Besides the demands of foreign interests, the government’s own unthinking adherence to a kind of fiscal conservatism has driven the Finance Minister to failure
“The purpose of a Budget – and the job of a Finance Minister,” P. Chidambaram declared in his speech, “is to create the economic space and find the resources to achieve the socio economic objectives.” Now that the presentation of and the spate of initial responses to the budget are behind us, it may be appropriate to ask how far the Minister went in accomplishing his self-defined task.
Mr. Chidambaram was handed the management of the nation’s fisc at a time when growth was slowing, inflation high and the current account deficit widening ominously. Reversing the slowdown required an expansion in expenditure. And this needed to be financed in ways that took account of inflation and the widening external deficit. Since, for right or wrong reasons, Mr. Chidambaram is also with those who believe that the fiscal deficit needs trimming, the requirement was a large dose of additional resource mobilisation. Fortunately, additional taxation was not just needed, but also possible. As the Finance Minister noted, at around 10 per cent of GDP, the tax to GDP ratio was “one of the lowest for any large developing country” and well below the 2007-08 peak of 11.9 per cent. So ‘reclaiming that peak’ was the obvious short-term objective.
Ten per cent surcharge
However, Mr. Chidambaram does not seem to have stretched himself to do that. In terms of taxation the only noteworthy initiative was the imposition of a 10 per cent surcharge on individuals and corporations with taxable incomes exceeding Rs. 1 crore. Given the large number of concessions and exemptions available, the number of tax-paying entities falling in this range is small. The Minister himself provides a figure of a paltry 42,800 individuals who qualify. They were, thus far, being taxed at 30.90 per cent on their taxable incomes in excess of Rs. 10,00,000. Now, they would pay the new marginal rate of just 33.99 per cent only on that part of their income that exceeds more than 10 times this sum. The effect on revenues cannot be substantial. Not surprisingly, despite the Finance Minister’s optimistic projections on tax buoyancy, the tax to GDP ratio is expected to rise by just half a percentage point in 2013-14. The task of finding resources has not been pursued seriously.
If tax revenues are not slated to rise enough, non-tax receipts or expenditure cuts must ensure deficit reduction. Mr. Chidambaram has relied heavily on both. “Miscellaneous” capital receipts from measures such as disinvestment or the sale of spectrum are projected at Rs. 55,814 crore in 2013-14, as compared to a revised figure of Rs. 24,000 crore for 2012-13 and a budgeted figure of Rs. 30,000 crore for last year. The state of the markets and the recent experience with spectrum sale suggest this projection would be difficult to realise even if the best assets are put up for sale.
But even after incorporating these uncertain receipts, the budget has had to rein in expenditures to meet its deficit target. In a year (2013-14) when GDP is projected to grow by 13.4 per cent, total expenditure is expected to rise by only 11.7 per cent budget-to-budget. This implies a lower expenditure to GDP ratio and a reduced fiscal stimulus. As a result, despite the election due around a year from now, the so-called “flagship” schemes of the UPA have not been favoured with larger allocations. Allocations for the MGNREGS, for example, are budgeted at Rs. 33,000 crore in 2013-14, which is the same as budgeted in 2012-13 and marginally above the Rs. 29,387 crore actually spent that year. In addition, expenditure reduction is being realised largely through curbs on food and fertilizer subsidies and a steep reduction in the petroleum subsidy from Rs. 96,880 crore to Rs. 65,000 crore. The latter would feed into the costs of a range of products and aggravate inflation.
Finally, there has been little attention paid to balance of payments correction. One item that has contributed to the widening trade and current account deficit is the import of gold. Increasing further the duty on gold imports was the way to go, since there is no justification whatsoever for a small minority to use the nation’s foreign exchange resources to purchase the yellow metal whether as ornament or investment. Instead, the Finance Minister has chosen to send out a signal encouraging the import of gold by raising the duty-free limit for import of jewellery through the baggage route.
Put together, these indications from the budget suggest that the Finance Minister had either not given thought to or ignored the tasks that circumstances had set for him. All he managed to do was juggle his numbers to show off a lower fiscal deficit of 4.8 per cent in 2013-14. That will please no one. However, there are a considerable number who would resent being harmed by the effect that the budget would have on livelihoods and real earnings. This being the last full budget of UPA II before the next general elections, effective measures aimed at showing concern for those who are chronically poor and distressed were a necessity. Yet the Finance Minister failed to accomplish the tasks he had implicitly set himself.
The budget speech seems to provide one hint of what could be influencing the government’s inexplicable policy drift. The Finance Minister has explained why the current account deficit (CAD) is a cause for worry as follows: “This year, and perhaps next year too, we have to find over USD 75 billion to finance the CAD. There are only three ways before us: FDI, FII or External Commercial Borrowing. That is why I have been at pains to state over and over again that India, at the present juncture, does not have the choice between welcoming and spurning foreign investment. If I may be frank, foreign investment is an imperative.”
Even a cursory survey of the views expressed by representatives of foreign direct and portfolio investors makes clear that there are two demands they consistently make of the countries they target. The first is that the government should display fiscal prudence in the form of a small fiscal deficit and limited public borrowing. The second is that there must be a continuous stream of “reform” announcements that liberalise the terms of entry and operation of foreign private capital. In recent times the government fearing an exit of capital launched on a new round of reform showcased by the decision to permit FDI in multi-brand retail. However, the fiscal deficit has been high by the standards set by foreign observers. The Finance Minister may be operating on the presumption or may have received a signal that if foreign capital inflows to finance the CAD have to be found, the fiscal deficit has to be controlled.
However, this argument does not explain why taxation cannot be resorted to in order to mobilise resources that can both curb the deficit and finance additional expenditures. Nor does it make sense to find ways of attracting foreign capital at the expense of all else if the fundamental problem of a high external deficit remains unresolved.
This suggests that besides the demands of foreign interests, the government’s own unthinking adherence to a kind of fiscal conservatism has driven the Finance Minister and his government to failure. Measures like the deregulation of petro-product pricing, the increasing resort to cost-plus pricing of power mediated by a tariff authority, and the introduction of a dynamic fuel price adjustment component into setting of freight rates of the railways had made clear that the focus of policy was on fiscal adjustment through a reduction in expenditures led by a cut in subsidies. This thrust was only corroborated by the Economic Survey, which stated that while the reason for India’s growth recovery after the global crisis was the stimulus provided by the government, the downturn was the result of a tight monetary policy adopted in response to the inflationary environment the stimulus created. Since higher taxation is seen as disincentivising savings and investment and deficit spending as aggravating inflation, the argument possibly is that the onus of triggering another recovery is now on the central bank, which needs to shift to an easy monetary policy. That may justify the decision to abjure another fiscal stimulus. But the idea may be difficult to sell to the voter.
(The writer is Professor of Economics, Jawaharlal Nehru University)