The Hindu Business Line : Balancing growth and demand pressures

With booming revenues and high GDP growth, the Finance Minister may be able to present a Budget showing a better fiscal deficit-to-GDP ratio than ever before. But that may be a Pyrrhic victory if the quality of infrastructure and other facilities remains appalling. The emphasis must shift from fiscal deficit reduction to the quality, both of expenditure and fiscal deficit, argues S. VENKITARAMANAN.

The debate on `overheating' of the Indian economy has caught the attention of international economy-watchers. The latest to join in is The Economist of London. It is on the side of the angels. It has magisterially declared that India is getting overheated, a declaration that leaves unanswered the question of how India is to solve the problem of growth with its demand pressures leading to price rises.

The challenge is how to handle growth without leading to price pressures. In spite of all the hectoring from the economy-watchers, or perhaps because of it, the Government and the central bank are trying their best to do the rope-trick — achieve growth while containing inflation through a combination of supply-side actions and monetary policy measures.

What is interesting is that the debate on overheating and the Government's stance on interest rate hikes has incidentally eased speculation in regard to the forthcoming Budget. The market have been so exercised about what Reserve Bank of India has or has not done that its concerns about the Finance Minister, Mr P. Chidambaram's Budget seem to have been muted.

Perhaps, there is something to be said for this turn of events. Budgets are non-events in most developed economies. We are also perhaps joining the brigade of better-off nations, at least in this respect. Why get concerned about the tweaking of a tax rate here or there when the economy is able to go ahead on its own steam? That is, of course, a simplistic view. Budgets do matter in India, where Government influences the economy by virtue of both what it does and fails to do.

The best raw material for a Budget exercise in regard to estimation of numbers is the trend of actuals up to the latest period.

The conventional Budget estimates take this trend into consideration and, based on assumptions of economic growth, estimate the receipts for the next year. The estimation proceeds on the same basis for items of expenditure also.

The Ministries put in their estimates, including demands for additional funds. The Budget Division of the Finance Ministry has to decide whether to accept these estimates, or modify them. The sum total of all these estimates of revenue and expenditure as accepted are incorporated in the Budget.

The Finance Minister makes an assessment of the deficit on this basis. The Planners' estimate of desired Budget support for the various Ministries leads to the usual ritual of their asking for more Budget support and the Finance Minister's signalling a reduction. Ultimately, the decision is often made at the Prime Minister's level.

Speculation is rife as to the size of the fiscal deficit. This is important because if the fiscal deficit-GDP ratio is higher than the permitted levels a la the FRBM Act, the Finance Minister will be justified in imposing tough taxation measures to raise revenue to abridge expenditure. By the time the Budget is presented, most of these decisions would have been taken.

Higher Revenues

The latest information shows that Mr Chidambaram is facing good prospects of higher revenue. The mid-term review of the economy presented by him recently shows that receipts are growing robustly, and corporate tax collections are on the rise because of the growth of the economy and booming demand. The latest economic report of the Finance Ministry also shows that these trends are continuing.

The Finance Ministry's economic report for December 2006 shows that the revenue receipts till November 2006 have shown an increase of 27.3 per cent over the receipts in the corresponding period last year. This compares with the lower figure of 16.5 per cent for the increase in 2005-06 over the corresponding period of 2004-05. The gross tax revenue in 2006-07 up to November 2006 has increased 31.1 per cent over the previous year, compared to 19.6 per cent in the last year.

What is, however, disturbing is that non-Plan expenditure has also risen faster in the same period compared to last year. The figure of increase for 2006-07 is 16.5 per cent, compared to 7.7 per cent last year. Particularly, the increase has been sharp in non-Plan revenue expenditure.

It is interesting that interest payments registered an increase of 16.4 per cent in the current year over the corresponding previous period compared to an increase of only 12 per cent for the previous year, reflecting the RBI's tighter monetary policies. Subsidies have also increased by 17.2 per cent in the current year compared to 1.1 per cent in the same period last year. All in all, expenditure management has failed to meet the test of fiscal responsibility.

But, because of higher growth of revenue in the current year over the last, the fiscal deficit this year for the period till November 2006 is less by 4.2 per cent than the corresponding period of last year. The decline also partly reflects the fact that capital expenditure in the period up to November 2006 decreased compared to last year.

Fiscal Deficit

The order of magnitude of fiscal deficit in the period of 2006-07 up to November 2006 was roughly Rs 108,201 crore, against a fiscal deficit of Rs 129,409 crore in the corresponding period last year. The ratio of fiscal deficit-GDP is bound to be even better than last year, since GDP has grown by 9.2 per cent in real terms — more than 14 per cent in nominal terms.

It is quite likely that the Finance Minister may thus be able to present a Budget that shows a better fiscal deficit-to-GDP ratio than ever before. But that is likely to be a Pyrrhic victory if the quality of infrastructure and other facilities continues to remain appalling.

We need to shift the emphasis of Budget-makers from fiscal deficit reduction to the quality, both of expenditure and fiscal deficit. These factors are bound to convey a more meaningful measure of growth impulses than a focus on mere fiscal deficit/GDP.

The "space" the expected fiscal deficit reduction gives the Government for completing the tariff reforms is also significant. The Finance Minister will be able to move towards Asean levels of duty structure without too much concern on the fiscal front. He has, however, to prepare his industry colleagues for the competitive implications that such tax reductions portend.

All in all, Mr Chidambaram seems to be riding a lucky wave with booming revenues and a high rate of GDP growth. His tough measures in ensuring better compliance of tax laws seem to have paid off in terms of better collections, aided by a rising tide of GDP. The Finance Minister needs to be cautious that in the euphoria generated by rising revenues, he does not allow himself to be led into more populist programmes, which consume a lot of revenue with little benefits.

Further, fiscal deficit reduction is all old hat. The pause button need not be pressed again. On the whole, the Finance Minister is on the right track and the views of The Economist notwithstanding, the economy is just hot enough and not overheated. May the Budget manage to keep the economic climate right — right for investment and growth of jobs!