The Hindu Business Line : Tackling medium-term challenges

No doubt, the Twelfth Finance Commission, with its multi-dimensional restructuring of government finance, has burdened the Centre's finances. But it has laid down essential medium-term obligations, however onerous, for both the Centre and States, which need to be dealt with if India is to emerge out of deficits and unsustainable debt by the end of the decade.

THE Budget for 2005-06 heralds a new framework in Centre-State fiscal relations, which enjoins on both the need to eliminate revenue deficit and limit fiscal deficit to 3 per cent of GDP by 2009-10.

By accepting the Twelfth Finance Commission's award on resource transfers to States and its scheme of restructuring of finances, analogous to what the Fiscal Responsibility and Budget Management (FRBM) Act ordains, the Centre has signalled its determination to achieve fiscal consolidation over the medium term.

This is equally applicable to the States, whose finances will be augmented by larger flow of Central tax resources and grants, along with significant debt reduction.

The States are seemingly in a better position than the Centre to bring down revenue deficit and achieve fiscal stability within five years. But the States have growing responsibilities of governance and that of channelling Central grants to local levels, ensuring effective delivery of services.

The Budget points to a far from encouraging medium-term fiscal scenario for the Centre. Continuing pressures on finance can frustrate expectations in successive Budgets. More than GDP growth and implementation of reform, the United Progressive Alliance (UPA) will be judged on its ability to deliver on the National Common Minimum Programme, especially its promise to raise rural incomes and provide employment.

With three more Budgets to go before the Congress-led coalition serves its full term, political compulsions are likely to dominate fiscal exercises for the next three years. Issues of borrowing/deficit financing will continue to dominate the Budget discourse.

The Centre's net revenue leaves a relatively small margin for non-debt financing of social and economic programmes. There is a huge resource gap that has to be bridged, even if progressive revenue deficit reduction creates some space for Plan financing in the future.

For the rest, like core infrastructure, the private sector, domestic and foreign, with or without public partnership will have to be relied upon.

All this has to do with the envisaged growth of not less than 7 per cent per annum on a sustained basis in an environment of moderate inflation of 5 per cent.

That the Twelfth Finance Commission, with its multi-dimensional restructuring of government finance, has burdened the Centre's finances is apparent, but it has laid down essential obligations, however onerous for both the Centre and States, if India is to emerge out of deficits and unsustainable debt by the end of the decade.

Failure to bring down deficits to projected levels could push India to financial crisis unless public expenditure is drastically cut. A downtrend in interest payments (Rs 1,33,945 crore in 2005-06) cannot be expected in the near future, so also with subsidies (around Rs 47,000 crore).

The two together with Defence expenditure (Rs 83,000 crore) account for the bulk of revenue receipts. Less than 30 per cent of Centre's expenditure is on Plan account, and that too drawn from borrowings. Increasing develop- mental expenditure at the Centre is only possible with substantial accretions to revenue, while non-Plan expenditure remains stubborn for some years.

The Finance Minister has made a gallant effort to project a growth-oriented Budget that is focused on social development, and has laid out a roadmap for Bharat Nirman.

Yet, gains at the end of the year may turn out to be far less than expected, even if all the proposed mechanisms relating outlay to outcome are made effectively operational.

The Budget estimates a 22 per cent rise in revenues, and according to the Finance Minister the figure is more realistic than last year's as the disputed tax arrears have been excluded.

Although the Finance Minister claims that the Budget has effected major tax reforms, the net additional mobilisation is only Rs 6,000 crore from direct taxes, and possibly another Rs 3,000 crore from service tax extension, other changes having been declared revenue-neutral. Some widening of the tax base will result, but perhaps not to the extent needed.

The Finance Minister has promised a new income-tax law that will clean up some of the exemptions and simplify the tax structure.

Considering that revenue from direct taxes has been rising to match that from indirect taxes (there will be an additional revenue of Rs 43,000 crore from direct taxes in the coming fiscal, and Rs 20,000 crore from excise), the thrust of resource mobilisation will be on personal and corporate income-taxes.

If stability is the watchword then rates, surcharges and cesses will come handy. The medium-term fiscal policy statement accompanying the Budget has projected the Centre's tax-GDP ratio at 10.6 per cent, a rise from 9.8 per cent in 2004-05 (RE), and at 11.1 per cent and 12.6 per cent in the following two years.

These projections are subject to growth of the economy at 7-8 per cent. Without meeting the projected tax-GDP ratios, the revenue deficit targets of 2 per cent and 1.1 per cent of GDP for 2006-07 and 2007-08 respectively, cannot be met.

For 2005-06, revenue deficit is estimated at 2.7 per cent, as in the revised figure for the current year, and the deviation from what is required under the Fiscal Responsibility and Budget Management Act has been attributed to the impact of the Twelfth Finance Commission.

The burden is equivalent to 0.75 per cent of GDP, and hence the "pause", as Mr Chidambaram put it, in fiscal correction in 2005-06. Fiscal deficit projected at 4.3 per cent in 2005-06 is to decline to 3.8 per cent and 3.1 per cent in the subsequent two years.

The 2005-06 Budget does not provide for disinvestment receipts, which will be hereafter "off Budget" (investment fund), while there will be annual reductions in the Centre's loan recovery and interest receipts from States because of debt consolidation, but the Centre will not extend loans to States which are to raise borrowings on their own.

The picture that emerges from the fiscal policy statements is that without subsidy compressions in the medium term, along with a relative decline in indirect tax revenue, larger grants to States and lower recoveries from them, and exclusion of disinvestment from Budget receipts, non-debt financing of development will devolve mostly on direct taxes.

Government revenues are inadequate to finance the current Budgetary support to the National Common Minimum Programme. The Centre admits that unless revenue deficit is eliminated by March 2009, surpluses to provide the desired flexibility in incurring capital expenditure cannot emerge.

This suggests the need for greater resource mobilisation in the intervening years, especially since the Centre seems unable to divest a good part of its equity in public undertakings without affecting its hold on strategic sectors.

Fiscal policy has also to contend with imponderables such as the behaviour of monsoon and international oil prices, which caused an inflationary upsurge in 2004, and exchange rate misalignments caused by global imbalances as US deficits continue to soar.

As IMF notes, global growth is relying too much on the US and China. A slowdown and a speculated move towards a managed float of its currency, the renminbi, by China by the middle of the year could have unsettling consequences for several Asian countries. All these factors will have a bearing on our macro-economic management, and on monetary and credit policy.

According to the Centre, its fiscal policy strategy is to create an investor-friendly environment by deepening the process of decontrol and deregulation, placing greater reliance on market borrowing for financing fiscal deficit and promoting a soft interest rate regime and long-term savings. It also favours a deep and wide market for government securities.

The Reserve Bank's Annual Monetary and Credit Policy Statement at the start of the fiscal should provide an operational framework for advancing some of the Budget initiatives.

(The author, former Chief Editor of PTI, is a New Delhi-based freelance writer.)

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