Lacking innovation

Status quo budget
Last Updated 15 March 2011, 16:45 IST

Now that the dust has settled down over the Union Budget 2011-12, we can discuss its implications methodically. According to Kaushik Basu, the chief economic advisor, the budget presented by Pranab Mukherjee is not a game changer and there lies its virtue. What he means is that no changes have been made in the basic tax rates like excise, customs, income taxes or service tax. So, the emphasis is on continuity of the tax regime and that is what it should be.

At the same time, the tax base has been further broadened by including more items under the excise and service tax net (specially on services used by the relatively affluent people like air-conditioned hospitals, higher-priced hotels, air travel). Minimum Alternate Tax (MAT) is imposed on SEZs. Total tax revenue is projected to grow by 18 per cent while government expenditure will grow by only 3.3 per cent.

The total subsidy bill is projected to go down by some 12 per cent. In particular, oil subsidy is expected to go down by Rs 15,000 crore compared to the current year while food subsidy will remain roughly the same. Fiscal deficit which has already come down to 5.1 per cent (as against the targeted 5.5 per cent for 2010-11) is further expected to go down to 4.6 per cent in 2011-12 and 4.3 per cent in 2012-13.

Pundits have doubts over the claimed success in fiscal consolidation. First, fiscal deficit for 2010-11 would have been 6.3 per cent, but for the bonanza of 3G spectrum sale which will not be available next year. Second, it is not clear how the oil subsidy bill can be reduced when the price of oil has been rising steadily in the midst of huge uncertainty in West Asia and the government does not have the political strength to raise the price of diesel, kerosene and LPG.

Third, the implementation of the Food Security Bill which would definitely increase food subsidy by a large amount has been postponed beyond April 2012 and hence its adverse impact will be on subsequent budgets. Fourth, the 18 per cent projected tax revenue growth crucially depends on achieving a 9 per cent GDP growth rate which again may not be achieved, given the falling FDI flows into India and the growing tendency of Indian companies to invest abroad.

The image of India being a good FDI destination has suffered due to rising inflation and lingering  land acquisition and  environmental hurdles affecting big-ticket investment projects like Posco and Vedanta. In the absence of a political consensus, there is no indication of progress in allowing FDI in multi-brand retail.

Possibly, the most significant announcement in the budget is the idea that direct cash subsidy will eventually replace the existing price subsidies on kerosene, fertilisers and domestic LPG. Along with the use of UID numbers to identify and target the real poor, it is expected that the direct cash subsidy will substantially reduce the leakage and improve the efficiency of the delivery mechanism.

A game changer

But at this moment it exists only as a concept. A task force has been appointed to recommend the implementation modalities. The team would submit its report sometime in the coming fiscal and then it would be first tried out through some pilot projects. If it can be successfully implemented, this would indeed be a game changer. Eventually the mechanism can be extended to direct cash (or coupon) subsidies on food also.

Apart from the uncertainties over the crude oil price and commodity price inflation (mainly due to global developments), the other major problem area is the deteriorating current account deficit (CAD) which would worsen further if crude oil prices continue to rise and remittances from the Gulf decline.

The rising CAD (as a percentage of GDP) is being increasingly financed by volatile FII money and less by the more stable FDI. Raising the cap on FII investment in infrastructure bonds to $25 billion and overall FII investment in corporate bonds to $40 billion should help reduce the infrastructure deficit but at the same time our reliance on unstable foreign funds would increase, making our economy more vulnerable in future. Even much of our foreign exchange cushion of nearly $300 billion consists of borrowed funds (like NRI deposits and FII money) rather than owned reserves like that earned through trade surplus (as in China).

The budget cannot offer much to contain high inflation — specially food price inflation — in the immediate run. That task is left to RBI monetary policy and export-import policy. The long term solution lies in improving productivity in agriculture. The budget offers higher credit flows (by Rs one lakh crore) to agriculture at lower interest rate, several measures to promote a second green revolution in the eastern region, to boost production  and storage facilities for vegetables, pulses and oilseeds — the major contributors to food inflation. The key, however, is not higher financial allocation but implementation of the various schemes at the ground level where we have a chronic deficit.

The biggest beneficiaries from income tax relief would be the people in the 60-64 years bracket who would gain by more than Rs 9,000, because of the lowering of the age limit for senior citizens. Those few who would live beyond 80 years would  benefit even more and would bless the finance minister in the twilight of their lives. Could not the FM reduce the age limit of the very senior citizens to, say, 75 years to enjoy a better life a little longer?

(The writer is a former professor of economics at IIM, Calcutta)

(Published 15 March 2011, 16:45 IST)

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