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A Budget to balance growth & deficits with distributive justice!

	June 22, 2009

With high expectations from the electorate and an ambitious agenda drawn up by the newly elected UPA government, all eyes are now on the forthcoming Budget. The Finance Minister, Pranab Mukherjee, who is scheduled to present his Budget on 6th July faces a formidable task of striking a balance between delivering on election promises and reining in the soaring fiscal deficit.



There is the legitimate demand for larger social sector outlays, clamour of industry for increased incentives, foreign investors demanding a more favourable investment climate and individual tax payers wanting enhanced exemptions/concessions. All these demands are legitimate but they have to be considered against the macroeconomic constraints.



The President’s Address to Parliament unequivocally commits the government to a policy of inclusive growth with the strengthening of various programmes on employment, education, housing, health and water supply and, as such, the government does not have the option of reneging on these commitments.



Growth projections



There are various projections for the growth of the economy in 2009-10. At the lower end of the scale are projections of a real growth of 6-6.5 per cent while upbeat projections range up to 7.5-8 per cent. While each projection has its own rationale, it is important to know the specific growth projection on which the Budget has been framed.



According to a renowned economist and former Deputy Governor of RBI, there are risks in generating expectations of immediately reverting to a 9 per cent growth rate. It would be best to recognise that the global crisis inevitably has some impact on the Indian growth rate.



A realistic objective could be to gradually revert back to the growth rate of 9 per cent by the end of the five-year period of the present government. The art of good management is to optimise growth and distributive justice.



The Finance Minister has admitted that there was a need to find ways to bring the economy back to higher growth path without increasing the fiscal deficit. He said the Government would focus on infrastructure, agriculture and employment generating sectors to protect growth and jobs.



Clearly, finding the resources to step up outlays on various flagship programmes and the proposed national food security commitment without further straining the exchequer will be a tightrope walk for the minister at a time when the tax revenues of the government would be lower.



While focusing on measures to put the economy back on a higher growth track, the priority areas that will need special attention include: (a) fiscal consolidation; (b) simplifying the tax laws and ushering in a benign tax regime; and (c) employment generation.



Fiscal consolidation: There is the all important issue of the gross fiscal deficit. As against a Fiscal Responsibility and Budget Management Act, 2003 (FRBM) target of a combined gross fiscal deficit of the Centre and States of 6 per cent of GDP, the deficit in 2009-10, inclusive of the quasi-fiscal deficit, is estimated at 12-13 per cent of GDP.



Over the past two years, the fiscal discipline of the Central Government has gone haywire, more so during 2008-09. According to recent RBI data, net bank credit to the Government — borrowings from the RBI and other banks that participate in government borrowing programmes — rose by a staggering Rs 3,95,330 crore during 2008-09 from a mere Rs 45,632 crore in the previous fiscal. Moreover, the Government has already announced that it will borrow Rs 2,40,000 crore during the first half of the current fiscal.



According to the Finance Ministry, the fiscal deficit during 2008-09 amounted to 6.2 per cent of GDP. But this figure does not take into account off-budget liabilities, including oil and fertiliser bonds. According to the Prime Minister’s Economic Advisory Council, under-budgeted and off-budget liabilities could add up to another 5 per cent of GDP. Thus the real fiscal deficit last year was 11.2 per cent of GDP which is unacceptably high. By adding the deficits of State governments, the picture becomes really scary.



A more worrisome feature of the government expenditure is the uncontrolled growth in revenue expenditure, which is largely unproductive as it is meant for current consumption. During the last fiscal, it outsoared the original Budget estimate by a whopping 337 per cent at Rs 2,41,273 crore, and amounted to 4.4 per cent of GDP.

While extreme conservative advocates could argue for an immediate correction of the fisc, it needs to be recognised that in any brutal adjustment it would be the social sectors that will bear the brunt.



However, what the Government could attempt during the current fiscal is to rein in the revenue expenditure by cutting down subsidies and prioritising expenditure. The next step should be to aim at fiscal consolidation over the next two-three years to make the economic recovery sustainable.



There is strong advocacy for the view that as inflation has been totally brought under control, the fisc can afford to be expansionist. This is a misleading line of reasoning.

The Consumer Price Index (CPI) for certain categories shows an annual increase of 10 per cent and it would be dangerous to frame macro policies on the premise that inflation has been licked. Inflation hurts the weakest segments the most and a government formally committed to inclusive growth cannot ignore the damage to the weakest segments.



Tax reforms: The contours of UPA 2's first budget are still taking shape but there have been three rounds of discussions between Mukherjee and PM Manmohan Singh and the overall thrust is becoming visible. The thinking is that a “tax shock” may not be the best way to find resources for the government's spending plans as it could dampen consumption at a time when demand is still sluggish.



There is a political deterrent as well. The thinking seems to be that a tax hike may not go down well at a time when there is a sense of expectation that UPA 2's first budget will have a feel-good touch.



However, the budget may not be altogether painless with the possibility of cesses being increased — like a further Rs 1 on every litre of petrol and diesel, or an increase in the education levy. These would be sugar-coated by being presented as “development-friendly” impositions while the government skirts around the politically sensitive area of personal taxes.



There is a possibility of some changes in areas like service taxes which impact consumer activity but will help government make up a part of what it has given away by way of three stimulus packages since late last year.



There is an urgent need to simplify tax laws to encourage better compliance and discourage tax evasion. Last year’s discontinuance of standard deduction meant for salaried employee apart from introducing irritants such as the fringe benefit tax and various other cesses have hurt the people and the business without much corresponding benefit to the exchequer. These need to be done away with to make the tax regime benign.



As for corporate tax, the economists argue that Finance Minister should consider doing away with all kinds of exemptions (which in any case, only a few large corporate houses are able to enjoy) and reduce the corporate tax rate to around 25 per cent.



Such a step would provide a level-playing field to all segments, including small and medium enterprises (SMEs), without in any way reducing the tax revenues of the Government. Then, there is clearly a need for a hard look at the burgeoning subsidies — both direct as well as indirect — which have failed to benefit the target groups and the really poor.



Employment generation: Stemming job losses and generating more employment opportunities hold the key to reviving the sagging demand and putting the economy back on the higher growth path. While growth is important, the accent should be more on employment intensive growth that will come from investments in infrastructure, agriculture, small-scale industries and export-oriented sectors, such as textiles, leather and leather products, and handicrafts.



The growth of the manufacturing sector which is so important for employment generation is constrained by serious infrastructural bottlenecks.



An estimated investment of $500 billon (Rs 23-lakh crore) is required to upgrade India’s roads, highways, ports, airports and the power sector. This is more than 10 times the current level of investment in infrastructure projects.



Hence the Government would do well to explore ways and means to make the public private participation (PPP) model a success. Also it could consider constituting a special fund with participation from LIC, UTI and other institutions, backed by the RBI, with allocation of $20-25 billon from its foreign exchange reserve for investment in infrastructure projects.



There is also a need to induce some of the better performing PSUs engaged in infrastructure, such as power, transport, construction and communication, to expand and speed up their investment programmes.



To put growth on a new trajectory and also to make it more inclusive, the agricultural sector needs to grow at a much faster pace, at least at the planned 4.1 per cent per annum, if not more. There is a need to make quick amends for the prolonged neglect of this vital sector.



To overcome resource constraint, massive amounts of funds allocated under ‘Bharat Nirman’ and National Rural Employment Guarantee Scheme could be better used to boost the asset base of the farm sector, particularly the durable water conservation and minor irrigation projects.