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Suresh Krishnamurthy

ECONOMIC reality does not completely conform to economic theory. There are always deviations from the theoretical framework. However, in India, the theoretical prognosis of the implications of large deficits has now been borne out by facts. The large deficits of the past few years are being reflected in increasing dosage of taxes. This year too, predictably, the incidence of both direct and indirect taxation has increased.

Large deficits are, per se, not the problem. Large deficits due to poorly targeted subsidies, rising defence expenditure that involves imports rather than domestic production, rising interest costs and wages are definitely problematic. These do not lead to growth impulses and, therefore, tax revenues are unlikely to exhibit buoyancy. Thus, the stage is set for increased dose of taxation in the following year. The vicious cycle continues.

Has this year been any different? Hardly. Rising subsidies, defence expenditure and interest costs are the primary reasons behind the rise in expenditure. Non-Plan expenditure is budgeted to increase Rs 31,527 crore. Around 69 per cent is accounted for by increase in defence, food subsidy and interest payments. If other subsidies are included, the proportion increases to 87 per cent.

It is not as if there are no positives. For instance, in 2001-02, the Government has been able to reduce non-Plan expenditure considerably, compared to the Budget estimates. Plan expenditure, on the other hand, has risen, compared to what was budgeted. It hardly had any effect on economic growth, though. This year too, Plan expenditure is being increased substantially. Will it have any impact? We will have to wait and watch.

In addition, inflationary pressures continue to exist. The inflation estimates measured by WPI and CPI do not match the experience of savers. The rising costs of services, such as housing are not captured in official inflation estimates. Initial indications are that the Budget has done nothing to arrest this phenomenon. Central government borrowings have increased and this will lead to money supply expansion in tune with that of earlier years. Overall, the experience of savers with inflation may not change.

So, what should investors do? There is a feeling that with reduced incentives for savings, especially long-term savings, investors may be better off consuming now.

However, investors may need to exactly the opposite. Consider this. Which section of people is in a better position to deal with increased taxes and inflation now?

Those that saved in earlier years when the Budgets indicated that the Government's profligacy will continue unabated.

Even if they cannot use the savings to consume now, their progress towards long-term financial objectives will be relatively less affected.

The message now is loud and clear. Reduce consumption and save more.

This is because taxes — direct and indirect (inflation) — can increase because of the larger deficits. If such a situation materialises, it may benefit you. These are tough days and even the Finance Minister will agree. So, save now and save more.

The only expenditure that makes sense is housing, financed by loans. That will provide you a hedge against taxes for the long term and against rising rents. Otherwise, indulgence can extract a price over the long term.

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