The Hindu Business Line : Betting on growth, not reforms

One would have expected the Finance Minister to press ahead with bold reform measures against the backdrop of a booming economy and healthy growth in tax revenues. Instead, he seems to be betting merely on the higher growth trajectory for achieving the desired results. While one need not find fault with higher allocations to various flagship programmes, the Finance Minister could have cut subsidies and increased the capital expenditure.

The Budget for 2006-07 contains neither surprises, nor bold initiatives. Since it has been formulated against the backdrop of a booming economy and healthy growth in tax revenues, one would have expected the Finance Minister, Mr P. Chidambaram, to press ahead with certain bold reforms. Instead, he seems to be betting merely on the economy's higher growth trajectory for achieving the desired results.

Buoyant revenues

Thanks to the revenue buoyancy seen in 2004-05 and 2005-06, the Centre's gross tax-GDP ratio, after rising to 9.8 per cent in 2004-05 from 9.2 per cent in 2003-04, increased to 10.5 per cent in 2005-06. It is expected to rise further to 11.2 per cent in 2006-07 on the assumption that the growth momentum of the economy will be sustained. The Finance Minister has budgeted for a 20 per cent growth in tax collection next fiscal. Additional revenues expected are: Rs 4,000 crore from direct taxes; Rs 2,000 crore from indirect taxes and Rs 11,500 crore from the service tax. Thus, there is a heavy reliance on the service tax to mobilise additional revenues. The service tax collection is estimated to grow by 61.97 per cent to Rs 23,000 crore in 2005-06 and by another 50 per cent in 2006-07 to Rs 34,500 crore.

The right move

The rate of service tax has now been raised from 10 per cent to 12 per cent, and 15 more services have been brought under its net bringing the total number of taxed services to 96. This is, no doubt, a step in the right direction, given that 54 per cent of the GDP comes from the services sector. Mr Chidambaram has indicated that hiking the service tax rate to 12 per cent is in keeping with his proposal that the country should move towards a national level Goods and Services Tax by April 1, 2010.

The total expenditure in 2006-07 is estimated at Rs 5,63,991 crore, up from Rs 5,08,705 crore in the previous year, representing a hefty rise of Rs 55,286 crore. Of this, non-Plan expenditure will be Rs 3,91,263 crore while Plan expenditure is expected to be Rs 1,72,728 crore.

Despite this increased expenditure, the Centre's revenue deficit for 2006-07 is expected to be lower at 2.6 per cent of GDP and the fiscal deficit at 4.1 per cent in the Revised Estimate against the Budget Estimate of 2.7 per cent and 4.1 per cent respectively. For 2006-07, the revenue deficit is estimated at 2.1 per cent and the fiscal deficit at 3.8 per cent of GDP. Mr Chidambaram has been able to show better fiscal management, thanks largely to the revised GDP growth estimate of 8.1 per cent for 2005-06 from the earlier projection of 7-7.5 per cent.

Plan expenditure

The Finance Minister said in the Budget speech that the Plan expenditure, as a proportion of total expenditure, rose from 26.6 per cent in 2004-05 to 28.3 per cent in 2005-06 (RE) and further to 30.6 per cent in 2006-07 (BE). He claims this to be an improvement in the quality of Government expenditure. A closer examination, however, reveals that the proposed capital expenditure (non-Plan expenditure on capital account plus Plan expenditure on capital account) has declined as a proportion of total expenditure from 22.77 per cent in 2004-05 to 13.45 per cent in 205-06 and 13.43 per cent in 2006-07 (BE). Even in absolute terms, the proposed capital account expenditure has declined sharply to Rs 75,799 crore in 2006-07 from Rs 1,13,331 crore in 1004-05 (actual). This does not augur well for the long-term growth prospects of the economy.

Although the overall Budgetary support to the Central Plan has gone up by over 20 per cent in 2006-07, an overwhelming proportion of it will go to the flagship programmes. The allocation for the eight flagship programmes has been increased by 43.2 per cent from Rs 34,927 crore in 2005-06 to Rs 50,015 crore. In this, it is heartening to see that the outlay on education has been enhanced by 31.5 per cent to Rs 24,115 crore.

While one need not find fault with higher allocations to various flagship programmes, the Finance Minister could have cut some of the burgeoning subsidies and increased the capital expenditure. The open subsidies for 2006-07 have been budgeted at Rs 46,214 crore. Also, there is no move to pass through the increases in the prices of petroleum products in the world markets as stressed in the latest Economic Survey.

It is evident that because of political compulsions, including the opposition from the Left parties, the Finance Minister has refrained from cutting down the subsidies. He stated in his Budget speech: "The issue of subsidies is proving to be a divisive one... I would urge Members to help the Government evolve a consensus on the issue of subsidies." Apparently, for the same reason, there is no mention of other reform measures such as PSU disinvestment, privatisation, labour law reforms, and so on.

Similarly, Mr Chidambaram missed a good opportunity provided by the better tax-GDP ratio to further simplify and reform the tax structure and the tax laws. For instance, a modest cut in the peak rate of Customs duty from 15 per cent to 12.5 per cent is accompanied by the extension of a four per cent countervailing duty on all imports. A bolder move would have been to cut the Customs duty to 10 per cent or at least to do away with the countervailing duty to provide a further boost to the booming investment activity.

Fringe benefit tax

In respect of direct taxes, there was a strong case for scrapping the fringe benefit tax (FBT) and the banking cash transaction tax. Despite some concessions in the FBT, the enormous paperwork involved for companies will remain the same and the gain for the exchequer will be only moderate. Moreover, the Government is likely to be saddled with a large number of litigations because of this controversial tax.

On the positive side, the Finance Minister has increased allocations for agriculture and infrastructure, but the effort is not good enough to provide a major thrust to these sectors. Of course, the Central initiative on horticulture and allocation of Rs 1,000 crore for food processing are welcome features of the Budget.

However, the proposal to make available short-term farm credit at 7 per cent rate instead of 9 per cent on loans up to Rs 3 lakh appears retrograde so far as banking sector reform is concerned. Moreover, it has been rightly pointed out by many experts that the real problem facing the small farmer is not so much the rate of interest as the non-availability of timely institutional credit.

Access to credit

By the Finance Minister's own admission, only 27 per cent of farm households have access to credit from formal sources and 22 per cent from informal sources. The remaining households, mainly small and marginal farmers, have virtually no access to credit. It is well-known that those who obtain loans from informal sources, that is, private money lenders, have to pay interest rates as high as 60 per cent.

What the farm sector needs, most of all, is higher public investment in vital areas, including rural infrastructure and agro-based industries to generate more employment opportunities in rural areas outside agriculture.