Repair and reform

Nirmala Sitharaman has done a good repair job on the fiscal front while announcing some potentially far-reaching financial innovations as well as changes in the definition of the public sector. She has also, unfortunately, reverted to hoary Indian tradition in her tax effort: Soak the rich, raise import tariff walls, and hit petroleum. On the expenditure side, there is little of note in terms of changes from what was presented in the Interim Budget five months ago. While the determination to remain fiscally responsible is welcome, the more important changes may lie outside of the Budget numbers.
 
But first, the fiscal effort. On the whole, the finance minister has done remarkably well to trim the fiscal deficit to 3.3 per cent of GDP, starting from a much lower tax base than had been assumed when the Interim Budget was presented. Unusually, and perhaps without precedent, the “revised” estimates for the year ended up being hopelessly optimistic. The “provisional actuals” subsequently reported by the Controller General of Accounts revealed revenue slippage of as much as Rs 1.6 trillion. Ms Sitharaman does not acknowledge this anywhere in her long speech or Budget numbers (whereas the Economic Survey did take them into account!). Still, it is last year’s tax shortfall that has forced her to lower the tax revenue target for the year by Rs 91,000 crore, compared to February, after taking credit for the benefit of the higher income tax surcharges and tariff hikes that she has announced. The rest of the gap has been filled by assuming higher numbers from disinvestment and a hefty additional dividend from the Reserve Bank of India.

 
This is heroic, but there may be a snag in the new numbers too. The assumption is that tax revenue will grow by over 18 per cent, whereas nominal GDP may grow by no more than 12 per cent. Such assumptions of revenue buoyancy do not always work out. The first quarter’s revenue from the Goods and Services Tax is not encouraging. On the expenditure side there are unpaid bills from last year, which will have to be paid now. Finally, it is not clear how the Rs 90,000 crore borrowed outside the Budget to pay for the food subsidy will be squared up, if at all. It is not enough to just meet the headline number on the deficit; that number should also be credible, and not seen as a fudge.

 

As for the tax effort, the insidious trend of raising tariffs continues on one pretext or other and speaks of a protectionist impulse that must be curbed. Equally insidious is the steady hike in tax rates at the top of the income ladder. The peak tax rate has remained nominally unchanged at 30 per cent since P Chidambaram introduced it two decades ago, but surcharges and cesses have been added on progressively since. With the latest hikes, the effective peak rate goes up to 42 per cent. That is high by any current reckoning, and counter-productive. No voices may be raised in protest, since there may be fewer than 50,000 in that tax bracket, out of some 70 million who file tax returns. But damage will be done in the long term, and hard to undo. Perhaps a higher tax slab was seen as a superior alternative to the re-introduction of the estate duty, which had been speculated on. On the corporate side, it is hard to understand the incrementalism involved in taking the turnover limit from Rs 250 crore to Rs 400 crore for a company to qualify for a tax rate of 25 per cent. Why not do the logical thing and remove some of the tax exemptions, and lower the nominal rate for all companies?

 
The finance minister has been more forthcoming, and imaginative, in her other reform measures. If she is able to carry through on the promise of reducing government shareholding in public sector companies to less than 51 per cent, she will take them outside the purview of the three “C”s that these companies’ managers complain about (the Central Vigilance Commission, the Central Bureau of Investigation and the Comptroller and Auditor General). Greater operational freedom could result, though whether that will automatically improve performance remains to be seen, given the many other limitations under which these companies function. Important meanwhile is the promise, repeated, of four labour codes to replace 44 labour laws, the opening of more windows for foreign investment, and the promise of monetising unused land. More could have been done, say, by selling completed infrastructure projects and using the money thus raised to finance further infrastructure investment.

 
The more interesting changes are the financial innovations, of which one is the proposal that the government should borrow overseas and not just in the domestic market. This is a good idea, if done within safe limits, because global interest rates are at historical lows (much of the market operates at less than 1 per cent interest), compared to about 6.7 per cent domestically. If India can borrow at about 2.5 per cent, and pay 3 per cent for a currency hedge, it works out noticeably cheaper than borrowing locally. There is the additional benefit that government borrowing will not drive up domestic interest rates, and could prompt private investment. Meanwhile, quite a lot has been promised for promoting the bond market, providing a backstop to banks buying highly-rated assets from non-banking financial companies, making life easier for foreign portfolio investors, introducing credit default swaps (of global financial crisis fame!), and other such.

 
The closing question is whether the Budget does enough to promote economic growth. The 7 per cent growth projected for the current year in the Economic Survey is tinged with some optimism. Within the tight fiscal corsets imposed on her, the finance minister has tried to address specific issues like keeping down interest rates, helping the financial sector get out of its troubles, and so on. Whether this will be enough to do the trick is what remains to be seen.