February 29 is the birthday of former Prime Minister Morarji Desai, who, like Prime Minister Manmohan Singh, also served as a Finance Minister. On this day, P Chidambaram will present the national budget for the seventh time, just one short of Desai’s record. Much of the Desai-era economic policies like import and credit controls have outgrown their relevance. But his fiscal conservatism is worth remembering.
This is the last budget before next year’s elections, and the coffers are quite full. Hence the list of sop-seekers is long. Coalition partners will impose hefty demands. Exporters hurt by the rising rupee are asking for compensation. The Cabinet is already thinking of a massive loan waiver for farmers. Hence the FM will find it very difficult to exercise fiscal restraint.
But this may be the year to stand firm, even though tax collections have grown like never before. Corporate taxes grew by 40 per cent, twice of what the FM budgeted last year. Even import duty collections have grown handsomely despite lower tariff rates. Much of this is because the country has enjoyed four years of high growth, a tax machinery that is more efficient, and an ever-widening tax net. The wealth effect of the rise of the Sensex from 5,000 to 21,000 swelled the kitty too. It was after all Chidambaram who introduced the securities transaction tax that effectively linked the stock market fortunes to tax buoyancy.
But the reasons for fiscal caution lie ahead of us, not behind. Strong GDP growth in 2008-09 is not guaranteed. There is a demography induced momentum that will continue. It is reflected in the high savings rate (now at 35 per cent). But for that high savings rate to translate into high investment rate, we need corporate profitability to remain robust. This has been dented by at least two factors — a rising rupee and relatively high interest rates. The global recession-like condition, especially in the West, has clouded domestic sentiment further. Hence if corporate profits don’t rise as vigorously, then tax intake will slacken too. Another reason for caution is the Sixth Pay Commission, whose recommendations will be implemented during this financial year. The pay hikes could put the exchequer back by a full percentage of GDP. The only way that pay hike can be absorbed is by ensuring high growth (as in the previous four years).
To provide such a growth impulse, the FM would do well to consider pruning surcharge on corporate income tax, and also reduce excise taxes. The former would provide a boost to corporate sentiment and profitability; the latter would additionally help reduce inflationary pressures. Excise is a form of indirect taxation and is regressive. It also cascades — i.e. you pay tax on the tax. Even though with the Cenvat credit system, some of the distortion of excise has been curtailed, there is enough room to cut excise further. The indirect tax burden on mass consumption items like petroleum products and cement is huge. The auto sector too deserves lower indirect taxes. Excise taxes will eventually wither away, when the country shifts to a goods and services tax in 2010. The Eleventh Plan calls for increasing infrastructure spending to go up from 5 to 9 per cent of GDP. Most of this will need to come from public sector, and the incremental load on the public treasury will be significant. Hence this is one more reason to be tightfisted today.
The FM also needs to be extremely cautious in treading the slippery slope of subsidies. The fertiliser subsidy, which is the difference of price paid by farmers and the price received by producers (domestic and foreign), is going to be a whopping Rs 70,000 crore next year. This figure is fast approaching India’s entire defence budget! The rise of this subsidy is entirely due to imports. It is benefiting foreign producers, since Indian fertiliser capacity has been frozen by policy paralysis. Fertiliser feedstock being related to oil and gas industry has become very costly internationally. Further, since India is a big buyer in the international market, the prices always move adversely whenever India enters the world market. Hence there is an urgent need to increase domestic capacity drastically, and also weed out inefficient producers. Just as half the fertiliser subsidy benefits foreign or inefficient domestic producers, so also much of the food and kerosene subsidy leaks out to the non-poor. There is a serious issue of inability to target subsidies effectively. Even the self-targeting Employment Guarantee scheme is reaching only 3 per cent of intended beneficiaries in some states as per the CAG. The same question can be raised about the proposed mega-loan waiver, whose bill could run into Rs 90,000 crore. The government’s own statistics show that less than half of all farm households have access to formal credit. So the loan waiver will leave out more than half of all farmers. What then is its efficacy?
Subsidies are increasingly being pushed as obligations for future budgets, through bond financing. That way they don’t show up as this year’s deficit. But to the extent that these are non-productive non-capex items, it is best to recognise them today, and not punish future generations.
These are heady days. Cricketers getting auctioned for millions of dollars, real estate at stratospheric prices and the tax kitty brimming. But this is the time to remain sober, cut a bit of taxes and a lot of subsidies, do better targeting, think of impending pay commissions and loan waivers and maintain fiscal restraint. Chidambaram need not be as adamant as Desai, who resigned as Deputy PM since he was opposed to bank nationalisation. But surely, Chidambaram can be firm, and can keep his belt tight.
Ajit Ranade is Chief Economist, Aditya Birla Group