Budget Expectations for a Rebounding Economy – challenges ahead

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S. Sethuraman**

There is a ground-swell of expectations for the Union Budget for2010/11, the second since UPA returned to power in May 2009, to be presented to Parliament by Finance Minister Shri Pranab Mukherjee on February 26.

Unlike last year, when the country was still in the grip of slowdown triggered by the global crisis, there is now a sense of optimism as Indian economy has relatively rapidly returned to its growth path. The worst is behind, with GDP recovering to 7.2 per cent, as officially estimated, in 2009/10 and the Finance Minister will likely budget for not less than 8 per cent growth for the next fiscal, thereby strengthening the fundamentals for getting back to the pre-crisis high growth trajectory.

The Budget is set against the background of clear signs of economic recovery with revival of business confidence for new investments, capital raisings, public and private, reversal of export contraction, return of capital flows signaling foreign investor confidence in India’s robust growth prospects, abundant liquidity in the banking system and a highly comfortable level of foreign exchange reserves. Conversely, expectations of all productive sectors – manufacturing, medium and small industry and exports and the services – remain high. These vary from sector to sector, from continued crisis-related stimulus measures to new fiscal incentives for investment and expansion and vigorous thrust to pending financial sector (Banking and Insurance) and other market-widening reforms. Taking ground realities into account, the Budget will begin a gradual withdrawal of the stimulus measures, limiting support to segments yet to revive.

Economic Scene

The economic scene, however, is not altogether rosy since headline inflation is rising mainly on the back of the prolonged double-digit food prices, unabated till January. There is a risk of inflation getting generalised and the Reserve Bank of India has already moved to reduce inflationary expectations by cutting excessive liquidity, though food prices are relatable to supply constraints. The price index for manufactured products (which include sugar and edible oils) has also shown some increase while volatile petroleum prices in global markets have always influenced the general price level.

The WPI (Wholesale Price Index) had risen to 8.6 per cent in the current fiscal year (April-January) and primary articles (including cereals and pulses) and also manufactured food products have been persistently high at 17-18 per cent. The Budget is hardly the instrument for combating inflation though care may be taken to see that its overall effect on the economy is non-inflationary.

The other major problem for the economy is the downturn in agriculture on which over 600 million people are dependent for livelihood. Growth will be negative this year. While agriculture is prone to vagaries of weather, and with telling effect from this year’s monsoon failure, sustained and diversified agricultural growth is vital for India’s food security, both for the rural and urban poor. Given the seriousness of the price situation, the Finance Minister may spell out a reinforced strategy for sustained growth in agriculture and farm productivity, in view of its critical importance for both growth of the economy and price stability.

Budget Strategy

On the positive side, 2009/10 has seen a gradual but strong revival of industry, mainly manufacturing, with a 16 per cent rise in December and 8.6 per cent in (April-December). The pick-up is notable in capital goods and consumer durables, the demand revival being attributed to Government’s substantial stimulus measures of 2008 and 2009. Growth was somewhat subdued in other segments of manufacturing. Based on accelerating trends with every quarter, CSO (Central Statistical Organisation) has given an advance estimate of GDP growth at 7.2 per cent for the current year.

Growth and Inclusive Development will remain the twin over-arching objectives of the Budget, as last year. Financing of infrastructure development will be a key part of the Budget. The Finance Minister will also provide higher allocations for all flagship programmes like the rural employment guarantee and national health and urban development besides Bharat Nirman which is focussed on rural infrastructure. Hopefully, the Finance Minister will also announce what credible steps have been taken to improve the quality of public expenditure.

The Budget, in the absence of direct tax reforms deferred for next year, will base additional revenue estimates mainly on the non-tax side, such as disinvestment and 3G spectrum auction. Still there will be reliance on a large order of market borrowings, as in the current year to plug the wide gap of 6.8 per cent of GDP, but the fiscal exercises for the coming year would be such as to make a decisive reduction in fiscal deficit to 5.5 per cent of GDP in 2010/11, a commitment already made by Government.

Centre-State Finance

The Budget will usher in a new fiscal devolution scheme for the five years (2010-15), as recommended by the ‘13th Finance Commission headed by Dr.Vijay Kelkar. The scheme will be designed to enlarge the share of resources that the Centre transfers annually to States from its tax revenues. The principles guiding the devolution to states, what measures are proposed to reduce inter-state disparities in development, and a road map for the Centre and the States to lower deficits and achieve fiscal consolidation will be known when the Government places the report in Parliament on February 25, a day before the Budget.

The major tax reforms on the anvil are the Direct Tax Code (DTC), which the Finance Minister had unveiled last year for public comments and the Goods and Services Tax (GST) – designed to unify the country as a common market. DTC is targeted for introduction in fiscal year 2011-12. The GST is already in advanced stages of consideration by State Finance Ministers in consultation with the Centre for a two-tier system of rates for the Centre and the States. GST, which will avoid multiple taxes, is seen as a promising vehicle of steadily rising revenues for the Centre and the States, as the economy expands. DTC proposals are for a reduction in corporate tax, higher exemption limits for personal incomes with rate adjustments and reclassification of income slabs. DTC is conceived as a simplified tax regime conforming to international standards which would evoke better tax compliance and revenue growth.

Medium-Term Fiscal Path

In making a calibrated withdrawal from stimulus, India will be ahead of advanced economies in exit strategy and also laying out plans for deficit and debt reduction over the medium-term. Countries which made fastest recovery like China and India have been enjoined to begin unwinding and resume the path of fiscal prudence. Similarly, global agencies which give India a high rating are also expecting the budget to give a push to financial sector reforms whereby banking and insurance sectors would open up to generate resources to fund India’s massive infrastructure requirements.

Meanwhile, with higher expenditure, plan and non-plan, mobilisation of internal resources through tax and non-tax measures becomes inevitable. It is in this regard that the Finance Minister will announce a major programme of disinvestment in public sector

undertakings. He may also propose, to the extent feasible, a reduction in the total outgo for major subsidies (food, fertilisers and oil products). Reduction in fertiliser subsidy is sought to be achieved by a system of nutrient-based subsidy which would be directly transferred to farmers. Government’s stand on the switch-over to market based pricing of petroleum prices with some revision of product prices in order to reduce the heavy burden on the Centre’s budget is awaited. Political exigencies will largely determine how far subsidy reductions and financial sector reforms could be pushed ahead in the coming fiscal year.

**Freelance Writer

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