Big budget challenges for Finance Ministry

As the government’s finances remain in a precarious state, inflation gets increasingly structural and with the failure to push big-ticket reforms, a limping economy throws multiple challenges ahead of the Union budget to be announced in the second week of March.

Surely, the finance minister has his task cut out, but balancing populist aspirations and crying needs of the economy may not be easy.

 The slow economic recovery in the western world and euro zone debt woes too, have stacked against India’s rebounding economy, making it difficult to put the fiscal mess in order. Add to it the crisis brewing between Iran and the rest of the world threatening disruption in oil supplies, especially to India. 

Presenting the Budget for 2011-12 last February, Finance Minister Pranab Mukherjee had estimated the fiscal deficit or the gap between government’s expenditure and revenue would be brought down to 4.6 per cent by the end of 2011-12. But, this could not happen, as government’s expenditure throughout the year kept rising relentlessly, while its revenues shrunk in comparison with the pre-crisis years of 2008-09.
 
Huge subsidies

The whopping spends on food, fuel and fertiliser, which are expected to rise by Rs 1 lakh crore over the budgetary estimates, are said to be the main culprits crimping the desired growth in the economy. Economists predict that the government’s fiscal deficit may rise by at least one percentage point, or nearly by Rs 90,000 crore. This throws the challenge before the finance minister to lay a realistic road map and reduce fiscal deficit.

 However, with less than expected tax collections in the previous year and enhanced social sector spending, it may become increasingly difficult to strike a fiscal balance. According to government estimates, the total amount of its revenue forgone owing to tax sops was Rs 5,11,630 crore of the total tax collected in the previous year. Apart form this, the government’s flagship social sector programmes account for at least 18 per cent of Centre’s total spending. Analysts say that the mega Food Security Bill, planned next fiscal could increase the amount further.

Curbing open ended subsidies on oil and fertiliser are some other measures the policymakers have been suggesting in order to cut government expenditure and reduce its extra borrowing needs.

 “Open-ended subsidies on energy and fertiliser can be extremely destabilising,” Prime Minister’s Economic Advisory Council Chief C Rangarajan said recently. He, along with Chief Economic Advisor Kaushik Basu have been suggesting that India must move to market-based energy prices and subsidies should be directly be credited to the account of poor and needy.

High spending, coupled with low tax and non-tax revenues have forced the government to borrow excessively from the market, crowding out the corporate sector, thus reducing the share of their investment in the economy, which further slows the economic growth.
According to Mahesh C Purohit, Director at Foundation for Public Economics and Policy Research, an increase in revenue, control over expenditure and rapid growth in the gross domestic output can only check the deteriorating fiscal health. In India, which has a very low tax to GDP ratio, tax exemptions are almost equal to tax collections.

GST/DTC needed urgently

The two most important tax reforms measures- the Goods and Service Tax (GST) and Direct Tax Code (DTC), which have a potential to rationalise and enhance India’s tax collections in the coming years are keenly awaited by the investors. Although it may not be possible for the government to introduce them from the next fiscal year, economists are of the view that some provisions of DTC relating to rationalisation of exemptions on taxes can be introduced in this year’s budget, to improve revenue collections.

 Similarly, certain provisions of GST like General Anti-Avoidance Rule and Advance Pricing Agreement can be implemented in the budget. Good and Services Tax, the most crucial indirect tax reform since independence, has been pending in Parliament for the need of a consensus among various political parties.
 
Rationalise taxes 

Besides this, rationalisation of excise, service tax and customs duties are the most demanded reforms, which the finance minister could take up in this year’s budget to correct his fiscal imbalance. Economists, in their pre-Budget meeting with the finance minister recently, suggested bringing the excise and service tax to the pre-2008 economic crisis level to check falling tax revenues of the government.

To help India’s economy, impacted by the global slowdown, the government had provided three fiscal stimulus packages starting from December 2008 which included reduced excise duties among other sops. Accordingly, the three major ad valorem excise rates of 14 per cent, 12 per cent and 8 per cent applicable on non-petroleum products were slashed by four percentage points each.

In subsequent year, following economic recovery, the duty cuts were partially resumed. Service tax was also increased from 10 per cent to 12 per cent in 2009-10 Budget in order to give relief to the industry reeling under the impact of economic recession. The rate was reduced from 12 per cent to 10 per cent in subsequent year.

 In the last Budget (2010-11), however, the government did not go in for any roll back as the fiscal deficit had declined sharply to 4.7 per cent from budgeted 5.1 per cent. The delay in rolling back the stimulus has added to inflationary impact on the economy that forced the Reserve Bank of India to go in for tight monetary stance in the past as many months.

 According to Principle Advisor to Planning Commission Pronab Sen, the rationalisation of excise and services taxes alone can add up to 1.5 per cent to India’s GDP. Purohit also advocates the need to end expansionary fiscal policy. The fiscal policy, according to him, has to be such that yields revenue for the government.

 But, the real question is weather the government will be able to raise these duties to pre-crisis level in the coming budget amid industry clamour of weakening investment climate due to rising interest rates in the country. Ficci Secretary General Rajiv Kumar recently said that any rise in excise duty cut would act as a dampener for fresh investment to pump-prime the economy. Other industry chambers also have expressed similar views in the past.

 Another issue, which needs immediate attention of the government, according to analysts, is tax compliance, especially the offshore compliance. Many Indian resident continue to evade taxes using tax havens. This deprives the government of its much-needed revenues.

Then, there is the most burning issue of rising spend on India’s creaking infrastructure. The government has envisaged $1 trillion worth of expenditure on infrastructure in the 12th plan, but the crux is mobilisation of its resources. 

But, seeing the current trend of foreign investment in India, it looks difficult the government will be able to mobilise that kind of money.
 
Rationalise policy reforms

Economy watchers say, the government needs to rationalise its policy reforms and come out of the mode of policy inertia. Some big-ticket reforms need fast clearance, one among that is allowing foreign investment in multi-brand retail in the country. The dissent from Opposition and some of the government’s own allies may come in the way of turning this dream into reality.

Economists say that India’s high savings rate has the potential to deliver a sustained 9 per cent GDP growth if it is adequately channelised into investment.  “We need to give a renewed push to stalled private corporate investment,” said Chief Economist of Aditya Birla Group, Ajit Ranade.

Analysts are also of the view that this is the only year, before India goes into election in 2014, the government can take some tough policy measures to spur economic growth. Next year it cannot, as the government generally does not take tough stance a year preceding the budget for fear of losing elections. Naturally, all eyes are on this year’s budget.