The Hindu : A balancing act

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Saturday, Mar 09, 2002

Opinion

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A balancing act

By M. Govinda Rao

With no feel-good factor in it, not much can be expected from this budget to revive the economy.

BUDGET TIME is festival season for economists and the media glare has added colour. This is because the budget is not merely a presentation of the Government's income and expenditure account, but an articulation of the changes in economic policies. During the heyday of planning, it attempted to implement the Plan objectives, but since 1991 the budget has been the main forum for articulating the strategy of transition.

Formulating a reform budget when the economy is in deep recession is really a challenging task. The Finance Minister has to keep a vigil on the fiscal situation and at the same time provide a stimulus for economic revival through public spending on infrastructure. He has to push the reforms forward even as the conditions are not exactly ideal for economic restructuring. But there is no ideal turf and the Finance Minister has to convert the challenges into opportunities.

The prevailing economic situation in the country warranted that the Finance Minister achieve three important objectives and it would be useful to judge the budget in this context. The first was to revive the sagging business sentiment. Second, this had to be done while pushing the reform frontier. It is more important to push the reform sentiment further now than ever before but a recessionary period is not exactly the time to push it. The third challenge was to keep the deficits under control. Despite a decade of fiscal adjustment, fiscal consolidation has remained elusiveWill the budget revive the economy?

How does the budget fare in terms of reviving the business sentiment? During recession, the Government can kick-start the economy by making large public investment in infrastructure. Unfortunately, despite much talk this budget does not undertake this task. During the current year, capital expenditure has been reduced by Rs. 4,500 crores to contain the fiscal deficit. The proposed capital budget for 2002-03 at Rs. 70,000 crores is only 9 per cent higher that the budget estimate of 2001-02. In absolute terms, capital spending during 2002-03 will be more than the current year's revised estimate by about Rs.10,000 crores. Of this, Rs.4,454 crores is for defence imports. Economic revival can also be achieved by reducing the tax burden on the corporate and household sectors. Therefore, it was hoped that the Finance Minister would abolish the Minimum Alternative Tax. In any case, MAT is an ad hoc and irrational measure. If there are problems with fiscal incentives and they allow some to become zero tax companies, the solution lies in rationalising the incentives and not in slapping an ad hoc tax called MAT. Equally dampening has been the increase in the income tax surcharge. It does not make much sense to say on the one hand that lower tax rates have led to better tax compliance and in the same breath increase the levies through surcharges. After all, to get an additional Rs. 2,700 crores, it was not necessary to dampen business sentiments. In this year of recession, there is no case for imposing an additional tax burden of Rs.10,700 crores.

Will the budget help achieve fiscal consolidation? The story of fiscal restructuring during the last decade is a sad commentary of political inability or unwillingness to bear the pains of adjustment. On a comparable basis, fiscal deficit in 2001-02 was higher than a decade ago and, the deterioration in the quality of deficit in terms of the proportion of loans used for current expenditure has substantially increased and the trend will continue. In fact, the fiscal deficit estimate of 2002-03 is overly optimistic. Calculations show that even when the revenue and expenditure estimates presented in the budget are realised, reducing the fiscal deficit to 5.3 per cent of GDP in 2002-03 will require the nominal GDP to grow at 10.6 per cent which is inconsistent with the assumption used for projecting individual taxes. It is assumed that the Centre's net tax revenue will increase by 21.5 per cent during the year. The budget assumes that Central excise duty will increase by 23 per cent, corporate income tax by 24.5 per cent and personal income tax by 23.5 per cent. At the prevailing buoyancy, this would require the nominal GDP to increase by more than 22 per cent! Even the most optimistic observer will find these estimates patently exaggerated. We should be prepared for a much higher fiscal deficit for the year as events unfold during the year.

What will be the reform impact of the budget? It is hard to push the reform frontier during a period of economic downturn. However, India is a country where there is a strong consensus for weak reforms and, therefore, pursuing consensus-based reforms may not be very difficult. Yet, the Finance Minister must be complimented for trying to keep up the momentum. The most important measure is the attempt to reduce the level and spread of tariffs. Other important measures include dismantling the administered price mechanism for petroleum products, pursuing small scale industry de-reservation, benchmarking interest rates on small savings to average annual yields of Government securities and rationalising the tax treatment of small savings to some extent, forging private-public partnerships in some infrastructure projects, liberalising the agricultural sector from the tyranny of controls and enabling the States to pursue reforms in urban development.

However, the story of missed opportunities has continued in indirect tax reform. The time was right for preparing the ground for switching over to manufacturing VAT by extending the service tax on all services with minimum exemptions. The Expert Group has provided the blueprint for the eventual integration of the service tax with MODVAT to evolve an integrated VAT at the manufacturing stage. It makes little sense to pursue selective taxation and target unorganised and small service providers such as beauty parlours and rail travel agents. From the point of view of administration and avoidance of litigation too general taxation of services was recommended. The only item included for service taxation this year that can generate worthwhile revenue is life insurance. In an economy where there is no social security system and given that life insurance is considered meritorious, the exemption suggested even while taxing other insurance was deliberate. Most countries do indeed exempt life insurance from the purview of taxation for these reasons. The budget is also silent on setting an enabling environment for the State-level VAT.

On the whole, the Finance Minister is holding the reform baby in his hand while trying to do a balancing act on a tightrope. With no feel-good factor in it, not much can be expected from this budget to revive the economy. Hopefully, the Finance Minister will pursue the agenda he has set for himself in the last budget with greater vigour during the year.

(The writer is Director, Institute for Social and Economic Change, Bangalore)

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