Highlights of India’s FY 2011-12 budget

Highlights of budget for next fiscal year (April 1, 2011- March 31,2012) presented by Indian Finance Minister Pranab Mukherjee on Monday to the parliament. Budget summary sourced from Reuters.

At US$ 1= IRs 45.18 exchange rate [100 crore = 1 billion], total estimated expenditure equals to US$ 278.38 billion, total estimated revenue (tax and non-tax) equals to US$ 174.83 billion; and total deficit borrowing (recovery of loans, other receipts and borrowing and other liabilities) equals to US$ 103.54 billion. Total estimated GDP for FY 2011-12 is US$ 1.99 trillion.

BORROWING

• Gross market borrowing for 2011-12 seen at 4.17 trillion rupees
• Net market borrowing for 2011-12 seen at 3.43 trillion rupees
• Revised gross market borrowing for 2010-11 at 4.47 trillion rupees

FISCAL DEFICIT

• Fiscal deficit seen at 5.1 percent of GDP in 2010-11
• Fiscal deficit seen at 4.6 percent of GDP in 2011-12
• Fiscal deficit seen at 4.1 percent of GDP in 2012-13
• Fiscal deficit seen at 3.5 percent of GDP in 2013-14

SPENDING

• Total expenditure in 2011-12 seen at 12.58 trillion rupees
• Plan expenditure seen at 4.41 trillion rupees in 2011-12, up 18.3 percent

REVENUE

• Gross tax receipts seen at 9.32 trillion rupees in 2011-12
• Corporate tax receipts seen at 3.6 trillion rupees in 2011-12
• Tax-to-GDP ratio seen at 10.4 percent in 2011-12; seen at 10.8 percent in 2012-13
• Customs revenue seen at 1.52 trillion rupees in 2011-12
• Factory gate duties seen at 1.64 trillion rupees in 2011-12
• Non-tax revenue seen at 1.25 trillion rupees in 2011-12
• Service tax receipts seen at 820 billion rupees in 2011-12
• Telecoms fees, auction of broadband spectrum to raise 296.5 billion rupees in 2011-12

SUBSIDIES

• Subsidy bill in 2011-12 seen at 1.44 trillion rupees
• Food subsidy bill in 2011-12 seen at 605.7 billion rupees
• Revised food subsidy bill for 2010-11 at 606 billion rupees
• Fertiliser subsidy bill in 2011-12 seen at 500 billion rupees
• Revised fertiliser subsidy bill for 2010-11 at 550 billion rupees
• Petroleum subsidy bill in 2011-12 seen at 236.4 billion rupees
• Revised petroleum subsidy bill in 2010-11 at 384 billion rupees
• State-run oil retailers to be provided with 200 billion rupee cash subsidy in 2011-12

GROWTH, INFLATION EXPECTATIONS

• Inflation seen at 5 percent in 2011-12
• Economy expected to grow at 9 percent in 2012, plus or minus 0.25 percent

TAXES

• Standard rate of excise duty held at 10 percent
• Service tax rate held at 10 percent
• Scope of service tax to be widened
• Minimum alternate tax raised to 18.5 percent from 18 percent
• Iron ore export duty raised to 20 percent
• Personal income tax exemption limit raised to 180,000 rupees

DISINVESTMENT

• Disinvestment in 2011-12 seen at 400 billion rupees

POLICY REFORMS

• Food security bill to be introduced this year
• Foreign direct investment policy to be liberalised further * Infrastructure debt funds to be created
• Infrastructure growth to be boosted with tax-free bonds of 300 billion rupees
• Foreign institutional investor limit in 5-year corporate bonds for investment in infrastructure to be raised by $20 billion
• To permit Securities and Exchange Board of India (SEBI) registered mutual funds to access subscriptions from foreign investments
• Public debt bill to be introduced in parliament soon

SECTOR SPENDING

• Infrastructure allocation increased by 23.3 percent to 2.14 trillion rupees in 2011-12
• To allocate more than 1.64 trillion rupees to defence sector in 2011-12
• Corpus of rural infrastructure development fund raised to 180 billion rupees in 2011-12
• To provide 201.5 billion rupees capital infusion in state-run banks in 2011-12
• To allocate 520.5 billion rupees for the education sector
• To raise health sector allocation to 267.6 billion rupees
• Mahatma Gandhi National Rural Employment Guarantee Scheme wage rates linked to consumer price index; will rise from existing Rs.100 per day.

