Budget 2013: Balancing fiscal prudence and populism

February 25, 2013

(Rajiv Deep Bajaj is the Vice Chairman and Managing Director of Bajaj Capital Ltd. The views expressed in this column are his own and do not represent those of Reuters)

With a four-month equity rally showing signs of fatigue, the focus is on Budget 2013 to provide further impetus.

Historically, budgets around election years have been anything but fiscally prudent. The situation may be different this time around with a huge fiscal deficit and an unsustainable current account deficit leaving virtually no room for any form of fiscal largesse.

Though portfolio flows from overseas have been robust so far — 1.3 trillion rupees in 2012 and 222 billion rupees in January 2013 — overseas investors will be demanding continued fiscal consolidation and structural reforms going ahead. Even the RBI, in its latest monetary policy statement, said future interest rate cuts shall depend on fiscal consolidation and structural supply-side reforms.

The finance minister faces the uphill task of balancing fiscal consolidation and structural reforms with populist measures designed to boost the chances of the UPA government coming back for another term. However, considering developments over the last four months, it seems the government is ready to bite the bullet and bring about economically prudent policy initiatives, even if they come at a cost.

Reforms such as FDI in multi-brand retail, a cap on domestic LPG cylinders, an increase in fuel prices and railway fares — all point to the government’s resolve. Whether this continues in an election year or fizzles out under political compulsions is something that will be keenly watched.

Some of the key points one needs to look at in the budget are fiscal deficit projection, government borrowing plan and subsidy estimates for 2013/14. The five-year fiscal roadmap unveiled by the finance minister in October had put the 2013/14 fiscal deficit target at 4.8 percent of GDP, which may be an uphill task in an election year.

But the fact that the fiscal deficit for 2012/13 is unlikely to exceed the revised target of 5.3 percent of GDP — despite forecasts to the contrary — makes it achievable, provided enough political will is mustered. A net borrowing plan of 5 trillion rupees or less for 2013/14 should comfort the bond markets.

On the taxation front, despite the fiscal burden, the government will be wary of increasing taxes on individual taxpayers and businesses, as it needs to increase domestic savings and jump-start investments.

There have been rumours of an inheritance tax as well as higher taxes for the super-rich (similar to the U.S.) coming in the budget, which if they do come, can be damaging. We cannot afford to have the rich shift base out of the country and/or another round of black money creation. There is empirical evidence to show that lowering tax rates and widening the base has led to higher growth in tax collections.

The government is also likely to introduce the revised Direct Tax Code (DTC) Bill in this Budget, and give a road map for introduction of the Goods & Services Tax (GST). Investors and taxpayers shall be anxious to know key provisions in the DTC Bill, particularly those related to investment-based income tax exemptions and their impact on tax liabilities.

Pressures from the widening current account deficit and investor apathy towards financial assets may force higher income tax benefits for financial savings instruments in order to make them attractive. We may expect the budget to widen the scope of the Rajiv Gandhi Equity Savings Scheme (RGESS) and give separate exemptions (over and above the existing limit of 100,000 rupees under Section 80C) for the New Pension Scheme (NPS) and pension plans from insurance companies. This should be rewarding for small savers and investors.

The Indian economy and financial markets are at a critical juncture after four months of policy action that have raised hopes of a brighter economic future and better investment returns. We will be keeping our fingers crossed.

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