The Hindu Business Line : The price and politics of the Budget

The Budget will have to be non-inflationary in its overall impact. It has to address urgent economic and social priorities without triggering new pressures on the price front.

The Finance Minister, Mr P. Chidambaram, faces far more challenging tasks in economic management than he perhaps bargained for and these will be reflected in his fourth Budget (2007-08) which would nevertheless seek to raise public investments and make another push for growth-sustaining reforms. With a 9.2 per cent growth in 2006-07, the base year, the economy seemed poised for even a double-digit growth into the Eleventh Plan period beginning April 1.

Nothing had kept the UPA Government happy so much as being able to show an average 8.2 per cent growth in its first three years. Suddenly, spiralling inflation has dramatically altered the scenario. Are the good times behind the Finance Minister?

Growth Vs Inflation

The Government's over-riding objective has been higher growth, even if it did not translate into tangible gains in terms of jobs or incomes for the poor. But the revenue buoyancy certainly helped the Finance Minister achieve targeted deficit reductions. This year all economic indicators have been flattering and price behaviour was taken for granted over the best part of the year except for a brief spell related to revision of petroleum prices.

Once primary article prices started firming up and headline inflation rose above 5 per cent, the Finance Minister pointed to supply side constraints which, he assured, would be overcome. Expectations of containing inflation within the targeted 5-5.5 per cent limit were belied, despite the mix of fiscal and monetary measures.

The Reserve Bank of India, on the other hand, was more perceptive of the build-up of demand pressures and began tightening monetary stance, somewhat guardedly, in the face of soaring credit and asset prices. It has been raising the short-term interest rates in successive quarters and revised the Cash Reserve Ratio twice (December-February) to reduce liquidity and thus moderate excessive demand. There is some hardening in bank lending rates no doubt, as a result but, with the Wholesale Price index close to 7 per cent and the Consumer Price Index nudging 9 per cent in February, the interest rate is yet to peak.

Supply-driven inflation

The inflation is demand-fuelled and supply-driven, the latter the bigger culprit. The headline number under-states the worrisome levels of prices of primary articles and manufactured products, accounting for 34 and 56 per cent respectively of the rise in inflation. The signs of overheating in the economy have been there for all to see, except the Finance Ministry. Supply management through fiscal and other measures is the key, apart from whatever monetary steps may still be required in the coming weeks, if inflation has to be kept in the indicated 5-5.5 per cent range.

Budget Thrusts

Plainly, the Budget, to be presented on February 28, would have to be non-inflationary in its overall impact. To ensure robust and sustainable growth, it is necessary to set the stage for orderly development in the Eleventh Plan period. Urgent economic and social priorities need to be addressed with equal emphasis, but without triggering new pressures on the price front.

The Finance Minister is likely to assume an 8.5 per cent growth to base his estimates of revenue and expenditure, taking into account the priorities in agriculture, infrastructure, education and other social overheads and the flagship programmes, including rural infrastructure and national rural employment guarantee. The test of the Budget will be what it does to promote "inclusive growth," the underlying theme of UPA's Common Minimum Programme and the Eleventh Plan.

To have a hold on prices, the Finance Minister can be expected to make several changes in the Customs and excise duty structures entailing a sizeable loss of revenue which he would no doubt make up in other ways. But not via subsidy reductions or new levies which, in less inflationary times, would have been justifiable as part of a rational fiscal policy framework that is investor-friendly and least burdensome for the common people.

The political climate, with inflation on the one hand, and elections on the other, is hardly congenial for the Finance Minister to make any bold proposals for additional resource mobilisation or revive controversial reforms.

Key Priorities

After 60 years of Independence, India has not overcome food shortages. The Budget cannot address the larger issues of farming for prosperity, but can at best raise outlays through greater institutional support for farmers and possibly cut farm lending rates to 4 per cent, which would meet a general demand.

In infrastructure, one hopes Mr Chidambaram will step up public investment and come up with a plethora of projects which could be financed under the public-private partnership concept as well as propose new funding mechanisms which would provide for use of a part of the foreign exchange reserves.

There will be an accent on institutional and regulatory reforms to facilitate private investments and raise the total public-private investments in infrastructure to at least 8 per cent of GDP in the coming year.

Likewise, the Finance Minister may provide a boost to higher education, given the growing needs of skilled professionals and India's aspiration to be counted as a knowledge-based economy.

Fiscal Measures

Budget support for the Central Plan and assistance for the Plans of States and Union Territories in the first year would be not less than Rs 200,000 crore. Irrespective of expenditure commitments (other than capital), Plan and non-Plan, the Budget would take forward the process of fiscal consolidation with probable targets of 1.5 per cent of GDP as revenue deficit and less than 3.4 per cent as fiscal deficit in 2007-08 so as to facilitate the achievement of the set goals of phasing out revenue deficit and limiting fiscal deficit to not more than 3 per cent by the end of March 2009.

While India is broadly on track in fiscal consolidation and the deficit (Centre and States combined) would likely be 6.2 per cent of GDP in 2006-07, down from 10 per cent in 2002-02, the IMF points out that the ratio of public debt to GDP at 80 per cent is too high.

Tapping services sector

Having to finance a considerably higher level of Plan spending, apart from the inexorable rise in non-Plan expenditure and forced to cut indirect taxes to control inflation, Mr Chidambaram will have to rely first on economic growth generating higher revenues, and second, tap the services sector, bringing more services into the tax net with possible rise in rates in some categories.

He would, according to official statements, do away with as many tax breaks as possible — exemptions or incentives that have outlived their purpose or are no longer justifiable in a more open and competitive economy — and this would strengthen the revenue base substantially, at least in the future.

In direct taxes, Mr Chidambaram had indicated in November that he could reduce rates depending on the extent of compliance, which led to expectations of a raising of the exemption limit or restoration of standard deduction. Business and industry would like the corporate tax to be pegged at 25 per cent.

In any direct tax changes that Mr Chidambaram may attempt, he has to be even-handed to disprove the Left charge that Government's economic policies were designed to satisfy corporate greed.

(The author is a former Chief Editor of PTI.)

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