AGRICULTURE

• To focus on removing supply bottlenecks in the food sector
• To raise credit flow target to agriculture sector to 4.75 trillion rupees
• Give 3 percent interest subsidy to farmers in 2011-12
• Cold storage chains to be given infrastructure status
• To provide 3 billion rupees for 60,000 hectares under palm oil plantation
• Actively considering new fertiliser policy for urea

MAJOR CONCERNS

• Food inflation remains a concern
• Current account deficit situation poses some concern
• Must ensure private investment is sustained
• "Certain events in the past few months may have created an impression of drift in governance and a gap in public accountability ... such an impression is misplaced."
• Corruption is a problem, must fight it collectively

The Service Sector as India's Road to Economic Growth

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While India is distinctive among developing countries for its fast-growing service sector, sceptics have raised doubts about the quality and sustainability of this service-sector growth and its implications for economic development. We show, consistent with the views of the sceptics, that while growth of the sector has been unusually rapid, it started 15 years ago from unusually low levels. That the share of services has now simply converged to the international norm raises questions about whether it will continue growing rapidly. In particular, whether service-sector output and employment continue to grow in excess of international norms will depend on the continued expansion of modern services (business services, communication and banking) but, also, on the application of modern information technology to more traditional services (retail and wholesale trade, transport and storage, public administration and defense ). The second aspect obviously has more positive implications for output than for employment.

We also show that the modern services that are growing most rapidly are now large enough where their future performance could have a significant macroeconomic impact. The expansion of modern service-sector employment is not simply disguised manufacturing activity. Finally, we show that the mix of skilled and unskilled labor in manufacturing and services is increasingly similar. It is no longer obvious therefore that manufacturing is the main destination for the vast majority of Indian labor moving into the modern sector and that modern services are a viable destination only for the highly-skilled few. We conclude that sustaining economic growth and raising living standards will require shifting labor into both manufacturing and services.

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That’s the abstract from Eichergreen and Gupta (2011) paper.

U-curve in economic development

Relative productivity of agriculture exhibits a U-shaped pattern over the course of development, argues Rodrik. Labor productivity first falls and then rises, as countries get richer.

Within countries as well, the trend is consistent.

Why does this happen? Because new, high-productivity activities (typically outside agriculture) are needed for development to happen. Relative productivity in agriculture falls. Labor tends to move from low to high productivity activities as economies grow. The gap between productivity in agriculture and non-agriculture reduces. Diminishing marginal returns (in terms of productivity) gradually kicks in on non-agriculture sector. Relative productivity in agriculture sector again rises and the curve starts to slope outward.

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economic development requires both new activities (diversification) and ongoing transfer of resources from traditional to modern activities. Some countries are stuck with no new industries, so they never grow. Others get a few new industries (e.g. mining and other natural resource-based industries), but these do not expand sufficiently and absorb much labor, so development gets stuck at an intermediate level of income. The real successful countries are those that pull off both tricks.

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Making fiscal policy effective

Abstracts of two latest working papers from the Levy Economics Institute.

Lessons from the Great Recession (Pavlina R. Tcherneva 2011):

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This paper reconsiders fiscal policy effectiveness in light of the recent economic crisis. It examines the fiscal policy approach advocated by the economics profession today and the specific policy actions undertaken by the Bush and Obama administrations. An examination of the labor market renders the contemporary aggregate demand–management approach wholly inadequate for achieving certain macroeconomic objectives, such as the stabilization of investment and investor expectations, the generation and maintenance of full employment, and the equitable distribution of incomes. The paper reconsiders the policy effectiveness of alternative fiscal policy approaches, and argues that a policy that directly targets the labor demand gap (as opposed to the output gap) is far more effective in stabilizing employment, incomes, investment, and balance sheets.

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Why aggregate demand management fails and what to do about it? (Pravlina R. Tcherneva 2011)

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This paper argues for a fundamental reorientation of fiscal policy, from the current aggregate demand management model to a model that explicitly and directly targets the unemployed. Even though aggregate demand management has several important benefits in stabilizing an unstable economy, it also has a number of serious drawbacks that merit its reconsideration. The paper identifies the shortcomings that can be observed during both recessions and economic recoveries, and builds the case for a targeted demand-management approach that can deliver economic stabilization through full employment and better income distribution. This approach is consistent with Keynes’s original policy recommendations, largely neglected or forgotten by economists across the theoretical spectrum, and offers a reinterpretation of his proposal for the modern context that draws on the work of Hyman Minsky.

