The Budget and the Macroeconomy

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The Budget and the Macroeconomy

• Suman Bery
• March 7, 2007
• India Habitat Centre

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About NCAER

• Golden Jubilee Year
• Joint work with Shashanka Bhide who coordinates
  QRE, Macrotrack
• Views personal

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Overview

• Budget affects growth, equity through multiple
  micro (supply-side) channels incentive effects
  provision of public goods, income transfers.
  Discussed by other speakers.
• But Budget also drives the macro framework mix
  of fiscal, monetary, debt and exchange rate
  policies which boosts growth by providing a
  stable investment climate.
• Latter is focus of my remarks.

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Key Questions

• Is the economy overheated?
• If so, is there a correct mix of fiscal,
  monetary and exchange rate policies to sustain
  high growth?
• Does the budget move us in the right direction?

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Analytic Framework

• India increasingly open both on trade and
  financial side.
• Changes the way we need to think about
  assignment of instruments to targets.
• Particularly important as we move to fuller
  capital account convertibility.

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Analytic Framework

• Useful frameworks impossible trinity and real
  exchange rate.
• Impossible trinity open capital account, stable
  exchange rate, independent monetary policy.
• Real exchange rate internal price of
  non-tradables to tradables.

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Analytic Framework

• Useful frameworks impossible trinity
  monetary approach to the balance of payments
  real exchange rate.
• Impossible trinity open capital account, stable
  exchange rate, independent monetary policy.
• Monetary approach with open capital account,
  agents will respond to domestic tightening
  through capital inflow.
• Real exchange rate internal price of tradables
  to non-tradables (See Lal-Bery-Pant 2003).

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Analytic Framework

• Like much of developing Asia, India trying to
  operate an intermediate currency regime the
  question is at what risk and cost.
• Lesson from Latin America sterilised
  intervention of capital inflows ineffective,
  fiscally costly. LBP argue there is also a growth
  cost.

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Sticking to FRBM Targets
From Budget proposals SBI share transfer
excluded
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Sticking to FRBM (continued)

• Growth has led to revenue buoyancy
• Revenue growth has made higher expenditure on
  social sectors feasible
• The Eleventh FYP had, however, looked at the
  potential need for some relaxation of FRBM to
  enable higher spending
• If anything this years budget shows that revenue
  growth may be under-estimated

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Sticking to FRBM has aided in achieving good
results
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Sticking to FRBM (continued)

• However
• FRBM alone can not guarantee there are no
  off-budget spending
• FRBM can not guarantee that there will be no
  inflationary tendencies
• More is required from the Budget and from other
  Policies

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Fighting Inflation

• Budget has observed FRBM framework
• Budget has reduced duties and taxes in some key
  input sectors
• RBI has tightened excess liquidity higher
  interest rate, higher CRR

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Fiscal Monetary Interface
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Current Context

• Given continued strong autonomous (and induced)
  capital inflows, for both cyclical and secular
  reasons the real exchange rate (the relative
  price of non-tradables) in India will tend to
  appreciate.
• This happens through appreciation of the nominal
  exchange rate (against a basket) or through
  domestic inflation.
• A widening current account deficit is an
  essential element of the adjustment/anti-inflation
  ary process.
• Aggregate fiscal adjustment can help mitigate the
  real exchange rate appreciation sterilisation on
  the other hand complicates both the fiscal and
  the exchange rate problem.

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Policy Assignment

• The current goals of an open capital account and
  autonomous monetary policy should entail freedom
  for the nominal exchange rate. In this case
  exchange market intervention should be abandoned
  (Korea, Thailand, Brazil).
• Alternatively, RBI could intervene and not
  sterilise.
• In all cases fiscal policy could play a useful
  counter-cyclical role.

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Fiscal Monetary Interface

• High growth
• Capital inflows and build up of reserves
• Inflation
• High interest rates
• Exchange rate depreciation
• Should there not be a different policy response?

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Another Reform in the Fiscal- Monetary Interface

• Separation of debt management from monetary
  policy body The DMO

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Thank You