Union Budget 2012: Need for a concrete plan

March 7, 2012

(The views expressed in this column are the author’s own and do not represent those of Reuters)

Like every budget since the subprime crisis of 2008, the one on March 16 will see the Finance Minister walking a tightrope between fiscal consolidation and growth. The only difference being — this time the government is really constrained to provide a fiscal boost to consumption.

Hence, support to growth can most likely be in the form of a boost to investment by adopting critical reforms and creating an atmosphere conducive enough for private investment to come back. With the markets and the Reserve Bank of India (RBI) breathing down its neck looking for a credible plan on bringing fiscal deficit down in the medium term and concrete steps to encourage private investment, the task is cut out for the government. It is now more a question of political will than anything else.

The results from state elections in Uttar Pradesh, Punjab, Uttarakhand, Manipur and Goa are likely to test the political will and commitment of the government to reforms and fiscal prudence.

Real GDP growth has dipped to 6.1 pct in Q3FY12, the lowest since Q3FY09 — the peak of the subprime crisis. A combination of high inflation, increased cost of capital and the weak global economy resulted in the slowdown in growth. Inflation has shown signs of moderation over the last couple of months, though doubts remain as to its sustainability. Cost of capital has continued to remain high in the wake of tight liquidity, high fiscal deficit and absence of clear direction from the RBI on interest rates.

India Inc will be looking towards the Budget to provide a credible plan on bringing down fiscal deficit and government borrowing to bring interest rates down. Also, investment as a percentage of GDP has moderated from about 33-34 pct to 30 pct levels over the last four years, thereby bringing the sustainable (non-inflationary) rate of growth of the Indian economy to about 7 pct. India Inc expects the government to kick-start reforms to boost private investment in the upcoming budget to bring the sustainable growth rate higher.

Mere lip service may not be enough in this budget. Markets need a concrete plan for execution. If fiscal deficit is projected lower, the assumptions and expectations forming the basis for such projections should be realistic and not over-optimistic. The Budget presented in 2011 had projected fiscal deficit at 4.6 pct of GDP, based on some practically weak assumptions such as a 9 pct GDP growth rate and understated subsidy bills. The reality is that fiscal deficit for FY12 is likely to exceed the budget estimate by a full percentage point.

The common man’s wish list, as always, includes a tax bonanza for the individual taxpayer by way of an increase in the maximum exemption limit (presently at 1.8 lakh rupees p.a.), widening of tax slabs and increase in various deduction limits prescribed under sections 80C, 80CCF (investment in infrastructure bonds), 80D (mediclaim premium), 24(b) (interest paid on home loans). The proposed Direct Taxes Code has sought to remove ELSS schemes by mutual funds and ULIPs and other insurance plans by insurance companies from the ambit of Section 80C. The common man would want this reversed as ELSS schemes present the best opportunity for long-term wealth creation and insurance is a necessity.

The Parliamentary Standing Committee on Finance, examining the DTC Bill has suggested a hike in personal income tax exemption limit under the DTC to 3 lakh rupees p.a. and a hike in deduction in savings to 2.5 lakh rupees. With the DTC Bill likely to be delayed, taxpayers are anxious to see how many of these suggestions are reflected in the upcoming budget. The government’s finances, however, paint a different picture. The need to contain fiscal deficit might force the government not to give too much by way of a dole to taxpayers.

However, there is a school of thought which believes, and rightly so, that enhancing tax breaks and leaving more disposable income in the hands of tax payers will increase savings (much needed looking at the huge financing needed for planned investments) and boost consumption.

Moreover, personal taxes do not contribute much to the overall tax kitty. Hence, small benefits to the individual tax payer are unlikely to upset fiscal calculations. Let us hope the government is not oblivious to this fact.

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