Background

Since economic liberalization in 1991, India has seen robust economic growth. This growth has been a result of the partial lifting of the heavy hand of the state. The rolling back of the elaborate system of licenses, regulations and accompanying red tape led to an unleashing of entrepreneurial energy in the second most populous country on the planet. Like the Chinese economy, the Indian economy has been less affected by the global economic crisis than expected. In fact, India has been one of the emerging economies that has driven global economic growth since the crisis.

Over the last few months, the Indian economy is facing the tension between controlling inflation and maintaining economic growth. The Reserve Bank of India (RBI), India’s central bank, raised interest rates for a 20-month period until October 2011. Consequently, growth, and especially manufacturing growth, has slowed down.

Why is the budget relevant?

At a time of economic slowdown, policy decisions assume a magnified importance. Part of the reason for economic slowdown is the lack of political commitment to further economic reforms. Powerful lobbies in the Indian political system have been placated by classic pork barrel politics. This means that money has been spent on subsidies instead of on creating long-lasting assets. Subsidies such as the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) have resulted in pure consumption expenditures which in turn have fuelled inflation which in turn has led to monetary tightening by the RBI which in turn has led to lower growth and asphyxiation of the manufacturing sector. Subsidies have also led to high fiscal deficit which in turn has led to government borrowing which in turn has led to higher interest rates which in turn has crowded out private investment which in turn has further slowed down growth.

India’s current account deficit has been pushed to the highest level ever. The RBI in its annual policy review has exhorted the government to control the deficit. The RBI declared, “with global capital flows to emerging markets projected at lower levels in 2012, financing of the deficit will continue to pose a major challenge.”

The budget is the most important instrument of government policy in India. It is watched with much interest not only in the country but abroad. This year most economists were looking for a signaling of growth-inducing fiscal consolidation. The budget gave no such signal. It did not give any indication of how the non-food subsidies will be reined in and how the food subsidies will be financed. In a hasty attempt to raise revenues the government has proposed taxing cross-border deals involving transfer of Indian assets with retrospective effect till 1962. This has soured the investment climate precisely at a time when the current account deficit is at its highest.

The relevance of the budget lies in its potential impact on the Indian economy. The 2012 budget is seen as weak, populist, and worrying, because it threatens to exacerbate the existing weaknesses in the Indian economy.