What's Pranab smoking? Will Sonia okay his budget cuts?

Having drunk all night, the alcoholic is promising abstinence in the morrow.

Everyone and his aunt knows that Finance Minister Pranab Mukherjee has busted his budget this year. The fiscal deficit is not going to be anywhere near the 4.6 percent promised last February. The betting is on whether it will even cross 6 percent.

[caption id="attachment_146441" align="alignleft" width="380" caption="The problem with Pranab Mukherjee's deficit cutting charade is simple: in the short run, it does not matter if the deficit is high when the economy is going downhill.Reuters"][/caption]

Everyone, and the dog at the lamp-post, knows that as Europe drops into recession and fears of a wider slowdown spread all over the globe, next year could be even worse for the Indian economy - especially as past rate hikes and future energy price increases kick in. The best case scenario for this year is 7-7.5 percent GDP growth, so next year should be 7 percent or less, assuming a middling scenario.

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Everyone, and the 12-standard economics student, knows that when an economy is decelerating, government should be thinking stimulus - not deflation. Inflation may be a lost cause in the short-term, and tax increases may be inevitable to make ends meet, but sharp expenditure cuts to bring down the fiscal deficit is for loonies right now.

But that's exactly what Pranab-da seems to be pursuing. According to The Economic Times, he has just sent a note to all ministries saying they must frame their expenditure proposals in such a way as to bring down the fiscal deficit to 4.1 percent in 2012-13.

Quoting the finance minister, the newspaper reports: "The proposals for revised estimates for 2011-12 and 2012-13 should be formulated with a view to retain the fiscal deficit for 2012-13 at 4.1 percent, as given in the medium-term fiscal policy statement."

Wonder what the finance minister has been smoking of late, but a reduction of this magnitude will be close to 2-2.5 percent of GDP. Can this level of trimming be done in government expenditure in an economy which is visibly slowing - as indicated by the second quarter GDP growth figure this year of just 6.9 percent.

The economy's current fiscal deficit is estimated by S Gangadharan in DNA at nearly 6.6 percent as against the 2011-12 budget forecast of 4.6 percent. He says: "Blame this on economic slowdown or poor fiscal marksmanship, or a cavalier approach to fiscal policy, (but) it is clear that Union finances are in disarray. Instead of a gross fiscal deficit of Rs 412,817 crore, the amount may be closer to Rs 600,000 crore."

According to the newspaper, 'Back-of-the envelope calculations suggest the centre's fiscal deficit as a percentage of nominal gross domestic product may approximate to 6.6 percent for 2011-12 as against the budgeted 4.6 percent."

In short, the fiscal contraction needed in 2012-13 will be of the order of 2-2.5 percent precisely when the rest of the world is reflating and trying to boost growth.

China has just cut bank reserve ratios, the European Central Bank has begun cutting rates to reduce the impact of inflation, and even the Reserve Bank of India has indicated a pause in rate hikes if the December inflation figure shows signs of moderation.

But our finance ministry seems to be on another planet. It is asking for one of the sharpest cut-backs in expenditure in recent history from the spending ministries.

To be sure, the political reality is that all this won't happen. With several state elections coming up in 2012 and 2013, the last thing the Sonia-Rahul team of social spendthrifts will allow is an expenditure reduction on this scale to meet Pranab-da's fiscal arithmetic.

The economy is sliding for several reasons - including policy paralysis, the atmosphere of scams and corruption, and the global slowdown. But it's also slowing because the government is cutting the wrong kind of expenditure - capital spending instead of unproductive subsidies and handouts - since the mother-son duo is standing guard at the gates of the latter.

As an editorial in Business Standard notes: "Once definitional changes are accounted for, the fiscal deficit this year will be no lower than when the now-all-but-dead reforms process began 20 years ago. The only change is for the worse: capital investment financed through the budget has fallen."

The problem with Pranab Mukherjee's deficit cutting charade is simple: in the short run, it does not matter if the deficit is high when the economy is going downhill. In the long-run, you have to cut expenditure - but of the right kind. This means expenses on things like food and fertiliser subsidies must be cut, but this is precisely what the Sonia Gandhi-led National Advisory Council is working against with its expensive Food Security Bill and the universal health proposals.

Since 2013 is the last year before the next general election, one can assume that the UPA will cut the wrong kind of expenditures (infrastructure and capital budgets) and expand the wrong kind of spending in election giveaways - social spending and food prices.

Cutting capital outlays and investment in infrastructure is the surest way to make the short-term slowdown into a near-permanent one. It has also given us slower growth and unending inflation, or Rahul-flation. The UPA may be about to lead us back to the low-growth trajectories of the socialist years that were wrongly labelled as the Hindu rate of growth.

My prediction for 2012-13 GDP growth, if Mukherjee does anything like what he has proposed, is 6-6.5 percent, not 7-8 percent. The 9 percent promised in the 12^th plan which begins next year is a pipe dream.