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Economy Feb 25, 2013

Chidambaram’s Budget is at risk of being ambushed

By Venky Vembu

For finance ministers, Budget Day is a chance to glow in the undivided attention that is showered on them. It's a chance for them to observe all the de rigueur rituals of the day: the photo-ops that show them gazing earnestly at the budget document in their office chambers, and then of them arriving at Parliament with the briefcase with the budget documents - and the secrets that will determine the fortunes of a billion-plus people. Budget speeches too have by now become so structured as to fit into a proforma template, complete with slip-in jokes, and the invocation of philosophical musings towards the end of the speech, which signals to sleepy parliamentarians that the FinMin is winding down. And then of course comes the endless circuit of television studios, defending the policy measures. That kind of attention can get addictive.

Finance Minister P Chidambaram. Image courtesy PIB

Finance Minister P Chidambaram. Image courtesy PIB

There is a case to be made that the Budget exercise as we practice is completely anachronistic, and that policymaking should be conducted transparently, not shrouded in (ostensible) secrecy that only creates arbitrage opportunities for the privileged few. To be fair, successive finance ministers have gradually whittled down the significance of the Budget Day by taking important policy announcements off-budget. For instance, in just the past couple of months, the Manmohan Singh government has announced several broad-sweep policy measures-such as on FDI in retail, diesel price deregulation and so on-that would, in an earlier time, have been built into the budget.

Even so, every finance minister likes the Grand Theatre of Budget Day, and Chidambaram, more than most others, has tried hard to make his Budgets count for something.

This time, however, Chidambaram's moment in the Budget limelight is at risk of being ambushed by developments farther afield over which he has no control. The collective impact of some or all of these developments will be rather more disproportionately felt on global and Indian economies and markets than any policy measure that he may unveil on that day.

On 1 March, for instance, barely a day after Chidambaram presents his budget, an event of extraordinary economic significance will likely be triggered in the US, which will cause markets' nerves to be extreme frayed. On that day, automatic spending cuts to the US budget will kick in, unless lawmakers there come to an agreement on phased and targeted reductions. The cuts are mandated under a long-term debt and deficit reduction programme, and could-given their sledgehammer approach to deficit reduction-cause services to be cut back and jobs to be lost. In the more extreme scenarios, the impact of the cuts could tip the US economy back into recession.

US President Barack Obama is calling on US legislators to avert the "arbitrary, automatic cuts" on the grounds that they will hurt everything from US defence preparedness to health services to airport services to schools. In a radio talk over the weekend, he urged Congress leaders to come together to iron out a compromise deal in which the cuts can be better targeted at wasteful spending. But given the hyperpartisan atmosphere in Washington, that contingency seems a bit remote.

Although the mandatory cuts are intended as bitter medicine that addresses the US' long-term deficit crisis, the markets are already jumpy, given the short-term pain that will almost inevitably be felt. In recent days, markets around the world, including in India have retreated a few notches, after the US Federal Reserve Board appeared to signal that the era of easy money may be about to end. That would have caused global liquidity flows to become tighter, which is why the Indian market too fell, oblivious to Chidambaram's assurances that he will deliver a prudent budget.

If the spending cuts take effect in the US on Friday, as seems likely, the global equity markets could be thrown into even greater turmoil. And the Indian market will not be immune, however good a budget Chidambaram may deliver.

In a column in Business Standard today, analyst Devangshu Datta too points out that "potentially explosive developments" on the global financial front could "upstage the impact of" Chidambaram's attempt to turn the Indian economy around.

In his estimation, Chidambaram's efforts face challenges on three counts. The first of them relates to a matter close to home: February 28, the day of the budget, is also derivatives settlement day; this time, FIIs are likely unwind their positions and review the budget proposals in detail before recommitting themselves.

FII s have been pumping money into India in the past few months, but in recent days, they have been easing up. Their position going forward will be shaped as much by the Indian budget proposals as by what happens to global liquidity flows, which in turn hinge on developments in the US and, in particular, on the prospect of an unwinding of the Quantative Easing policy.

To these is added a third element of economic uncertainty following the decision by rating agency Moody's over the weekend to strip the UK economy of its AAA status. That, in Datta's estimation could trigger a "tectonic upheaval in forex rates". That could of course open up currency trading opportunities, but the underlying weak fundamentals of the economy would nevertheless cast a shadow on global economic outlook, and have ripple effect in India.

Chidambaram has repeatedly indicated that his budget this year will be prudent and pragmatic, rather than flamboyant, since the focus will be on fiscal consolidation, which requires nose-to-the-grindstone work, rather than flair. In that sense, his budget speech will be delivered in sotto voce, so to speak. But this time, there is a heightened risk that any short-term feel-good effect he may generate with his budget proposals will likely be tempered very soon by developments on the global economic front, over which he has no control.

by Venky Vembu

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