March 3, 2011

March 3, 2011 | Commentary on India

Budget 2011: India has Ignored Both Market Reform & Fiscal Responsibility

History, including recent history, is filled with governments insisting basic laws of economics don't apply to them. Failure is inevitable, as are attempts to shift the blame. The Indian federal government could be the chief present example of this self-delusion, which includes its new budget but extends further.

The annual spectacle of the budget as gigantic handout is today more lurid, as the handout - as in the United States - comprises gigantic borrowed sums. Defenders of this year's budget note a stronger commitment to controlling the deficit. But the problem is more fundamental. Delhi anticipates limits on the deficit from fast growth bringing in revenue. Why, when happily projecting 9% GDP gains and already suffering high inflation, is India running any deficit at all? Countries that cannot control budgets in times of high growth are invariably humbled, and India will prove no exception.

There is also the question of how such growth will be achieved. GDP decelerated to an 8.2% increase in the October-December quarter. Worse, growth is to be driven by state-led infrastructure spending.

Infrastructure development can be an excellent response to growth, it has never been the principle driver. And the Indian state might be the worst possible choice to lead a huge program. Each month brings more indications of failure of federal infrastructure programs. The private sector is asked to fund infrastructure on a massive scale but public-private interactions are fraught with corruption.

In addition, the government conducts high-profile violations of property rights for multinationals, as for Cairn and Vodafone, yet puzzles over foreign disinterest in infrastructure. An ugly regulatory environment caused foreign investment to plunge in 2010 while senior officials blame external conditions, even though these improved.

The goal of double-digit growth and lack of reform has also bred inflation. The federal government has for a year and a half done nothing more than claim inflation will ease soon. Eventually, this will appear to be true, but only because prices are so high their rate of increase naturally slows. A new baseline of much higher prices and 7 percent inflation is no victory and leaves the country far more vulnerable to developments beyond its control.

Politicians often lack will to fight inflation, especially when accumulating huge government debts that beg to be inflated away. This round also undercuts stated priorities. While talking of benefits for the poor, Delhi instead brought double-digit food price increases. The Reserve Bank of India , which is not independent, makes a show of trivial interest rate increases that leave negative returns when inflation is included. Negative real rates do not fight high prices, they encourage them. Closing the loop on government failures, the negative rates persist to spur growth in the absence of reform and to lower the cost of unjustified borrowing. The poor turn out to be secondary.

Derek Scissors is a research fellow in Asia Economic Policy in the Asian Studies Center at The Heritage Foundation in Washington, DC .

About the Author

Derek Scissors, Ph.D. Senior Research Fellow
Asian Studies Center

First appeared in The Economic Times