There is near unanimity on the first item on the new government's economic agenda, and that is to present a credible budget for 2014-15. A credible budget, they say, will restore the confidence of the markets, industry, international investors and, most importantly, the global rating agencies, so that they do not rush to downgrade India. As the civil servants point out, the current account deficit could start widening again if international investors get disillusioned about the new government's economic agenda and start pulling out their money, triggering a downgrade in its wake.
What would constitute a credible budget? One, the new Budget should account for all the expenses of the government. That is easier said than done. A savage cut in government expenditure in the last month of the financial year can keep the fiscal deficit on target. But that is not a sustainable strategy for fiscal consolidation. Equally harmful is an attempt to show a lower financial burden on account of subsidies by transferring those costs on to state-controlled companies, or simply postponing such expenditure to the next year. Such measures are like painkillers, relieving the discomfort temporarily but leaving the cause of the pain untreated. It is, therefore, important for the next budget to transparently reflect the government's expenses and meet them through sustainable sources of tax and non-tax revenues.
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The second focus area that should make the budget exercise look credible is the manner in which the new government addresses the concerns arising out of the current stress in the financial sector. The next budget must be upfront about acknowledging the enormity of the problem and, to begin with, provide for funds needed by public sector banks to raise their capital adequacy to meet the Basel-III norms. Official estimates put the additional capital requirement for public sector banks in the next five years at Rs 8 lakh crore, assuming an average annual growth of 20 per cent in their risk-weighted assets.
Nobody believes that the next budget can provide that money to capitalise the public sector banks in one go. But a reasonable expectation would be that instead of allocating funds in driblets as has been done in the past few years, the next Budget would do well to put in place a more durable solution. Many years ago, the National Democratic Alliance government had proposed to gradually reduce the government equity in public sector banks to around 30 per cent. This proposal had to be rolled back in the face of strong political opposition. It is time to revisit the proposal. It is simply impossible for the central exchequer to provide budgetary resources of that size in the next five years.
Allowing a more broad-based shareholding base for these banks by allowing them to tap the capital market would reduce the banks' financial demand on the government and, at the same time, a reduced government shareholding would hopefully give the bank managements more autonomy and make them more accountable to market principles. An additional advantage likely to arise from this exercise would be that regulatory controls over public sector banks would be fully enforced by the Reserve Bank of India. To start with, the banking regulator can usher in a more transparent, merit-based recruitment policy for the public sector banks' top management, which will lay more emphasis on performance-based incentives than on seniority or the number of years a manager has spent in a certain position.
The third element of a credible budget would be unveiling a blueprint for eliminating all poorly-targeted subsidies. A budget will inspire confidence, for instance, if it removes the remaining subsidy on diesel and outlines a timetable for phasing out subsidies on liquefied petroleum gas or LPG over the next two or three years. The mechanism for protecting the poor against the removal of such subsidies is already there and can be expanded if necessary. But the absence of an attempt to first curb and then stamp out the subsidies raj will seriously dent the credibility of the next budget.
The fourth and final step needed to help prepare a credible budget would be to present a clear action plan that reforms the taxation system and, at the same time, helps boost revenue collection. A quick start to implementing the goods and services tax and the direct taxes code would go a long way in reviving confidence in the Indian economy. Such efficiency-enhancing new taxes would certainly help, but equally important would be to reform the tax administration regime. Tax reforms are not just about new taxation policies or stable and moderate tax rates, but also about making the life of a taxpayer easy, with no fear of uncertainty or harassment. A combination of all these factors will help the government boost its tax revenues and eventually help it present a credible budget next July.