Budget lays the foundation for building castles

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It is good to think ambitiously so long as the ground is laid for achieving the objectives. Budget 2006 goes quite a way in doing just that for the country to achieve 10 per cent growth, says ALOK RAY.

Alok Ray

The Finance Minister, Mr P. Chidambaram, finds nothing wrong in building castles in the air, provided a solid foundation is laid. And his favourite castle? Presumably an India growing at 10 per cent. His Budget 2006 seeks to lay the foundation.

No doubt, the Indian economy is in good shape. The GDP has grown 7.5 per cent plus for three consecutive years an unprecedented development. Inflation is under five per cent, despite rising oil prices. The savings rate is above 29.2 per cent, up from 24 per cent a few years ago. This rise in savings rate has partially come from higher public sector savings no mean achievement. The rate of investment is 30 per cent plus. That, in a sense, indicates a growing faith in the future of India. Else, why add to capacity?

Further, in a globalised economy, investors would want to build factories in India only if they believe in a globally competitive India. Foreign exchange reserves are $140 billion. The economy seems poised for an accelerated growth trajectory.


So, the basic focus of the Budget is to maintain this growth momentum. The Finance Minister did not want to do anything to rock the boat, as it is sailing fairly smoothly. Also, Assembly elections in a number of States are round the corner. Consequently, he did not want to pursue any politically unpopular reform. Yet, it is not a populist Budget.

Mr Chidambaram has not deviated from the pursuit of his longer-term goals to reduce tariffs to Asean levels, to move to a uniform goods and services tax (GST), and to achieve zero revenue deficit. Thus, he has brought down the peak (non-agricultural) import duty from 15 per cent to 12.5 per cent, raised the service tax rate from 10 per cent to 12 per cent while reducing the excise rate on a few major consumer items (such as the small car), and has achieved a marginal reduction in the actual revenue deficit (as a per cent of GDP) in 2005-06 compared to the Budget Estimate for 2005-06. He would like to gradually reduce the core excise rate from 16 per cent to 12 per cent and bring it in line with a 12 per cent service tax.

Most economists agree that the real problem with government finances is the rising revenue deficit, rather than the fiscal deficit. The revenue deficit measures the gap between government's income and consumption expenditure. It implies that the government is maintaining its extravagant consumption habit by borrowing, which, if continued over the years, is a recipe for disaster.


A third important deficit concept is the primary deficit. It is fiscal deficit (which is equal to government's borrowing from the market) minus interest payments on past loans. Since the interest payments are a legacy of earlier governments, it should be ignored while evaluating the current regime's fiscal performance. Hence, the primary deficit is considered a better measure of the government's fiscal stance than the fiscal deficit. Here, there is a major cause for concern. Though the actual revenue deficit and fiscal deficit (as percentage of GDP) for 2005-06 are almost the same as the actuals for 2004-05, the primary deficit has worsened by 0.6 per cent.

This is basically due to lower interest payments (as a percentage of GDP). So, the lowering of interest rates has helped the Government post lower revenue and fiscal deficits, which hide the fact of a worsening fiscal performance.

Physical infrastructure particularly rural infrastructure (roads, power, transportation, irrigation, communication) is currently the biggest constraint on growth. So, it is understandable why a lot more money has been allocated to those areas. All politicians also recognise that eight per cent growth alone will not bring votes. The Government needs to provide

bijli, sadak, pani

(the so-called BSP factor), basic education, health, sanitation, drinking water, and some minimum incomes to the poor.

As a result, the financial allocation to the eight flagship programmes (like mid-day meals, universal education, drinking water mission, rural employment guarantee scheme, rural health scheme, urban renewal mission, etc.,) combined has been raised by 43 per cent. No one will question the need for more attention to these areas. However, unless significant improvement happens to the administration of these schemes, the delivery of the public services would continue to be poor. Unfortunately, there are no new initiative for administrative reforms in the Budget or outside.


Mr Chidambaram has assured that short-term rural credit up to Rs 3 lakh would be provided at seven per cent interest rate. But the basic problem of small farmers is not so much the interest rate as availability of timely credit. In other words, the delivery system is the villain and unless that improves the benefits are likely to be cornered by richer and better-connected farmers.

The Finance Minister has tried to provide a level playing field to the local producers by having a uniform five per cent countervailing duty (CVD) on all imports, to offset the disadvantage of excise and other duties that only local producers pay. The domestic players are facing stiffer competition not only from reduced peak import duties but also from various free trade agreements, which have further reduced the effective import duty on many products. So, domestic producers should be happy with the uniform CVD.

With growing affluence, a lot more people would like to own their private means of transport. Certainly, the reduction in the excise on small cars would help the process. An expansion of the auto sector, along with that of road networks, should create greater mobility and less locational concentration of employment, income, and prosperity. The negative effects would be the greater demand for petro products (higher oil import bill), more pollution, and more congestion on the roads.

Another castle built by the Finance Minister is that India will become a manufacturing hub for textiles, automobiles, steel, metals, gems and jewellery. He hopes that recent policy changes will attract a lot of FDI in these areas. No doubt the potential is there. But this Budget, apart from reducing the excise duty on small cars, has done little else to build the foundation.


People relying on interest income for survival expected some tax concession on the interest income. Though investment in bank fixed deposits above five years has been made eligible for tax concession (within the unchanged overall limit of Rs 1 lakh), interest income would remain fully taxable. The much-feared EET (exempt-exempt tax) scheme under which withdrawals from the Public Provident Fund would attract taxes has not yet been introduced. However, Mr Chidambaram has indicated that he would consider moving in this direction.

One final question to him: Whose brainwave caused the prices of umbrellas, walking sticks and henna to rise and that of pasta to fall this time as a result of excise tax rate changes? Is it due to lobbying or just the die-hard habit of tinkering and the feeling of self-importance by the backroom "experts" behind the Budget? When is this mindset going to change?

(The author is a Professor of Economics, Indian Institute of Management, Calcutta. He can be contacted at

(This article was published in the Business Line print edition dated March 15, 2006)
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