4 areas that Modi govt should focus on in its '1st real Budget'

FM should avoid hare-brained proposals, such as to tax financial transactions and fringe benefits, says Shankar Acharya.

The importance of Union Budgets for overall economic policy and outcomes is certainly high, but nowhere near the stratospheric levels to which the annual media hoopla typically sends it. This Budget is, of course, more important than usual as it is anticipated by many as the "first real Budget" of the new Narendra Modi government, the July 2014 Budget having been presented within six weeks of assuming office and having been deemed as something of a damp squib.

In assessing any Budget, I generally find it useful to focus on four distinct dimensions: the overall fiscal stance; the tax policies; the expenditure policies; and the vision-cum-reform elements. But before turning to priorities in each of these dimensions, let's take summary stock of the economic context for this Budget.

Economic context

As I observed in a recent column, the outlook for the world economy remains subdued, despite the steep drop in prices of oil and other commodities. The Chinese juggernaut is expected to slow further to below seven per cent growth, Japan is unlikely to boom, and the stagnant European economy is burdened by legacy problems and the dark shadow of a "Grexit" from the euro zone.

Only the United States is recovering steadily, powered by years of expansionary fiscal and monetary policies, flexible and responsive markets, and the revolution in shale oil and gas. Global growth in 2015 is likely to be a modest 2.5 per cent, with world trade expanding at an anaemic two to four per cent. Unpleasant surprises may lurk from "Grexit", rebounding oil prices or a rise in US policy interest rates. So the global economy may not be a force-multiplier for India's development in the year ahead.

Until end-January 2015, the well-accepted narrative for the Indian economy was clear: an economy slowly recovering from over two years of a serious growth slowdown, six years of double-digit inflation and a mini balance of payments crisis in 2013-14, with industry stagnant, infrastructure in disarray, stubborn fiscal deficits, weak government banks and stagnating employment.

The re-based and revised national income estimates published on January 30, 2015, have created considerable confusion and debate by painting a more optimistic picture of growth in gross domestic product (GDP), industry and trade in 2013-14 than can be squared with the ground realities of an external finance crisis, high interest rates, slowing bank credit and tax revenues, and sluggish corporate sales and earnings. Whatever the outcome of this debate, the 2015-16 Budget has to strive for faster growth of national output and employment, while nurturing lower inflation and sustainable external balance.

Overall fiscal stance

Although the finance ministry's mid-year review in December 2014 favoured a boost in public investment to spur growth, even at the expense of breaching the announced fiscal consolidation path, this may be unwise in the context of a weak and uncertain global economic environment. There is certainly a good case for raising public investment in roads, railways and ports, but this has to be accommodated within a prudent fiscal envelope.

Given the recent, publicly reported commitments by the prime minister and the finance minister to peg the 2014-15 fiscal deficit at the budgeted level of 4.1 per cent of GDP, and bring it down to three per cent by 2016-17, the deficit level for 2015-16 has to be calibrated around 3.5-3.7 per cent of GDP. This modest reduction in the deficit (net government borrowing) will also support a sustained, growth-supportive reduction in nominal and real interest rates that has recently begun.

Tax policies

It is important to recall that the Centre's gross tax receipts as a percentage of GDP had risen steadily from eight per cent in 2001-02 to 12 per cent in 2007-08 (a major contributor to the improvement in public savings in this period), before declining thereafter. In 2014-15, it is expected to be below 10 per cent.

In order to accommodate higher public investment and the (rumoured) increase in tax devolution to states recommended by the 14th Finance Commission, and ensure a modest reduction in the fiscal deficit, it is imperative to raise the gross tax revenues-to-GDP ratio significantly in 2015-16.

Moreover, this projected increase has to be based on credible measures, not on absurdly optimistic revenue projections, as in 2013-14 and 2014-15, which then lead to hugely disruptive expenditure cuts. The six best ways of enhancing tax revenues in a credible and economically sensible way are:

• Increase the general rate of Cenvat from 12 per cent to 13 or 14 per cent; the latter was the rate before the "global financial crisis";
• A corresponding increase in the current rate of services tax from 12 per cent to 13 or 14 per cent;
• Drastically prune the myriad end-use, concessional rates and special exemptions currently embedded in both the excise and customs duty structures. This will yield considerable revenue, reduce economic distortions and special favours, and pave the way to ushering in the goods and services tax (GST) in a year or two;
• Restoration of the customs duty on crude oil to five per cent;
• Increase special excises on luxury consumption goods, such as cars and sports utility vehicles (SUVs) with higher (above 1,600cc?) engine size, refrigerators above a threshold capacity, air-conditioners above a designated capacity, televisions above 36-inch screen size and so forth. By confining such special excises (over and above the general Cenvat rate) to final consumption products, distortive consequences for the product chain will be avoided;
• Increase the cess on petrol and diesel, earmarked for roads by one per cent or so;

Also, avoid hare-brained proposals, such as to tax financial transactions and "fringe benefits". They have been tried before and failed.

Expenditures

On the expenditure side, in line with the recommendations of the Expenditure Commission's preliminary report (as indicated in the media) and the Shanta Kumar High Level Committee Report on the Food Corporation of India, the Budget should announce road maps for direct cash transfer approaches in respect of existing major subsidies for kerosene, foodgrain and fertilisers, as has already been initiated for cooking gas cylinders. This will greatly enhance targeting of subsidies (currently, there are huge leakages and corruption), while helping to contain their size.

Furthermore, with the funds from additional taxation and subsidy containment, the Budget should ensure significantly higher expenditures for roads, ports, electricity transmission, public health and defence.

Reforms

Road maps for shifting major central subsidies to direct cash transfer approaches will constitute major reforms for the relevant sectors of petroleum, food and fertilisers. So will rapid progress on the implementation of the national GST. In addition, it would be very good if the Budget announced:

• A road map for reform/restructuring and recapitalisation of public sector banks, which have huge value locked in their extensive networks but suffer from poor performance;
• A plan for reviving a credible approach to private-public partnerships (PPPs), which have run into all sorts of trouble in recent years;
• A road map on reform of labour laws, with the objective of encouraging much greater employment of India's growing population of young job-seekers.

These are my Budget priorities and hopes. In a couple of weeks, it will be interesting to see to what extent, if any, these hopes are realised.