Budget 2013: Chidambaram’s chance to bell the cat

February 18, 2013

(Any opinions expressed here are those of the author and not of Reuters)

This year’s budget will be an interesting one and it will hopefully be more pragmatic than populist.

Not much has changed since Pranab Mukherjee presented the budget in 2012. At the time, India was battling high inflation at 9 percent, fiscal deficit at 5.9 percent of GDP and a current account deficit (CAD) at 4.2 percent of GDP.

In the run-up to Budget 2013, although inflation has eased, fiscal deficit at 5.3 percent of GDP and CAD at 4.6 percent of GDP does not augur well for the economy. Also, the consumer price index remains high due to food inflation.

Though the Feb. 28 budget will be the last before elections due in 2014, the populist decisions of 2008 may not feature in it this time.

Crippled by a higher than sustainable fiscal deficit as well as a weakening rupee, Finance Minister P. Chidambaram finds himself with the onerous task of balancing savings for individuals (allowing them to cope with inflation) with increasing foreign fund flows into the country to rein in its fiscal deficit.

With pressure from rating agencies to cut down its deficit showing no signs of abating and with India’s investment grade rating in the balance, one of the priorities of Budget 2013 would be to avoid a junk rating.

Assuming that the direct cash transfer scheme would play the role the National Rural Employment Guarantee Act (NREGA) played in the 2009 elections, there doesn’t seem to be a need for populist measures this time around. But the proposed food security bill could be a bigger threat for Chidambaram’s delicately balanced budget.

To move back onto the path of fiscal consolidation, the government needs to solve problems of both revenue and expenditure.

I would expect the budget to include steps to raise government revenues from direct taxes by means of increasing the tax base. Chidambaram could bring more services into the tax net and also increase the excise duty selectively, especially on diesel cars.

With inflation already eating into taxpayer savings, Chidambaram may not consider increasing individual tax rates. He may increase the limit of tax deducted at source (TDS) on bank deposits. Marginal tax rates may be raised to 35-40 percent beyond the threshold for the super-rich. We could also see the possible introduction of an inheritance tax.

Chidambaram might provide tax incentives on various savings in financial instruments and make them more attractive for investors. With him already anxious over gold imports, I believe the finance minister will take budget measures to curb gold imports. The corporate bond market could also be deepened to attract foreign capital by cutting withholding tax rates.

The current Securities Transaction Tax (STT) is seen as a stumbling block for institutions as well as reluctant individual investors in the equity market and they have been demanding a reduction. This could be met to an extent to boost the investment sentiment but could be balanced with the introduction of a Commodity Transaction Tax (CTT). This could be a tool to curb excessive speculation and bring in transparency in commodity transactions.

There could be sector-specific sops to encourage investment in infrastructure. Along with this, there could be an increase in limits for tax-free bonds. The capital goods sector may get some respite with an increase in import duties and higher depreciation.

Budget 2013 could also elaborate more on the implementation of the Goods and Services Tax (GST), which is essential to overhaul the economy and spur GDP growth.

On the expenditure front, a rising subsidy bill and lower-than-expected revenue realization has put pressure on government finances. Though managing the fiscal deficit is still a challenge, the government has already taken positive steps in the past few months by limiting LPG subsidies as well as increasing diesel and petrol prices at regular intervals.

Planned expenditure could face the axe in order to reduce the government’s burden. Chidambaram plans to curb expenditure by means of cuts in defence, railways and in other ministry budgets. Latest reports suggest he may cut the public spending target by about 10 percent.

Overall, I see a pragmatic and fiscally prudent budget from a finance minister who has proved that he has what it takes to bell the cat.

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