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Mainstream, VOL L, No 14, March 24, 2012

A Pre - and Post - Budget Analysis

Tuesday 27 March 2012, by Anshuman Gupta


Pre-Budget Outlook

The Budget is very significant for an economy. It gives the direction to the economy by presenting the statement of its total expenditures and revenues, and initiating the new economic programmes. Though its importance has scaled down after 1991 as a result of the pro-market reforms’ programme, it still holds a significant position for the businesses.

This year the Budget is important for more than one reason. It is the second last Budget for the present government before the general election due in 2014. Most of the economists expected this Budget to address the real economic issues pending for a long time rather than being the usual one influenced by political considerations. In fact, in the modern word, the main task of the government is to create the right economic atmosphere so that private businesses could prosper. How-ever, the UPA Government seems to be deviating from this and again trying to control the major economic activities.

Last year was termed as the year for consolidation of fiscal finances. In the Budget (2011-12), the fiscal deficit was targeted at 4.6 per cent of the GDP. However, it is estimated to be ending up at 5.9 per cent of the GDP as a result of the persistence of many old entitlement schemes and the starting of new ones. It is the combined result of reduced GDP growth, which is estimated at about six per cent for the current year, and increased fiscal deficit.

The failure of the government to control its fiscal deficit has resulted in the shooting up of the inflation rate in the economy. The headline inflation rate is stubbornly at a high level, though other reasons, like structural problems in the economy, high energy price in the world, etc., are equally attributable to the high inflation rate.

This high inflation rate has been attempted to be tackled through monetary policy. The RBI has scaled up the basic policy rates 13 times during the last almost two years. This has adversely affected the investment growth rate in the economy, which has, in turn, negatively impacted the overall growth rate in the economy.
During the last mid-term monetary policy review meeting, the RBI indicated that the phase of increasing the basic policy rates had peaked out and it would, from then on, follow the expan-sionary monetary policy. Though this did not reduce the basic policy rates, it heralded the easy time ahead with the scaling down of the CRR rate by 0.5 per cent. It has further cut the CRR by 0.75 per cent just before the Budget. The would inject additional liquidity in the economy to the tune of almost Rs 60,000 crores. It was a timely move on the part of the RBI as the system was running liquidity deficit owing to advanced payment of taxes by the corporate sector.

Though the RBI has not reduced the basic policy rates yet, its dovish stance would help the econo-mic agents in the economy to expect the easy time ahead. They might expect the lower nominal and real interest rates in the economy in the near future. However, the role of the Budget is crucial to firm up the future expectation of the economic agents. The bold steps to streamline the fiscal finances and reducing the sovereign debts would portend well for the economy. It would give the policy space to the RBI to meet its commitments by reducing the interest rates.
However, the results of the recently concluded Assembly elections in the five States do not augur well for a business-friendly Budget. The poor performance of the Congress in these elections might come in the way of taking bold steps at the fiscal deficit and economic policy fronts.

The role of the Union Budget 2012-13 is crucial to complete the work initiated by the RBI. The Finance Minister would have to come out of the image of an inactive government perpetuating policy paralysis in the economy and take some bold steps to put its finances on a sound footing. The credible Budget proposals and plans to consolidate at the fiscal front for the current year and future would help the economic agents make favourable expectations about the economic variables for the future which would, in turn, help propel the economic growth even in the short run.

The consolidation of finances can be brought about either by increasing the tax rates or by reducing the expenditures. Increasing the tax rates is a good idea neither for the short-term nor for the medium- and long-terms. It will leave less disposable income for the households and less investible income for the firms, which would adversely affect growth in the short run. The world experiences show that it would not be conducive to forming positive expectations in the long run either. For instance, the same route was applied in Ireland in 1981 for consolidating the fiscal position. However, it left an adverse impact on growth not only in the short run but also in the medium and long runs. It reduced the investment rate, increased the unemployment rate and increased the savings rate of the house-holds, which was a sign of reduced expectation of the economic agents about economic growth in the future.

However, it would be advisable to widen up the tax base by moving to the negative list for the services tax. The excise duties and CANVET should be restored to the pre-crisis level. MAT may also be revised to the pre-crisis level. The new direct tax codes and GST should be initiated.

The second method of restoring the finances is by reducing expenditures. Though some expenditures cannot be reduced on account of their significance for the economy, some others might be attempted to streamline them. For example, subsidies can be reduced by doing away with the universal element from them and making them well-targeted. The fuel products’ prices, like diesel and LPG, should be fully deregulated. Diesel prices, at least, can be made market-determined for the personal vehicles. Even the LPG used in homes should be charged the market price.

The social entitlement schemes, like the MGNREGA, the newly proposed Right to Food Act, etc. should be made more focused and the beneficiaries should be properly defined so as to cover the needy sections only rather than pursuing the unmindful generous approach to cover as many people as possible for populist considerations.

