Budget 2011: Need to focus on fiscal reform
(The views expressed in this column are the author’s own and do not represent those of either Principal Pnb or Reuters)
Let’s begin with what could be seen as the most crucial drivers of our economic fortunes in fiscal 2012 and topping the list by far is inflation, followed by the combination of fiscal and current account deficits and finally the need to maintain the pace of growth.
The government’s task gets complicated when we bring into the discussion the dichotomous factors of global growth and our dependence on foreign fund inflows.
The road to financial stability gets slippery when we consider oil prices.
Inflation is the result of a complex concoction of demand arising out of rural social spending, supply side pressures resulting from capacity constraints and the structural inadequacies in our development enabling infrastructure.
While the RBI continues to vocally pursue its tight money stance in an attempt to ensure transmission of its monetary policy measures, it clearly seems limited in its ability to arrest inflation alone. The RBI very rightly fears snuffing the growth buoyancy which is so very important if seen in light of the need to generate enough to keep our fiscal deficits under control.
Commodities, especially oil, and spiraling food prices in the global markets continue to retain the pressure on the current account deficits.
The public debt which is almost at 75 percent of GDP, with almost a third of the revenues required to service its cost, severely limit the government’s fiscal flexibility.
Government borrowing needs which could be about 435 lakh crore rupees combined with upward pressure on interest rates have made it difficult to push credit growth.
Consistently negative real interest rates have made deposits accumulation slower. In the longer term, this could adversely impact our credit ratings making access to cheaper global capital difficult.
What could we therefore expect in this budget?
Firstly, the government may look to shore up its revenues required to finance its social spending programs by removing the remaining excise duty exemptions especially with exports looking up. It may also look to raise other taxes, service taxes in particular.
Second, it is most likely to cushion the impact of inflation on middle classes by providing marginal tax relief. Social spending which is now inflation-linked will do the same for rural classes. It has already denied the possibility of relinquishing control over diesel prices.
Third, one could expect the bank deposits be provided fiscal benefits possibly, reducing the lock-in term for tax deposits and for long-term bonds with the intention of smoothening their ALM gaps so as to promote the laggardly non-food credit.
The RBI has been very vocal in expressing its concerns on the economy’s dependence on portfolio inflows to cover our balance of payments.
One would have liked to see material changes being made to our licensing policies to aggressively promote FDI and fiscal discouragement of portfolio inflows. This is important if we are to attract capacity building capex badly required to boost depressed industrial growth rates.
Our prime minister estimates that $300 bln will be needed for our infrastructure over the next five years which translates into all round double-digit growth rates.
This will also be critical if we are to break ourselves free from the vice-like grip of the supply and demand inflationary grid lock.
The only way we can meet the FRBM fiscal deficit targets and meet the demand side inflationary pressures is to ensure that 9 percent GDP growth rates are achieved.
More importantly, the government can no longer shy away from biting the bullet when it comes to undertaking genuine reforms to curtail its bureaucracy spend and subsidy regime. One cannot expect to keep depending on windfalls of the like of spectrum and PSU share sales to meet fiscal gaps.
It is interesting to note that, of the projected government expenditure in fiscal 2011 of about 11 lakh crore rupees, 40 percent went to pay government salaries, 22 percent to interest on debt and about 10 percent to subsidies. This left a mere 30 percent for the nation of which a mere 16 percent is for defence and 14 percent for infrastructure.
It is difficult to miss this absurdity.
Issues like agricultural income tax and the subsidy regime will have to taken head on.
There is no reason why we cannot establish agricultural income if we can claim to establish the household incomes at the lowest level as is being proposed in the MFI policy.
We cannot expect to continue financing growth by preying on soft targets like the salaried classes, when our tax revenues from about only 33 million people are a mere 11 percent of our GDP, possibly the lowest in the world.
In this background, one cannot but help being skeptical about facing another budget which will merely tinker around the periphery resulting at best in a growth neutral document leaving these serious issues to posterity.
I would believe that this budget is as good as any to take a hard look at real fiscal reform by placing national economic interests ahead of electoral dividends.