The Hindu Business Line : Budget benchmarking from a macroeconomic perspective

Normally, post-Budget meetings are endurance tests. It is not easy, you'd agree, to sit through series of presentations for over three to four hours. At the end of the exercise, you may be excused if the only words of recall are a cocktail comprising tax, sections, rules and clauses, apart from the ubiquitous `amendment' and `proposal'. Thankfully, to help participants switchback to reality and leave the hall with some hope, there is invariably a lunch or dinner.

It was a refreshing change, therefore, to sit through a lecture of Dr D. K. Srivastava, Director of the Madras School of Economics, on the big picture at a recent meeting organised jointly by the MCCI (Madras Chamber of Commerce and Industry) and KPMG. Dr Srivastava began by saying that his first impressions about the Budget are not positive, judging by five parameters — fiscal consolidation, inflation, tax reforms, agricultural growth, and overall growth. Over the next about 30 minutes, he made such a coherent dissection of each of these that calling his analysis `first impressions' would be an understatement. Which is why, Business Line caught up with Dr Srivastava to know more about the Budget benchmarking he had done, from a macroeconomic perspective.

Dr Srivastava studied at the University of Allahabad for MA and the University of St. Andrews, UK, for M.Litt and Ph.D. Prior to joining MSE, Dr Srivastava was a Professor at the National Institute of Public Finance and Policy, New Delhi (1996-2005). He was a Member of the Twelfth Finance Commission from November 2002 to December 2004. He was also the Principal consultant to the Eleventh Finance Commission and the Economic Advisor to the Tenth Finance Commission.

Excerpts from the interview:

On fiscal consolidation

We need to congratulate the Finance Minister for achieving the fiscal deficit target stipulated in the Fiscal Responsibility and Budget Management Act (FRBMA). The fiscal deficit for 2007-08 is estimated at 3.3 per cent of GDP. It should not be difficult to achieve the 3 per cent FRBMA target in 2008-09, as the margin of adjustment is now quite manageable. For the revenue deficit target, with continued reduction, the revenue deficit-to-GDP ratio has come down to 1.5 per cent. Still, the target for 2008-09 of achieving balance on revenue account seems difficult for two reasons.

First, the distance that is left to be covered is quite large, as the revenue deficit in 2007-08 is more than Rs 70,000 crore. And, second,with the build-up of pressure on interest rates and the likely revenue burden following from the recommendations of the Sixth Pay Commission, achieving balance on revenue account in 2008-09 as prescribed in the FRBMA will be an uphill task. Achieving the revenue deficit target is critical because it has a significant bearing on savings coming from the government sector.

On inflation

Keeping the rate of inflation under check is looking difficult because it has strong monetary roots laced with supply-side pressures. The rate of growth of broad money supply is now more than 21 per cent. Even accounting for 9 per cent GDP growth rate, there is a gap of about 12 percentage points. As the inflation rate is about 7 per cent, there is still a latent inflationary pressure of about 5 percentage points.

The inflation rate in the case of food and essential products and some infrastructure items is now touching 10 per cent. Consequently, there is also a build-up of inflationary expectations. Inflation in food items has been allowed to go out of hand quite unnecessarily. With a proper information system and timely predictions for essential food items, it should have been possible to import in time and even out these supply-side imbalances. There are, however, some fiscal measures in the Budget to reduce the inflationary pressure from the cost side, particularly the reduction in the peak Customs duty rate to 10 per cent and a reduction in the ad valorem component of the excise duty on petroleum.

On tax reforms

There is no doubt that once the tax system is fully reformed, a no-change Budget is the best Budget. However, we still have some distance to cover, particularly in commodity taxes. In fact, the one percentage point reduction in the Central Sales Tax rate spells out the Government's commitment to prepare the ground for a comprehensive goods and services tax (GST). Not much has been said in the Budget as to the roadmap for GST.

The rates of the CENVAT and State VAT at 16 and 12.5 per cent respectively, add to 28.5 per cent, which is too high a rate for taxing value added in goods and not many instances can be found for this level of tax burden. There is a large differential between the tax burden on goods vis-à-vis that on services.

In a federal framework, the overall tax rate is to be divided between the Central and State governments and the responsibility of administering the taxes is also to be suitably specified. The vision of the Government does not come out clearly apart from the use of the phrase national GST, which also raises doubts whether the idea is to go towards a fully centralised GST.

On agricultural growth

Agriculture in India has been neglected for a long time. Agricultural growth is low on average and highly volatile. This volatility affects both prices and output. The risk-adjusted rate of return on agriculture is quite low. The trend rate of growth of agriculture, after reaching a peak of about 3.7 per cent in the early 1990s started to decline and is now not much above 2 per cent.

The rate of growth of capital stock in agriculture is about one per cent. The employment elasticity in agriculture is zero. Therefore, the main source of growth can only be an increase in productivity. The productivity of soil has been damaged over a long period due to disproportionate subsidisation of urea. Even a large number of small budgetary measures will not solve this deep-rooted malaise.

Reforms should be based on a proper diagnosis of the problem. However, the increased emphasis on secondary and higher education is a welcome sign, as it is only education and training that will enable the absorption of a large segment of our young population into industry and services away from agriculture.

On overall growth

The long-term growth prospects of the Indian economy are on a sound footing. The main driver of this growth is the sustained increase in the saving rate of the economy. In the last five years, all the three sectors — household, private corporate and government — have contributed to the upsurge in savings. The link between revenue deficit and governments saving is important. It is the reduction in the revenue deficit that has reduced government dis-saving from the late 1990s to the present by about five percentage points. However, saving alone is not enough and it should be converted into investment on reasonable interest rates. If interest rates keep rising following the pressure on the inflation rate, then an adverse impact on the investment rate would become unavoidable. We must take all necessary care to ensure that high interest rates do not damage our growth prospects in the immediate future.

D. Murali

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