent of GDP - were announced to revive the economy.

Shome's personal view was that the stimulus need not have been so large, but he acknowledged that it was "politically convenient". At a road show in London in late January, Chidambaram, too, conceded that the stimulus was excessive.

After the 2009 elections, the new UPA coalition appointed Mukherjee as finance minister. "If we had come to power in 2009, we would have been squarely blamed for ruining a perfectly healthy economy," says Yashwant Sinha, former finance minister and current Bharatiya Janata Party parliamentarian, explaining the economic situation that prevailed then. Mukherjee's tenure was marked by a reluctance to withdraw the fiscal stimulus soon. As the deficit rose, reaching 5.89 per cent in 2011/12, it stoked inflation, which blunted the impact of RBI's monetary policy to control inflation.

The political difficulty in rolling back what was meant to be temporary spending to boost a troubled economy made it a long-term challenge to manage the deficit. Former RBI governor Y.V. Reddy highlights the distinction between the structural and cyclical aspects of the fiscal deficit.

In his book Economic Policies and India's Reform Agenda, he suggests the stimulus package has become a structural problem. "There is, perhaps, a structural deterioration in the fiscal situation," he writes. "The nature of stimulus has been such that the consumption expenditure and the committed expenditure have increased."

In a recent interview with Business Today, he emphasised that a stimulus was something that would be withdrawn. He said: "You have to make a distinction between stimulus [and structural issues] - something you can do now and remove in normal circumstances."

Looking back at the last nine years, it is hard to see how the country could repeat the economic performance of 2004-08. "Now, people are beginning to wonder if 9.5 per cent was a fluke, driven by overbloating in liquidity globally," says Vohra of the EIU.

Chidambaram has promised that the fiscal deficit in 2012/13 will be limited to 5.3 per cent of GDP - an overrun of 20 basis points. Moreover, he assured overseas investors in January that the year, unlike 2008/09, will not be one of profligate spending.

Samiran Chakraborty, Head of Research, Standard Chartered Bank, says of Chidambaram: "He does not have the option of presenting a radical budget this time around."

A bird's-eye view of government finances suggests that little can be done in a short time frame. About 56 per cent of the total expenditure of Rs 14.9 trillion goes towards interest payments, pensions, subsidies, grants to states, and defence.

Experts say the revenue deficit is key to fixing the fiscal mess. The revenue deficit is the excess of current expenses over current income, and it represents erosion of savings by the government. By borrowing to meet current consumption, the government is diverting part of national savings away from investment in the building blocks of future growth.

"Insofar as the revenue deficit reflects government dissaving, it reflects a fall in the overall savings rate," says Srivastava of Ernst & Young. Revenue deficits over the last four years have been among the highest in four decades, and have dragged down national savings, investment and growth.

Subsidies over the last nine years are an important cause of the rise in the revenue deficit and its impact on economic growth. Subsidies for four years - from 2008/09 to 2011/12 - were over two per cent of GDP. In almost four decades before that, subsidies exceeded two per cent of the GDP only twice.

The government has tried to cut subsidy costs by gradually increasing the retail price of diesel and disbursing subsidies through cash transfers. Unless subsidies can be compressed by increasing government efficiency, there seems little hope of a sustainable solution to end the use of national savings to support government consumption.

"India is an inefficient spender of its resources," says Vohra of EIU. A cut in consumption is necessary to step up government investment in infrastructure - the building block of long-term growth. And yet the UPA's Budgets show a steady fall in capital expenditure as a percentage of growth, which has weighed the economy down.

If Chidambaram begins to set government finances in order, it will still be years before momentum picks up. As he presided over the beginning of the fiscal mess and the understatement of the deficits, it would be poetic justice if he started the clean-up.

Additional reporting by Shweta Punj