Budget 2012: Growth should be the only fulcrum of economic policymaking in India.

As the process to finalise, what is probably the UPA's most critical Budget, enters the final stages, the recent touch of optimism and surge in the stock markets should buoy the sentiments in the finance ministry. Part of the uptick can be ascribed to additional liquidity, both in India as well as in Europe.

In India, RBI cut the cash reserve ratio (CRR) by 50 basis points, thereby injecting an additional 32,000 crore into the system. Another CRR cut is expected in the next few days. In Europe, the European Central Bank's Long Term Re-Financing Operations is injecting massive liquidity into the euro system. This, in turn, is having an effect globally, as European banks that were withdrawing from emerging markets last year have decided to come back with a vengeance.

Yet, there are other causes of optimism too. Last year, the Indian economy faced a quadruple whammy. High inflation led to high interest rates and consequent slowing down on investments. Current account deficit peaked having a precipitous impact on the rupee. Fiscal deficit was out of control, leading to a serious liquidity crunch in the system. To top it all, there was a policy paralysis as the government had to battle multiple political issues.

In the last couple of months, however, several of these factors have changed for the better. Inflation is showing signs of coming under control, recently reaching the sub-7% levels. While the RBI has justifiably taken a cautious approach when it comes to interest rates, it has already indicated that if inflation continues to be low, it could look at slashing rates over the next 3-6 months. Lower interest rates are likely to rekindle investment demand by corporates.

Last year, one major factor that has contributed to the higher current account deficit was record gold imports. Import of gold is akin to almost direct export of capital with the consequent negative impact on current account deficit. Following raising of import duties on gold and silver, the demand has subsided and industry estimates that in calendar 2012, we will see a drop of almost $10 billion in gold imports.

Couple that with increased inflows from NRIs - thanks to attractive interest rates offered to them and return of FII investments, which were negative last year - and India's position on the current account deficit front is likely to be much better. According to some estimates, the cumulative impact of these three factors could be a net positive forex impact of about $50 billion. This is being reflected in the value of the rupee that now seems to be stabilising.

In the last couple of months, it also seems like the government has at last taken cognisance of the policy vacuum and started taking control of policy decision-making. Although the government has had to backtrack from big-bang reforms like 51% FDI in retail, there are enough straws in the wind to give hope.

So, of the four factors that adversely affected the Indian economy, there seems to be positive movement on three of them. That leaves the fiscal deficit as the elephant in the room. Here, the FM is likely to face the classic conflict between politics and economics.

The options available to the FM are: increase taxes, reduce spending on social programmes or have higher fiscal deficit. It seems higher deficit may be the only real option as both raising taxes and/or cutting spending may be good economics but will be very bad politics.

Of course, the larger question should not be about politics versus economics - but about growth. Growth is eventually both, good politics as well as good economics. Growth is the only way we can lift the masses out of poverty - as China has done so successfully. So, we hope that the FM will end up focusing on growth.

For growth, two things are then inevitable: supply-side reforms and an indication from the FM that the government will bring these back on the agenda. Be it FDI, be it GST, be it DTC - the government should give us confidence that these will happen.

Secondly, some higher-than-comfort-zone fiscal deficit is also inevitable. Some of this may be mitigated by accounting for spectrum sale - resale of 2G and 4G - receipts, some disinvestment flows and some rollback of excise stimulus. But even with all these, the fiscal deficit of 5% or so is here to stay. We will have to reconcile ourselves to this.

So, finally, the choice is between higher growth and lower fiscal deficit, and let's go for growth and reduce fiscal deficit over the next few years in a slow and steady manner. As any physical fitness expert will testify, a starvation diet is the worst way to lose weight. You are better off taking incremental measures over the long term.

Source : economictimes.indiatimes.com