The Redeemer of Fiscal Sins

Image: Vijay Mathur/Reuters.jpg

By now, it is evident that Indra, the Lord of Heaven who rules over thunder, storm and rain, is Finance Minister Pranab Mukherjee’s favourite god. It is quite apt that the near-octogenarian minister must invoke in his Budget speech the name of one who lives under the shadow of bigger gods but is the only one capable of freeing the light of dawn from the envelope of darkness. Not unlike Pranab Mukherjee himself.

For years, darkness has indeed shrouded India’s fiscal policy. Successive budgets have carried economic reforms forward or taken populist schemes to the doorsteps of people. Some finance ministers focussed on industrial growth, others on inclusive growth. And there were quite a few dismal, boring budgets too. But there has hardly been any one budget that has made fiscal discipline its core agenda. Good financial sense almost seemed to be a liability in the art of budget-making.

Until Monday.

Pranab Mukherjee’s seventh Budget in a career of 40 years wasn’t exactly an overflowing package of goodies. Nor was it a new milestone in oratorical excellence. For those looking for big-bang reform announcements such as opening up the multi-brand retail sector to foreign direct investment or ushering in a Central Goods and Services Tax or even a mega privatisation plan, there was disappointment in store. Similarly, there wasn’t much for those from industry by way of tax breaks. So it is tempting to write off Budget 2011 as an inconsequential and unimaginative document.

But the Budget’s brilliance lay elsewhere. After two years of fiscal expansion designed to stimulate the economy out of the impact of a global recession, it was time to go back to financial discipline. The stimulus programme had not just revived the economy but had also led to inflation and a strain on government finances. A cutback in fiscal deficit was an imperative. One way to do this was to raise taxes, but this being an election year, Mukherjee had little room there.

It is in this context that Mukherjee has surprised economists as well as laypeople by setting a stiff 4.6 percent target for fiscal deficit in 2011-12. This would even surpass the 4.8 percent target outlined in the government’s Medium Term Fiscal Policy Statement for that year. As a corollary, another target set to be achieved in 2014-15 will be crossed in the coming year itself — to bring the government’s debt below 44.8 percent of the gross domestic product (GDP).

So, where is the catch? Normally in budget speeches, a sweet Part A leads to a bitter Part B; social and infrastructure expenditure must be funded by the tax proposals. In Budget 2011, Mukherjee managed to keep both parts moderately sweet. He gave a handsome increase of 23.3 percent in the allocation for infrastructure to a whopping Rs.214,000 crore, gave a similar raise to both health and education, announced measures for financial inclusion and set a record target of Rs.475,000 crore for agricultural credit. And he did all this by keeping taxes largely revenue-neutral, in fact taking a tiny Rs.200 crore knock in that department.

Much after Mukherjee completed his Budget speech, many were left wondering where the money would come from if the government will neither borrow nor tax more.  The answer lies in the voluminous and often imperspicuous documents that form the Budget as well as the tone with which the government has been talking of late.

Contrary to the predictions of some economists, the government is gung-ho on the economy. The optimism was obvious in the Economic Survey released days before the Budget. The survey saw the economy growing at 9 percent in 2011-12 and the growth accelerating in the coming years. Mukherjee, in his Budget speech, stuck to the same line. The growth has returned and how.

And here’s where it becomes risky and tricky. Budget 2011 is all about one assumption. That the economy will grow at such a scorching pace that the tax revenues will be buoyant and help Mukherjee meet his goals. Listen to what the documents say: “Any slippage in the growth forecast would impact these projections.”

There you are. This Budget will work only if the economy grows at 9 percent or above and there is improving tax compliance by the people. Even in the current fiscal year, tax revenues have grown by an impressive 26 percent, as against a target of 19.6 percent. This coupled with the windfall the government received from the auction of spectrum for third-generation (3G) mobile telephony and wireless broadband put a lot of cash in the finance minister’s hands. This extra money could have all been used to bridge the fiscal gap. Instead, Mukherjee chose to use part of those funds to raise allocations for social and infrastructure plans in 2010-11.

Gross tax revenues stood at 10 percent of GDP in the current financial year. Mukherjee is taking a gamble by expecting it to further improve to 10.4 percent in 2011-12.  

In other words, Mukherjee hopes to repeat the tax collection performance of 2010-11 in the new fiscal year as well. If he fails to do so, the betaal that fiscal policy is, would have escaped his shoulders again.

Mukherjee knows the risks only too well. As one economist talking to Forbes India put it, he has also taken steps to ‘ring-fence’ economic growth as he tries to bring back fiscal discipline. He has sought to remove infrastructure bottlenecks by focussing on execution and governance in addition to a large allocation. The decision to give government subsidies for fertilizer and kerosene directly to the beneficiaries will not only reduce ‘leakage’ but also provide a template for subsidy plans in other sectors such as education.

He has also addressed the supply side constraints that are at the root of the spike in food inflation by encouraging investment in storage and transport of food items. He sought to bring corporate profits earned abroad back to India, by halving the tax on overseas dividends of Indian companies. He has allowed foreign institutional investors to invest in mutual funds, another move to attract capital into the system. In social sectors, he has given a boost to education.

But it is not as if the Budget can guarantee growth. Rising oil prices in the wake of the ‘Jasmine Revolution’ in the Arab World poses a serious threat of inflation to India. Lacklustre stock markets and corruption scandals could drive away potential investment. Industry’s withdrawal symptoms over the reduction of stimulus measures could reduce capacity utilisation. All this could depress GDP growth.

But the Congress Party faces three high-stakes elections (West Bengal, Kerala and Tamil Nadu) this year and must nurture the economy’s growth impulses as best as it could. That he will come out with a soft Budget was quite expected. But that he also stuck to fiscal prudence is a bonus.

The starkest reminder of this new policy is in the allocation for UPA’s flagship social security programme, the Mahatma Gandhi National Rural Employment Guarantee Scheme. Mukherjee has actually cut down allocation for this plan marginally to Rs.40,000 crore. Given that wages under this scheme are being linked to inflation, this can mean only one thing: that the coverage of the plan will shrink to fewer beneficiaries.

The UPA hasn’t entirely abandoned its inclusive growth agenda. But fiscal consolidation seems to be the new favourite. Let us, then, call it a tie.

(With inputs from Udit Misra, Ashish K. Mishra, Samar Srivastava and K.P. Narayana Kumar)