MAVERICK VIEW. A Budget that compromises the fisc

Hosannas are being sung for Arun Jaitley’s Budget of great aspirations. It is well packaged and bears the stamp of credibility.

There are concerns about some of the key fiscal indicators and some measures. Measures in the social sectors should benefit the masses if well executed.

The fiscal consolidation path to attain a target of a gross fiscal deficit (GFD) of 3 per cent of GDP has been elongated by a year. With the revised GDP numbers, an assessment has become difficult.

The Budget is based on a nominal GDP growth of 11.5 per cent in 2015-16.The new series estimates real GDP growth for 2014-15 at 7.4 per cent and the Budget projects real growth in 2015-16 at 8.0-8.5 per cent, which generates a breathtaking vision of double digit growth on the anvil.

While it is good to have aspirations of higher growth rates, unrealistic aspirations, without the concomitant higher savings to meet the higher investments, would only point to a sinister nemesis lurking around the corner wherein real growth falls precipitously. Consistency of projections would require an implicit inflation target in 2015-16 of 3.0-3.5 per cent. Obviously, the agreement between the government and the Reserve Bank of India would not indicate such a low target.

Since the nominal GDP is very large relative to the GFD, small variations in the GDP growth can have a big impact on GFD-GDP ratio. The GFD-total expenditure ratio in 2015-16 is projected at 31.3 per cent which should ring alarm bells. Again, the revenue deficit accounts for 71 per cent of the GFD which is of concern.

Underlying the Budget assumptions is the acceleration of growth but there is little assurance that the return on financial savings would be improved.

On the contrary there is an overbearing emphasis, in influential quarters, to reduce the returns on financial savings. The fact that the reduced inflation rate implies that negative returns on financial savings are in the positive zone is no solace for savers. The bottomline is that unless the return on financial savings is made more attractive, savers would continue to veer towards physical savings.

The introduction of tax-free infrastructure bonds for projects in the rail, road and irrigation sectors proposed in the Budget is commendable. Invariably, a good part of the year is spent in sterile debate on the modalities of these schemes, and markets could be in turmoil towards the end of the year, and finally the proposed issue of bonds does not take place.

A more serious problem is that the yield curve is inverted with short rates being higher than long rates. The analytics of the term structure of interest rates is that the long rate should be the average of the anticipated future short rates, adjusted for risk and uncertainty. The main reason for the inverted yield curve is that we start with the assumption that borrowing is unviable at market-related rates and therefore, long rates should be low. If money is to be raised for 10-15 years, the rate on such bonds should be 7.5-8.0 per cent tax-free. While the government is not obligated to buy back these bonds, there should be no curbs on secondary market trading.

The government intends to set up an independent Public Debt Management Agency (PDMA). The danger of prematurely setting up such an agency, without the prerequisites being met, has been discussed in detail in a number of earlier columns. The PDMA cannot remain in swaddling clothes and expect the RBI to bail it out. The RBI should not have a member on either the PDMA council or the management committee, especially as the mandate of the PDMA is to have unanimous decisions and that money should be raised at low rates. With an independent PDMA, the RBI should have unfettered freedom to run its open market operations exclusively to meet monetary policy objectives and not provide a feeding bottle to the PDMA.

Again, while setting up the Resolution Corporation, deposit insurance for banks should be kept totally out of it. If deposit insurance is within the Resolution Corporation, deposit insurance funds for banks would be misused to bail out financial companies. In India, by the time the Resolution Corporation intervenes, the financial companies would be empty shells without any net assets.

A path-breaking measure in the Budget is the announcement of the Gold Monetisation Scheme and a Sovereign Bond as recommended by the KUB Rao Working Group. It is unfortunate that the setting up of a gold bank, which was announced in the Union Budget of 1992, was subverted in a cloak and dagger operation.

We have lost almost a quarter century in developing this scheme. It is fervently hoped that we will learn the lessons of history and not commit the same mistake and hopefully the Budget proposal will be fully implemented during the course of 2015-16.

The Sovereign Gold Bond would require the investor to invest rupees which the government (or its agency) would buy domestic gold and on-lend it to users of gold. The bond could have a seven-year maturity and carry an interest rate of 5 per cent (tax-free).Under the Gold Monetisation Scheme the depositors would place gold with the concerned authority and there should be a reasonable minimum lock-in period, say a year.

The interest rate on this scheme should be 7 per cent (tax-free) which should be credited in metal to the holder’s account. On maturity or withdrawal the investor would be paid in gold. This would disgorge very large hoards of gold. If the measure proposed is implemented it would make the Budget for 2015-16 a watershed in fiscal history.

The writer is a Mumbai-based economist

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