The Union Budget is always expected to achieve multiple objectives. First, poverty alleviation and income redistribution through government’s expenditure functions, while, second, garnering tax revenue in increasingly higher amounts, yet without causing disincentives for the taxpayer; third, providing guidance for forward-looking macroeconomic management; and fourth, a strategy for structural reform. Thus, if the exercise is carried out with care and due diligence, it has to be perspicacious, balancing the nation’s heart and cerebrum. In real life this translates into structural as well as immediate matters that the forthcoming 2012-13 Union Budget needs to address.(Click here for graph)
Let us take stock of recent economic developments that will be the springboard for the Budget. They reflect both lacklustre trends and some emerging challenges. While GDP growth suffered during the 2007-08 and 2008-09 global economic crisis, it began picking up thereafter. The sudden and unanticipated deterioration in GDP growth in the first half, or H1, of 2011-12 (graph 1) (compared to H1 of 2010-11) was not anticipated. Though industry had been giving warnings, it almost became a matter of crying wolf too many times. Indeed, it is realistically a matter of jumps in costs and the near-impossibility of planning business operations when facing rising and volatile commodity – in particular, oil – prices. Examining sectors, the numbers reflect negative growth for mining — and one wonders whether it is the southern wind or environment-related constraints that brought that piece of bad news. Whatever the causes, and there are more, it is imperative for investment to pick up from its lowered GDP share, and to reverse the declining investment growth of last two years (graph 2). A major challenge in the Union Budget is how to address dampened investment and revive GDP growth.
The uncertainty prevailing in the economy is taking its toll. Quarter to quarter, performances of both agriculture and industry have worsened and are volatile, while that of services has been both better and more stable (graph 3). First, agriculture’s share in GDP has been declining annually, even as recently as between 2009-10 and 2010-11 — from 15 per cent to 14 per cent. Yet, 46 per cent of employment is provided by agriculture. The dips in agriculture at particular points in 2008-09 and 2009-10 were stark, crying out for policy redirection. Second, between the fourth quarter of 2006-07 and the third quarter of 2008-09, industry experienced declining growth rates, then picked up, but started declining again from the fourth quarter of 2009-10 (graph 3). Policy needs to be directed to support industry in the light of a simmering global recession.
Given that there is little evidence that inflation can be reduced by serial monetary tightening at this point – since inflation has become highly structural in both domestic and international perspectives – the Reserve Bank of India’s stance needs to be rationalised. Though real interest rates have not been high, due to inflation (graph 4), industry should nevertheless be given a boost through monetary relaxation through interest rate policy. However, quantitative easing or tax incentives are not immediately essential. The year’s continuing depreciation of the rupee by more than 10 per cent has provided a fillip to exporters, while posing higher import costs to industry for its raw materials and machinery. On balance, industry’s experience seems to be not that positive as a result of the depreciation.
Viewing the government’s expenditure policies at a top-down macro level imparts little confidence either. Fitting simple trends for development and non-development expenditures (graph 5) and revenue and capital expenditures (graph 6) leads to an unhappy realisation: in terms of GDP, developmental and capital expenditures have decreased, while revenue/current consumption and non-development expenditure have increased. This implies that the investment support that industry and agriculture need has not been forthcoming as GDP grows; while direct subsidies rise despite landing up in unintended hands, government salaries grow irrespective of government productivity, and it has to pay out more in interest costs.
Using the heart for the right reasons while keeping a steady head remains the Budget’s challenge. Development expenditure policy has become suboptimal, lacking strategy, over the last years. For example, for a quarter century, capital expenditures in health and education have each lurked at 0.1 per cent of GDP, while their revenue expenditures have been almost 10 times as much. The Budget needs to reverse this trend, for these sectors need rationalisation desperately. Equally important is monitoring and evaluation (M&E) at sub-national levels for such expenditures. Field surveys reveal unacceptable execution and high leakage by international standards. The Budget should clearly specify the government’s intended reform in expenditure management and control in social sectors.
There is a lot that could be done, therefore, in the forthcoming Budget to provide direction to the macro economy, and in rebalancing composition and improving execution on the expenditure side. Equal challenges remain on the revenue side. Next month, I plan to touch upon revenue and tax reform which is much needed in the forthcoming Union Budget.
The writer is Director and Chief Executive of the Indian Council for Research on International Economic Relations (Icrier), New Delhi. These views are exclusively his own.
His book, Tax Shastra: Administrative Reforms, will be released next month
