INDIRECT TAXES
| Budget will be a platform to provide directions on reforms Fri, 18 Feb 2011 22:10:50 GMT |
| This year's budget is significant for two reasons. First, the recent spate of corruption scandals has dampened investor sentiment and the budget will be an important platform for the government to provide policy direction on reforms. Second, the current macro challenge facing the government is one of containing inflation and sustaining growth, unlike the last two years when a fiscal stimulus was the need of the hour. Hence, the government's resolve in tightening its fiscal belt will be closely watched. The Reserve Bank of India has been doing a lot of heavy lifting in terms of containing inflation, but monetary policy is less effective if fiscal policy is not supportive, particularly since the food price inflation partly reflects supply constraints in agriculture. At least on paper, the budget should persist down the path of fiscal consolidation. In FY11, the central government budgeted a fiscal deficit of 5.5% of GDP, but this will likely be bettered at 5.2% due to seignorage (inflation tax) and a one-time revenue gain from 3G spectrum auctions. In its medium-term fiscal policy statement, the government committed to lowering the fiscal deficit to 4.8% of GDP in FY12 and the Finance Minister is likely to stick to this number. The amount of market borrowings will also be important to the bond market - net market borrowing are likely to be around 8% higher next financial year with gross borrowings at roughly the same level due to lower redemptions. Fiscal consolidation requires the Finance Minister to project a small rise in total expenditure, much lower than the average annual expenditure growth of close to 20% over the last four years. Such belt tightening would require cuts in discretionary spending on defence, investment-related allocations, and a reduction in central government assistance to the states. This would make the fiscal stance slightly contractionary, but are necessary in an environment of high inflation and robust growth. They would also help create room for other high priority expenditure in areas like heath, education and rural development schemes. Given the pressing need to encourage a supply-side response to tackle food inflation, the budget should focus on agriculture. This would mean increased spending on agriculture, promotion of the use of genetically modified seeds, drip and micro-irrigation systems, and incentives to set up cold storage and warehousing facilities. Greater public-private participation in agriculture should also be encouraged. Lower spending is not enough. The budget will have to target a substantial rise in revenues to meet its fiscal targets. This can be done through an aggressive target for disinvestment and such revenue-garnering measures as widening the services tax net, reducing the excise exemption limit and pruning excise duty exemptions. Changes in either corporate or personal income tax rates are not necessary at this stage and the Finance Minister should steer away from demands to increase the income tax exemption threshold. The investment climate in India has been affected by recent scams and the government is aware of the perception that reforms have stalled. Therefore, some focus on the medium-term reform agenda is important. The budget should aim to improve governance via better transparency in the allocation of national assets, such as telecom spectrum, land and minerals. The budget session should address such critical reforms such as boosting foreign direct investment in insurance and multi-brand retail, introducing the Pension Bill , creating a roadmap for tackling subsidies and re-affirming the government's intention to introduce a goods and services tax and a direct tax code from 1 April 2012. While the budget will likely show fiscal consolidation, attaining it will be a tightrope walk. Routine expenses that do not generate any assets, such as interest payments, subsidies and wages, account for 86% of total expenditure. Growth in this kind of nominal revenue expenditure has not dropped below the inflation rate for many years. High interest costs on public debt, the upcoming Food Security Act and rising oil and fertiliser prices will all put upward pressure on expenditure. Allocation of funds to the government's flagship employment scheme will also rise since rural wages are now linked to CPI inflation. Moreover, a sharp cut in plan expenditure will be difficult. FY12 is the last year of the 11th five-year plan and historically expenditure surges in the last year to make up for any shortfall in earlier years. Overall, total expenditure may end up rising by much more than the government shows in the budget and fiscal consolidation may end up being achieved only on paper. |
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