Mr Chidambaram’s fiscal chimera

From the ignominy of being branded as one of the Fragile Five last year, India is suddenly one of the shining stars of the emerging markets.

The current account has come down dramatically and the government now says fiscal deficit for the current financial year will be lower than even its own somewhat optimistic estimate, given earlier.

Better still, the fiscal deficit for next year is forecast to slip further. The rupee has stabilised and did not fluctuate much even when several other emerging market  currencies faced another sell off last month. This is the magic of fiscal consolidation, the new buzzword in town.

And the magician is, who else, finance minister P Chidambaram.

One of our longest-serving finance ministers, Chidambaram would be remembered for some of the landmark reforms, such as the rationalisation of direct taxes. Unfortunately, his record would also be marked by an easy readiness to resort to accounting gimmicks and unrealistic estimates that jeopardise future policy.

Look closely, his latest exercise – interim budget or vote on account or whatever you call it – would make even the most creative of corporate CFOs proud.

Chidambaram's most notorious contribution to fiscal profligacy must be the oil bonds,  which he introduced in 2007. Instead of recognising oil subsidies as and when they incur, Chidambaram converted them into liabilities in the form of bonds issued to the oil marketing companies.

Without paying any cash to the oil companies for the subsidies they incur, the government issued IOUs which are payable several years later. This was almost a disingenuous way to kick the can down the road. If the then Comptroller and Auditor General of India was a member of the Institute of Chartered Accountants, he or she would have been professionally required to qualify the government's financial statements.

In his defence, Chidambaram has always maintained that international oil prices had gone through the roof and there was no way he could have fully accounted for the subsidies without inflating the fiscal deficit alarmingly. And there is some truth to it.

But the trouble with any effort in delaying pain is that it becomes a habit and will give a real bite in future. Chidambaram's accounting innovation delayed the much needed rationalisation of oil subsidies, and is partly responsible for the fiscal mess we are in.

Even now, Chidambaram refuses to learn from that mistake. This year he has given up the oil bond mechanism and has simply pushed oil subsidies to the next year. The interim budget estimates that Rs35,000 crore worth of current year subsidies will be accounted only during the next financial year.

As with most government estimates, this one is also likely to be very optimistic. And this is only the oil subsidies; it is unclear if the government is also pushing some fertilizer and food subsidies also to next year.

With the improved global outlook and the severe winter in Europe and North America, oil prices have recovered. Brent crude is now hovering around $110/barrel, and the rupee is not expected to strengthen from the current levels.

Hopes of further rationalisation of subsidies have faded after Rahul Gandhi's decision that the aam aadmi should not be deprived of his  annual quota of subsidsed cooking gas. The new government that comes in after the election may not want to reduce subsidies during its so called honeymoon period.

The Food Security Bill should push up food subsidies next year, and fertiliser subsidies are unlikely to decline if input costs remain at the current level. Given these, it would be almost foolhardy to expect that the total subsidy bill would not increase next year. Yet, that is exactly what Chidambaram has chosen to believe.

Not content with his magic on current year numbers, Chidambaram decided to leave an almost impossible target for his successor, whoever the  hapless soul may end up becoming the finance minister. The interim budget estimates next year's fiscal deficit at 4.1 per cent.

By Chidambaram's standards, this is pretty easy. He started by forecasting a very optimistic GDP growth target, and then claimed that the growth in tax revenues would almost double from this year.

Even after these rosy assumptions on the revenue side, the fiscal deficit probably did not budge much.

So, Chidambaram took a machete and slashed the budgeted allocation to several departments. The poor folks at the rural development ministry would have to make ends meet with a mere Rs7,600 crore next year, compared to Rs60,000 crore this fiscal. If Chidambaram's successor sticks to his allocation for the department of school education and literacy, expect the number of illiterates in the country to rise alarmingly in the coming years. The cut in allocations to this crucial social development department is cruel, from Rs50,000 crore to just Rs6,000 crore.

This is absurd. Anyone can make up numbers like this, without any connection to reality, and meet any target. Then why have this budgetary charade?

Chidambaram pretends that the telecom spectrum and disinvestment golden geese would live forever. Yes, spectrum winners from this year's auction have chosen to pay some of their dues in instalments and this should add to the government's cash flows over the next three years.

But there are no major spectrum auctions likely for the next several years. And disinvestment is always a roll of the dice for the government. Market conditions, political climate, the performance of state-owned corporations  and several other factors could derail planned disinvestments.

Finally, Chidambaram has wasted no opportunity to take credit for the lower current account deficit. Apart from the gold restrictions, which have helped revive the once famous career choice of gold smugglers, what exactly has the government done to deserve praise?

After the 15-20 per cent  currency depreciation and with an improved global economy, current export growth is way too low. If anything, most of the credit should go to the ever opportunistic NRIs who ran to the nearest bank to borrow and send money home when the rupee slipped past 60 to a dollar.

Chidambaram has created a fantastic fiscal chimera with his interim budget. Unless growth picks up dramatically, for which this government would deserve no credit,  the estimates and forecasts for next fiscal year would be well off the mark. It would only undermine the confidence in government and make it more difficult for the next finance minister. If he or she decides to follow Chidambaram's lead in fiscal gimmickry, then the country risks slipping to the bottom of the heap of the emerging markets.

But Chidambaram's chimera is nice to look at while it lasts. The stock market seems to like it, even if the wiser investors understand the inherent dangers. The day after the interim budget,  banking stocks have surged. Why?

The speculation is that the government's 'admirable fiscal restraint' could possibly force the recalcitrant RBI governor Raghuram Rajan to consider interest rate cuts.

Fat chance!

Nevertheless, this illusion would make us all feel good until it pops.