The world experiences show that a long-term plan for improving the finances with less cuts in the short run and more cuts in the long run would bring the most desirable results. Less cuts would have less unfavourable impact in the short run and improved expectation about the future condition of the economy would motivate the economic agents to increase their spending in the short run as well. As a result of improved economic activities, the government would be able to have more tax collections which, in turn, would help in further reducing the fiscal deficit.

Post-Budget Analysis

THE Budget is on expected lines. It reflects the compulsions of the coalition government espe-cially after the results of the recently held Assembly elections and the desire of the government to re-establish its rather lost credibility. All the assumptions, on which the Finance Minister based calculations for the Union Budget 2011-12, turned out to be wrong with a large margin. It is the combined result of over-optimism on the part of the government about the current year, the deteriorating situation in Europe and feeble recovery in the US, economic policy paralysis at domestic front, etc.

The most positive thing about this Budget is its attempts to attach seriousness to this exercise by presenting a realistic Budget based on ground realities rather than unrealistic assumptions. It has set the target for fiscal deficit at 5.1 per cent of the GDP for the year 2012-13 and planned an achievable roadmap for its further reduction.

Unlike last year, the Finance Minister has projected a realistic growth rate for the fiscal year 2012-13. It is 7.6 per cent unlike the nine per cent projected last year. Coupled with increased excise duties and services tax by two percentage points, this should give 19.5 per cent growth in tax revenue, which he has projected. The widening of the tax net by switching over to the negative list-based services tax is a step in the right direction.

The outlay earmarked for the subsidies at Rs 1.9 lakh crore also seems to be a realistic one. Explicitly capping subsidies at two per cent of the GDP (currently at 2.4 per cent of the GDP) for the year (2012-13) and eventually bringing it down to 1.7 per cent of the GDP in three years are welcome steps. The Finance Minister has made it clear that the subsidies on food would be fully taken care of within this cap. It implies that in the near future, the subsidies on fertiliser and fuels would be scaled down, which, in turn, would increase their prices in the economy. It requires biting the bullet, which needs a lot of courage on the part of the government. It also requires the elimination of the universal element from the subsidised programmes by focusing them well to the real beneficiaries. The promise of the use of the UID to dole out cash-based transfers for fertiliser, LPG and kerosene is in the right direction.

There are some attempts in the Budget to boost investment in the infrastructure by raising the limit on tax free bonds for infrastructure to Rs 60,000 crores, pushing the National Highways of Authority of India to go for 8800 km of new roads, incentivising the investment in the agriculture sector, etc.

However, the main cause of concern stemming from the Budget includes the raising of Rs 5.6 lakh crores from the bond market by the government. It would add the additional demand to the existing private demand for the available fund in the economy. It would crowd-out the private invest-ment by raising the cost of capital. Other worri-some areas, including increased excise duties and services tax coupled with increasing energy and other commodities’ prices in the world market, would further give rise to cost-push inflation.

Impact Analysis

WHETHER these measures would be able to create the right atmosphere for the private businesses is a billion dollar question. This would largely depend on how they would help the economic agents make their expectations about the future variables—what their expectations are about the future inflation rate, nominal and real interest rates, etc. If they feel favourably about these econo-mic variables in the future, they might take up new investments even in the short run, which, in turn, would propel the economic growth.

As far as this Budget is concerned, though it is based on real assumptions, it did not take enough tough decisions regarding consolidating fiscal deficit, pruning the subsidies by substantial margins, announcing some bold economic policy initiatives, etc. Although it has tried to rein in the subsidies and deficit to some extent, they do not give much policy space to the Reserve Bank of India (RBI) to initiate the policy rates’ reduction in the near future.

Projecting the deficit at 5.1 per cent of the GDP appears reasonable if one compares it with the actual current year fiscal deficit, which is 5.9 per cent. However, it does not give much leeway to the RBI to scale down the interest rate in the near future. The Finance Minister could have taken some bold steps to reduce subsidies by making them more rationalised. He could have taken some concrete steps to kick-start the cash-based transfers to real beneficiaries beyond the pilot projects. Though the Finance Minister has explicitly stated the two per cent (of the GDP) cap on the overall subsidies and its eventual reduction to 1.7 per cent of the GDP in three years, the past records about profligacy do not give much confidence to the private economic agents and RBI.

Moreover, Rs 5.6 lakh crores budgeted for raising through bonds by the government is another dampener for the market. It would be likely to crowd-out the private investment by raising the cost of capital. The increased excise duty and services tax along with increasing energy prices and other commodities’ prices would add to cost-push inflation. All these factors would compel the RBI to think twice before initiating the scaling down of the policy rates.

The intention of reversing the Supreme Court verdict on Vodafone and bringing in a tax amendment, with retrospective effect, is another blow to the business atmosphere. It is sending very wrong signals to businesses, both domestic and international, that even the ruling of the Supreme Court is not final here. It can be reversed with the amendment in law with retrospective effect. This would surely have a damaging effect on the confidence of both national and foreign businesses. At least, this could be avoided at this moment.

Dr Anshuman Gupta is the Head, Economics and IB Department, University of Petroleum and Energy Studies, Dehradun.

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