The Hindu Business Line : Rain check for the Budget party

The Budget turned out too ordinary, given the expectations of a dramatic turn in fiscal policy to tackle the problems the country faces, the latest of which is the south-west monsoon’s poor progress, says A. SESHAN.

Despite all the progress made, the Indian economy is still a gamble on the monsoon.

Forecasting is very difficult, especially when it concerns the future. — Mark Twain

The Union Budget for 2009-10 has turned out to be a run-of-the-mill exercise with no specific character to distinguish it from the previous ones. In the normal course it is only to be expected as it is officially called the Annual Financial Statement. Still, there were expectations of a dramatic turn in fiscal policy given the problems facing the country, with the south-west monsoon’s poor progress being the latest.

Official thinking continues to naively assume that liberal spending will pull us out of trouble. The emphasis on efficient implementation of projects is only on paper. After the Administrative Reforms Commission produced massive volumes of reports, the Government is thinking of appointing a Group of Ministers to consider ways of carrying out the recommendations. Would it be the end of the process? It is quite likely that a committee of Secretaries will be put in place as a follow-up.

The projected growth rate of around 7 +/-0.50 per cent in Gross Domestic Product is reassuring. The current economic problem requires a sectoral approach as long as it is not a general macroeconomic one.

The Budget has certainly taken note of this. Raising exemption limits for income tax is, however, only nominal and will not mark any significant rise in aggregate demand. In a country where income-tax payers constitute around 3 per cent of the population, the reduction in per capita tax liability by a few hundred rupees will not greatly boost the offtake of goods and services.

Saving the superrich

But what is not understandable, and what many observers have failed to note, is the rise in wealth tax exemption limit from Rs 15 lakh to Rs 30 lakh, while financial assets remain excluded from the liability.

This is ostensibly to mitigate the erosion in property values of the poor superrich due to inflation. However, they do benefit from inflation by making capital gains in the sale of properties and there are ways of legally avoiding taxes thereof.

In a poor country where there are not only rupee billionaires but dollar ones too, the need is to bring financial assets into the tax net, especially in the context of widespread benami (fictitious) transactions to minimise tax.

One understands that although such transactions were legally prohibited many decades ago, the laws are not in force in the absence of notification of the follow-up rules and procedures. The Economic Survey held out hope for rationalisation of the dividend distribution tax to ensure full single taxation of the recipients. It has not been done.

Spending to the rescue

The Economic Survey has expressed concern at the “sharp dip” in the growth of private consumption from 8.5 per cent in 2007-08 to 2.9 per cent in 2008-09, attributable to uncertainty in the labour market and the negative wealth effect of declining equity/property prices on spending. Further, the slowdown in private consumption accompanies the falling growth in gross fixed capital formation from 12.9 per cent to 8.2 per cent. The deceleration has been partially offset by Government consumption.

The substantial growth in government spending, the increase in nominal incomes due to Pay Commission recommendations, the rise in support prices for agricultural commodities, release of purchasing power due to tax concessions, a favourable ambience for the industrial sector, debt waiver and abundance of liquidity in the system are some of the factors that should yield results with a lag in the current financial year.

It is received wisdom that growth is a function not just of investment but also increasing net investment. Samuelson’s seminal thesis on the interaction of the multiplier and the accelerator brought out this important idea after discussing the role of depreciation and replacement investment. Lewis Carroll anticipated Samuelson when he said: “It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that.”

Will it rain?

The Government is right in emphasising its investment strategy. But the references to investment or capital formation are to the gross, and not the net, figure. Despite all the progress in the provision of irrigation facilities, Indian economy is still a gamble on the monsoon, a statement attributed to Lord Curzon. The party can be spoiled if there is a failure of seasonal rains. One hopes that the saying “It never rains, it pours” will not be proved right!

Plan expenditure accounts for only one-third of the total in keeping with past trends. The Centre’s additional capital expenditure for 2009-10 is Rs 70,841 crore and Rs 26,099 crore respectively over the budget and revised estimates for the previous year.

It includes maintenance expenditure for depreciating assets. The net investment expenditure will be smaller. Would it make a substantial difference to the situation?

Much will depend on the role of the private sector in capital formation. And the sector demands a reduction in lending rates. With the massive government borrowing of about Rs 4 lakh crore this year, banks will demand their pound of flesh in yields to lend over and above what is prescribed under the law. Corporate spreads have been falling in the recent period, which is a good sign of returning confidence to corporate lending. What the government borrows it spends. Thus the money returns to the system.

Reverse repo action

There is no impounding of liquidity, as in the case of Open Market Operations by RBI. The question is one of timing. The borrowing calendar is announced in advance. The corporate sector needs to act in unison in raising funds when the government is not in the market.

The relentless reverse repo operations are indicative of excess liquidity in the system. The outstanding Certificates of Deposits issued by banks have risen from Rs 1,52,901 crore as on January 2 to Rs 2,11,370 crore as on May 8. And the interest rate range has fallen from 7-11 per cent to 3.75-6.2 per cent. The Commercial Paper issued by companies rose from Rs 40,803 crore as on January 15 to Rs 57,845 crore as on May 15, the interest rate range falling from 7.75-14 per cent to 2.83-9 per cent.

The limitations for the companies to engage more in disintermediation needs to be looked at by the central bank at its next policy review. As yet, there is no official explanation for the massive reverse repo operations since the beginning of April this year.

One has to keep fingers crossed on the impact of the fiscal and monetary packages on the economy. Mark Twain’s quote, though humorous, is appropriate in this context. Will all the relief measures raise the GDP level or prices or a combination of both?

(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. blfeedback@thehindu.co.in.)

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