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Trade & Food Security in Nepal

My latest piece is about the rising food prices in Nepal and what can be done about it. I tie up food security in Nepal with international trade (and to some extent with climate change). Nepal is a net food importer country since the domestic supply is insufficient to meet domestic demand. This production deficit is met by either imports or by food grains grant, especially via WFP. Here is an article on the same issue I wrote in 2009

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Food Security in Nepal

Recently, the Food and Agriculture Organization’s (FAO) Food Price Index surpassed the upper bound reached during the peak of the food crisis in 2008. The World Bank says global food crisis has reached “dangerous levels”. In Nepal, the World Food Programme (WFP) argues that about 3.7 million people are at risk of food insecurity. Rising food prices have triggered a wave of protests across the globe and forced countries such as India, Russia and Vietnam, among other countries, to impose food grains embargo. These events directly or indirectly affect food prices and food availability in Nepal. Already, domestic food prices have reached second highest level since 1990.

As a net food importer nation, is Nepal prepared to deal with any further rise in food prices, production, and supply shocks at both domestic and global levels? The answer is uncertain, given the virtual absence of discussion about this issue at policymaking level. Meanwhile, the political leaders, who seem oblivious of the dangers of looming food crisis, are more worried about securing ministerial berths than ensuring enough food on plate for the poor, vulnerable and food insecure people. It is crucial for policymakers and selfish political leaders to realize that a further rise in food prices could not only affect economic growth and poverty, but also engender a series of protests and political instability.

Domestically, food prices are fast outstripping overall general prices. The Food Price Index (FPI) has been continuously dragging up Consumer Price Index (CPI), whose annual percentage change is a popular measure of inflation. Since Nepal does not produce enough food to satisfy domestic demand, it has to import food equal to domestic production deficit. So, shocks in production, supply and prices of agricultural goods at the global level affect food prices in our local markets as well. There was 316,000 metric tons food deficit in 2010, an increase by 139 percent from 2009, according to the WFP. In 2009, agricultural trade deficit was US$270 million, up from US$157 million in 2003. As the demand for food is fairly price inelastic, even if prices increase, Nepal will be importing at least the same amount of food, but it will have to spend substantially more, which will further widen total trade deficit.

Globally, higher temperatures, shifting seasons, more frequent and extreme weather events, flooding, wildfire, and drought in Russia, Canada, Australia, Pakistan, China, Argentina, and Kazakhstan, among others countries have created production shocks. Meanwhile, supply shocks occur when major exporting nations take precautionary measures to curb exports or impose embargos on certain agricultural products so that their own domestic demand is met and prices remain below a threshold for their citizens. For instance, it recently happened when India, Russia and Vietnam, among other nations imposed food grains embargo. Additionally, speculation by brokers and investment firms, who bet on the future price of major agricultural items based on existing production, inventory, and future expected production level, have also contributed to price shocks.

All of these events have not only affected demand, supply, and prices of agricultural goods at the global level, but also, to some extent, in our own economy. Note that a Nepali spends, on average, 59 percent of his income on food. Of this about 58 percent and 15 percent are spent on breads and cereals, and fruits and vegetables, respectively. Since food prices are already high in the domestic market, any further price rise will force more people to scale back discretionary expenditures and savings, which will directly affect investment and economic growth.

What options do we have to mitigate the negative impact of rising food prices on the economy?

First, there should be higher investment geared towards increasing agricultural production and productivity so that domestic production deficit can at least be narrowed down. Meanwhile, domestic production of climate resilient varieties of food grains should be encouraged. Equally important are state subsidies on appropriate varieties of seeds and fertilizers, plus some sort of guarantee to facilitate transport of surplus production of each household to the market. The government and development agencies should provide sufficient infrastructure and policy structure to make this happen.

Second, to facilitate unhindered distribution of agricultural items in the market, carteling should be checked. The agricultural traders, who are mostly affiliated to one party or the other, purchase food items (especially veggies) from farmers at dirt cheap rates and sell them in the market with a wide margin. If prices start to come down, then they restrict supply to put upward pressure on prices. This sends deceptive, undervalued price signals to farmers, who are neither encouraged to produce more nor are motivated to seek innovative methods to produce improved varieties of food items crucial for food security and for putting downward pressure on prices. The supply-side bottlenecks have to be adequately addressed to not only encourage farmers to produce more and motivate them to seek innovative farming methods, but also to curb price manipulation and hoarding of agricultural goods.

