Indian Budgets – Missing the Forest for the Trees

Indian Budgets: A legacy of interventionism and economic control

I have consciously avoided commenting on Indian budgets despite writing extensively on various macroeconomic issues over the years. For a nation whose economic advisors have been steeped in Keynesian witchcraft, it would have been easy to dismiss my arguments in favour of individual liberty, limited government, and sound money as preposterous, or worse, anti-poor or anti-growth. What has changed now? Today, we have Javier Milei (current Argentina President democratically elected 1 year back) demonstrating in real time that ONLY Libertarianism works. I no longer have to go back to the days of the Classical Gold Standard or Patrick Henry to justify my arguments. So here it is.

On the Budget passed – I can discuss income tax exemptions, the supposed ease of doing business, FDI hikes, etc. Countless experts have opined but all of those discussions miss the “Forest For The Trees.”

The criticism in this article is valid for all Indian budgets without exception. In fact, there is hardly any difference whatsoever between the UPA and NDA budgets. Incidentally, Congress could have presented the same budget as Ms. Nirmala Sitharaman did, and the BJP would have dismissed it as anti-growth and Inflationary (…or whatever). If I were to summarize the issue in one phrase that has plagued Indian Economic policymaking since Independence, it is “Interventionism” – from a fiscal, monetary, and regulatory perspective.

Starting from 1947 would be difficult for this article. However, we supposedly have adopted a reformist path since 1991 and so will start there.

How has China leapfrogged India when we were both at the same level in 1991? Should we not even question the basic premise of Indian budgets and the philosophical leanings of our economic advisors? How is it that the Yuan has appreciated over the last three decades vis-à-vis the US Dollar while the Rupee has virtually plummeted with no end in sight? China has a trillion-dollar Annual trade surplus while we run trade deficits—so much for the arguments that a cheaper currency helps in promoting exports.

As a country, we have buried our heads in the sands of “The General Theory of Employment, Interest, and Money.” When we should have followed Mises and Rothbard, we have chosen to borrow from Keynes and Karl Marx. In fact, from an economic policy perspective, we are closer to Marx than Keynes today.

There is nothing remotely close in our budgets to describe the BJP as a “Right of Center” or “Far Right” party. Economically speaking, it’s even to the left of what the Congress was between 2005 and 2014. Right of Center used to mean something – balanced budgets, reducing regulations, minimum government, etc. Today it is a political slogan. But this was the case even with Ronald Reagan so I don’t find any point in picking on current-day conservatives.

For the record, even Keynes never advocated running deficits during periods of growth. But this is like leaving a bottle of booze unchaperoned in a school and telling kids to drink only in an emergency. No prizes for guessing what would have happened next. Governments around the world, led by the US, have spent like there is no tomorrow.

Fiscal deficits – The cancer of our economy

Firstly, we need to understand the gargantuan size of our deficits. Reporting the deficits as a % of the GDP, notwithstanding the international consensus on this, is a very disingenuous move on the part of governments. It hides the extent to which the governments are living beyond their means.

Let’s take our FY2025 numbers: Government revenues were 31 La Cr, expenditures were 48 La Cr, and the interest component was 11 La Cr. I am using whole numbers because decimals are truly rounding off errors in the scheme of things. The fiscal deficit was 4.8% of the GDP as reported. I can pick several holes in the accounting principles used to report a lower deficit than is really the case, but I am skipping all of it and jumping ahead.

Here is the big picture – The total amount available to the government after paying interest on current borrowings was 20 La Cr and they spent 37 La Cr. The Indian government has overspent to the tune of 85% as compared to what was available to them.

So, how does the government fund the balance of 17 La Cr? That comes through the “Inflation Tax” (though it’s euphemistically referred to as borrowings from the Central Bank). I am simplifying here, but this is not far from the truth. At the end of the day, in essence, what doesn’t get funded directly through taxation gets indirectly funded through inflation. So the cost of government to the citizens is not what it taxes but what it spends.

The above 85% is not an exception. This would be the ballpark from 1991, perhaps even 1947. So what are the consequences of this interventionism on the Fiscal front by the government?

There is one hallmark of Interventionism that is just plainly obvious to somebody who understands Laissez-Faire economics, but in reality, almost everybody seems to be oblivious to the fact. That interventionism begets more interventionism and this begets even more interventionism becoming an infinite loop.

So here are the follow-on effects. Not an exhaustive one by any standards.

