Subir Gokarn: To all, a good time

BUDGET ANALYSIS/SECTOR VIEW

The first full-year Budget presented by Mr Chidambaram in his second tenure as finance minister has cemented his reputation as a harbinger of good times.

A healthy macroeconomic environment offered him an opportunity to take some risks with the tax structure and he took it with both hands. The main contribution of the changes in the personal tax regime is that it removes the incentive to channelise savings into financing government consumption expenditures and swings it towards instruments that would presumably finance capital expenditures. This should both boost the growth in demand of such instruments, offered by the nascent insurance and pension companies and make available more funds for long-term investments.

The corporate tax rate has been brought down from 35 per cent to 30 per cent. Several exemptions, expected to be phased out, were not touched. This is, therefore, a clear windfall for corporate earnings. The minister has placed a calculated, and, to my mind, a reasonable bet on corporate earnings buoyancy for the coming year, so the risk of revenue losses may not be all that great. However, it must be remembered that, in the event of an economic downturn, the persistence of exemptions in the face of a lower rate may come back to haunt the government. For now, however, the good times will roll.

Since exemptions are weighted towards the manufacturing sector, this is where the positive response has mostly been. This will be reinforced with the larger commitment that the minister has made for the highways programme. He has raised the investment in roads from about Rs 6,500 crore in 2004-05 to about Rs 9,200 crore in 2005-06. All, or much, of this will be financed by a small increase in the fuel cess, which, by virtue of the readjustment of customs duties on oil products, does not affect the retail prices of petrol and diesel.

Investment in highways has had significant short-term macroeconomic benefits in the last three years, which were plateauing off as a result of the peaking of annual expenditures. This boost will provide some new momentum, and what's more, do it through a delivery system that is working reasonably well. These extra resources bode well for a variety of sectors related to construction as well as for low-end consumer goods, demand for which is created by the employment generated by the programme.

Coming to specific industries within the manufacturing sector, textiles and sugar are the two special recipients of customised packages. From capital subsidies to reduced customs duty rates on machinery to dereservation, the Budget does lots to take this industry closer to exploiting the opportunities offered by the free global trade regime.

However, the ability of the industry to exploit these benefits is going to be severely hampered by the absence of movement on labour reforms. There is no point in creating fiscal space for large capacities if nobody is willing to hire large numbers of workers to operate them. Sugar is getting some benefits for a set of input price distortions. Sometimes, you do have to use fiscal instruments to offset political interventions!

In agriculture, clearly, the minister's heart is in the right place. All the rational signals are in the Budget""infrastructure, water management, crop diversification, and an emphasis on horticulture. Also, the increased role of microfinance institutions in delivering credit to farmers and other borrowers is a welcome means for banks to make their priority sector lending more effective and less risky.

But, as always, the proof of the pudding is in the eating. Once we go beyond the domain of the finance ministry, we have to discount the aspirations of the Budget by the effectiveness of the ministry responsible for delivering on them. Some of these plans might be realised, while some will remain on paper. But, until the fundamental distortions in this sector""product and input prices""are addressed, it is reasonable to argue that the benefits of any other investment are going to be restricted. Things may not get any worse as a result of this Budget, but let's not bet on things getting better overnight.

Coming to services, there is some increase in coverage, which was expected and will cause little disruption to the momentum in this sector. The two significant proposals in this sector are both related to financial services. The classification of securitised loans and derivatives as securities will deepen the markets for these and open up larger opportunities for financial players to manage their risks through the use of the market.

Just as New Delhi railway station is to be transformed into a "world-class" facility, Mumbai is the chosen one to be transformed into a regional financial centre. Of course, funds will be made available only after an expert committee makes its recommendations. So many things need to be done to realise this objective; but, on the other hand, this focused development effort, in essence, a cluster approach, has merits, whether applied to Mumbai or any other location.

It is becoming increasingly difficult to visualise either New Delhi station or the city of Mumbai as anywhere close to world class in anything, but then, a Budget is also about dreams!

The finance minister's hands were tied from the day he presented his first Budget. He had to tread between a constituency charged up with the idea of using government money to solve the country's problems and his own commitment to fiscal responsibility. He has certainly held on to the latter, even if with a pause button this year; as for the former, everybody should realise that money is perhaps a necessary but certainly not a sufficient condition to achieve the desired objectives.

Overall, this Budget is less ambitious and sweeping in its scope than the first year Budgets of the past; but that is because the onus of reforms has shifted from the finance ministry to many others. One can only wish for a comparable level of delivery from them.

(The author is chief economist, Crisil)