Third, smooth regional agricultural trade is crucial to meet Nepal’s food demand. Since agricultural imports from India constitute over 40 percent of total agricultural goods imported by Nepal, it is in our interest to convince India—a net exporter of agricultural goods— to make an exception, or at least ensure a quota that is enough to meet our domestic needs, for food supply to Nepal even if it imposes ban on export to other countries. Since Nepalis and Indians consume pretty much the same kind of food items and the two countries share an open border with free flow of pretty much all goods and services, it is in both countries’ interest to smoothen trade. Else, the negative political and economic spillovers and black marketing will further haunt the regions on both sides of the border. Moreover, greater cooperation on agricultural trade among South Asian countries could also help to ease food deficit.

Fourth, a fully functional regional food bank is needed for emergency purposes. The 14th SAARC Summit held in New Delhi in 2007 agreed to establish SAARC Food Bank, which is expected to serve as a regional food security reserve for SAARC member countries during normal food shortages and emergencies. The food bank was authorized to start functioning with a total reserve of 0.24 million tons of food grains. Since this amount is not enough to ensure regional food security, Bangladesh recently proposed to raise the strategic reserve to 4 million tons. Sadly, the whole concept of SAARC Food Bank is yet to become functional. There is a need to address the issue of price incentive and access threshold to enable the release of grains from the reserve.

Fifth, and most importantly, it is high time political leaders, and officials at National Planning Commission, Ministry of Finance, Ministry of Agriculture & Cooperatives, and Ministry of Commerce & Supplies woke up and acknowledged the fact that rising food prices and a potential food crisis pose a real economic threat and could engender political instability. They have to plan and work in tandem to eschew a potential food crisis and its spillover on the economy and political front. Remember, in 2008 and early this year riots have broken hell loose and regimes have fallen around the world partly because of the hardship inflicted by rising food prices. We cannot discount similar fate in the Nepali economy if domestic food crisis spirals out of control.

[Published in Republica, February 22, 2010, p.7]

Trade balance in South Asia

In South Asia, Maldives has the highest trade deficit (% of GDP), followed by Nepal, Pakistan, Bangladesh, Sri Lanka, and India. Bhutan is the only country having trade surplus in South Asia. My wild guess is that the countries that have negative trade balance have high trade complementarity, i.e. they produce the same kind of goods and services and compete in the same section of the global market for customers. Bhutan stands out because of its high electricity export to India (something other countries are not doing despite having the potential. E.g. Nepal). It is high time governments thought about diversification of both products and markets. Exploring of products with comparative advantage based on resource endowment, and industrial and trade policies to steer production in that direction is needed. May be following the lead of India (and China) and getting on board its growth trajectory would help (definitely for Nepal).

Monopsony in factor market and monopoly in product market

What happens if traders directly purchase vegetables from farmers and then they themselves sell it in the market (and deprive of others from doing so, including the farmers)? Three things happen: (i) farmers either lose or gain; (ii) traders usually gain; and (iii) customers either lose or gain. Farmers will see gains if the traders pay high price for vegetables in the factor market (or they lose if the opposite happens). Traders mostly gain. Customers will see gains if traders purchase in bulk and sell it at a low price, largely accruing from economies of scale (or they lose if traders form a cartel and jack up prices in the product market).

What usually happens in a developing country is that traders pay low price to farmers, don’t let farmers directly sell produce in designated wholesale market set up by the government in cities, and traders form a cartel and jack up prices in the product market. Welfare of both farmers and consumers is reduced by traders by creating monopsony in factor market and monopoly in product market (they play with the quantity supplied in the product market to keep up high prices). This is what happens in Nepal and in other South Asian countries.

But, the story from Ghana is different. Traders in Ghana purchase tomatoes from rural farms and bring them to the large urban markets. A research by Robinson and Ngeleza 2011 shows that, in Ghana, the traders do operate a cartel but that farmers who sell to them receive higher prices than if they sell to the local market, even though there is little difference in quality compared with tomatoes sold to the local market.

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This suggests that traders share cartel rents with these farmers, resulting in lower prices in rural areas, higher prices in the cities, and a greater constriction of total market volume. Our paper suggests that policymakers would do better to focus on the full value chain and on opening up the urban markets rather than on strengthening farmers’ bargaining power with the traders, which restricts market volumes and harms farmers unable to sell to traders.

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What about the loss in welfare of consumers (due to high prices) in the product market? Does the welfare gains to farmers in the factor market offset the potential welfare losses to consumers in the product market?