• The deficit is met by the RBI monetization and this is “the monetary Inflation (MI)”. One of the consequences of MI is Price Inflation and this results in high interest rates.
• RBI then “intervenes” to lower the interest rates below what would be the “Natural Rate of interest”.
  • This artificially low interest rate leads to the business cycle (refer to “Austrian Business Cycle Theory”) or what is more commonly known as the boom-bust cycle.
  • This leads to artificially high asset prices eventually resulting in the bursting of bubbles – the NASDAQ 2000 bubble, the 2008 housing Bubble, etc. The bursting of these bubbles necessitates the need for even greater Interventionism from Central Banks. The bubbles we have had in India are smaller in comparison and I have used the US bubbles to illustrate the point. But the principle involved is much the same.
• Another example that can be correlated with this is the “Gold” buying patterns. The high fiscal deficits lead to the debasement of the currency, and so citizens buy gold as a mechanism to protect their purchasing power.
  • This gold buying leads to trade deficits, and governments come up with import duties to discourage this buying.
  • Of course, this creates an opportunity for people wanting to smuggle gold, necessitating regulatory interventionism at customs.
  • At least some customs agents have a price for ignoring their duty and this leads to bribery. Even assuming customs officials are all straightforward, it leads to various other schemes to smuggle gold.
  • This led to another intervention in the form of “Sovereign Gold Bonds” where the Government thought they could make the citizens believe they owned Gold without any physical backing of the metal.
  • When gold prices go up as they have started doing so since 2022, this Interventionism leads to even greater fiscal deficits.
  • So instead of tackling the fundamental cause, i.e. fiscal deficits, the Govt creates interventionist policies that lead to even greater fiscal deficits years down the line.
• Another effect of the high fiscal deficits is the poor international currency ratings. And a broken domestic bond market.
  • Because of the lack of a good market for bonds, corporations borrow in International markets, and this leads to currency risk for these organizations as well as for the country. More interventionism is needed to handle these international borrowings through approvals and quotas. The need for interventionism never ends.

I can list plenty of other problems caused by deficit spending. Policymakers seem to be unaware that balancing the budgets would solve a host of problems in one stroke. Of course, it means less power for politicians and bureaucrats.

The bureaucratic economists will never suggest balancing the budgets on their own. Otherwise, we would not have been running these massive deficits for decades. It’s not that they are evil-minded. It is just incentive-caused bias. They have learned all the wrong lessons from Keynes, the chief one being “stimulating demand.” They have a great incentive not to unlearn it.

I keep hearing the phrase over and over from Industrialists: The government needs to stimulate demand. So here is “Supply-Demand 101“

Supply-Demand 101

The government can never create “Demand”. They can only create “Monetary Inflation” that pulls forward demand. Just imagine an extreme situation, i.e., the Government gives a handout of 10 Crs to all Indians, and sure enough, there will be demand for, in a manner of speaking, 1.4 Billion Ferraris overnight. Of course, we all know that the Rupee would collapse if the Government were to attempt such an exercise. So, the question is when does this handout translate into a weakening currency? It starts with the first Rupee of Monetary Inflation.

There is a much misunderstood economic axiom “Says Law”, that states “Supply creates its own Demand”. Let me explain what it really means – The supply of desired goods and services by a market participant X in the markets leads to the creation of demand by X for other services. For example, we have had a thriving software industry and this has created a demand for housing, automobiles, tourism, etc. The government could never have created a demand for these in isolation by printing the money – it is the supply of software services that has resulted in the creation of this demand.

There is no constraint of “Demand” at any point. All of us want all the goods all the time. It is the supply that is always the constraint. In fact, Austrian Economics starts by addressing the fundamental proposition of “How we can satisfy our unlimited wants (i.e. demand) with our limited resources (i.e. supply)”.

A budget wish list

Free Market Economics is not for the rich. It really benefits the poor. Socialism or Communism (an extreme form of Socialism) results in a society with few wealthy individuals and a massive disparity in incomes and wealth. I have expanded on the issue of fiscal deficit above, but this is just one issue, and I am giving a budgetary wish list below.

What should Modi do?

If Viksit Bharat were to become something more than a political slogan, then the current path we are on isn’t the correct one. On trend, forget 2047, even by 2147 we will not get there. In fact, the path we are on almost guarantees the destruction of the Rupee, as has happened to so many other currencies before.

The economic downturn that lies ahead is something the world has never experienced, and we are grossly ill-prepared to handle it. Even at the best of times, the path we were on was unsustainable; given what lies ahead, doing anything other than what has been suggested above would almost be reckless.

If Modi wants to be remembered the way US citizens fondly remember George Washington, Patrick Henry, and Thomas Jefferson, then the above framework outlines the path to operate under. Argentina was experiencing 30% monthly inflation when Milei took over just 12 months ago and today the price inflation is on its way to zero. From an economic basket case just a year ago, it will also be the fastest-growing economy this year.

Milei, was an Economics Professor turned politician. He was just another Keynesian economist till he ran across an essay by Murray Rothbard. It’s very hard for somebody to unlearn something and accept the very intellectual opposite of what they have been professing for decades. Milei not only did that but has managed to put the country on the path of Lassiez Faire Economics in just 12 months without even a majority in his parliament.

Modi should get on a plane and go to Buenos Aries at the earliest. Modi’s economic think-tank is certainly not going to give the correct advice.

Note:
1. Text in Blue points to additional data on the topic.
2. The views expressed here are those of the author and do not necessarily represent or reflect the views of PGurus.

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