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Mainsteam, Vol XLIX, No 12, March 12, 2011

Union Budget 2011-12: The Road Ahead

Wednesday 16 March 2011, by Anshuman Gupta

Many economic changes have occurred in India after the year 1991, supposed to be a watershed year in the economic history of India. These changes can even be observed at the budget level as well. They mainly include change in the people’s attitude to the Budget, enhance-ment in the eagerness of the people for the Budget, and change in the seriousness of the government to the Budget.

Elaborating briefly on these three conspicuous changes, first, now the common man waits for the Budget more eagerly than in the 1980s or before. It has turned out to be a significant event. In fact, it is the reflection of the increased level of education and awareness of the people. Now they have started deciphering the intricacies of the Budget. Earlier, only few people, either belonging to government policy-makers or intellectuals of elite academic institutions, used to discuss it. The common men would give rather emotive reactions to some provisions directly impacting them. However, the Budget is discussed more widely and more objectively of late. This is a very positive change.

Second, since more people now study or discuss the Budget objectively, their outburst to an unfavourable provision, if it is based on some economic rationale, is less. They are more open to accept the economic realities and take even an unfavourable provision directly impacting them more sportingly. The example of repeated increases in the price of petrol—after its price was linked to the market—is there for citation. This is also a positive change.

Lastly and perhaps more important, there is a remarkable change in the seriousness of the government about preparing the Budget. This also shows the maturity at the economic and political levels. At the political level, following the arrival of rather competitive politics during and after the 1990s, the government has become more conscious about its policies. It realises that if it is not able to deliver pro-people and sound economic polices, it might lose power in the coming election.

The recent Budget also bears testimony to the three broad observations made above. It too was prepared more seriously with the realisation of the ground realities of the day. It attempts to strike a balance between the low inflation rate and high growth rate without losing the focus on inclusive growth. To understand the Budget’s implications for the economy, it is worthwhile first to understand the present status of the economy and the expectations from the Budget and then study the provisions of the present Budget to analyse how far they are on expected lines, based on sound economic principles.

Present Status of the Economy

THE Indian economy seems to be robust recording an 8.6 per cent growth rate for the current year 2010-11 as per the advance estimates for the economy. (Economic Survey of India, 2010-11) The target set for the year 2011-12 is nine per cent, which is the pre-crisis level. This high optimism is based on two factors—one, new momentum in the savings rate (33.7 per cent of the GDP) and investment rate (36.5 per cent of the GDP) and two, India’s demographic dividends. However, this demographic dividends depend on whether the government is able to convert the increasing young population into human capital by imparting to them the required education and training.

India has remarkably managed a respectable growth rate in the face of the global economic crisis triggered by the sub-prime crisis in the US. It recorded 6.7 per cent and eight per cent growth rates during the years 2008-09 and 2009-10, the second highest in the world after China. This is mainly attributable to the strong domestic demand in the economy and stimulus polices initiated by the government at the fiscal and monetary policies’ fronts in response to the coordinated approach decided by the G-20 countries to beat the recession. It was also helped by the inclusive growth policy initiated by the UPA Government to deliver the benefits of high growth to the less privileged populace of the country, who could not share the gains of the market economy owing to their being less skilled or unskilled. The Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) and the spread of the micro-finance institutions were helping to bring about more inclusive growth.

Our export growth is also lately showing signs of recovery by recording a 29.5 per cent growth rate for the year 2010-11 as per the advance estimates of the government. This is the result of both the low base factor as well as recovery in the developed countries, especially in Western countries. However, the increasing trade deficit is a cause for concern for the policy-makers. Thus trade and current account deficits are being financed by foreign investment, especially portfolio investment. This is also a cause for concern for the economy, as this investment can leave the Indian market at short notice in search of better return on investment.

The quantitative ease at the monetary policy front in the advanced countries to combat recession and rescue the troubled financial institutions is paving the way for increased investment by these institutions in the emerging economies’ stock markets. India, being one of the fastest growing economies of the world, is the preferred destination for such investments. Though it was giving a lift to our sensitive indices in stock markets till recently, this was not without cost. It was resulting in appreciation of the domestic currency which was rendering our exports uncompetitive in the international market. It was also increasing the money supply in our economy thereby pushing up the inflation rate. Attempts to neutralise the effects of increased money supply through sterilisation by the RBI are increasing the interest rate in the economy. However, Indian foreign reserves are at a comfortable level ($ 297 billion).

The high inflation rate is also a downside risk for the economy with the Wholesale Price Index Inflation (52-week) hovering at around 9.4 per cent and Consumer Price Index Inflation being at 11 per cent as per advance estimates for the year 2011-12. This is the combined effect of demand and supply factors. As the economy is approaching the potential level of the GDP as a result of strong recovery from all sources, the inflation rate is inching up. The increased inflow of foreign investment (portfolio) and attempt to have more inclusive growth are also contributing to it.

From the supply side, bad weather conditions and neglect of the agricultural sector for a long time led to a slow growth of agricultural products. Even at the world level, the food prices are skyrocketing. This is partly the result of shifting the focus to cash crops and bio-fuels from food crops and partly the increased demand for protein-rich foods at the world level as a result of increased income in some emerging economies (China, India, Brazil, South Africa etc.). So the option of importing food products was also costly. However, the good Kharif and Rabi production would likely ease the situation.

The Indian manufacturing sector is also showing signs of recovery by recording an 8.1 per cent growth rate for the year 2010-11. However, it has still not yet touched the pre-crisis level, as the recovery in the Western countries is yet at its infancy. The tax revenue growth is also bouncing back with a growth rate of 16.2 per cent, up from 3.6 per cent in the previous year. The growth in non-tax revenues has been 27.7 per cent during year 2010-11, up from 19.7 per cent during 2009-10.

The Indian industries’ sale growth is estimated at 20.6 per cent for the whole year 2010-11, which is up from 4.2 per cent recorded during 2009-10. This also indicates a strong recovery for the economy. However, the profit growth for the Indian industries is estimated to be lower at 26.6 per cent in year 2010-11 from 36.2 per cent in 2009-10.

The government has been able to reduce the ratio of fiscal deficit to the GDP to 5.1 per cent in the current year from 6.3 per cent last year. This is the result of the combined effects of increased GDP, recovery in tax revenue and windfall receipts from selling government assets. However, further reduction of the fiscal deficit next year would be a challenge. It requires some hard decisions on the part of the government, such as targeting subsidies, reform in petroleum prices (including diesel and kerosene), nutrient -based fertiliser subsidies etc. An early introduction of a Goods and Services Tax (GST) regime would also be helpful in this regard.

One more downside risk is the Middle-East crisis triggered by the Tunisian and Egyptian uprisings. The impact of this is already being felt the world over in terms of the increasing price of crude oil. If the crisis persists for a long time, this would pose another hurdle towards achieving the growth rate of nine per cent set for the next year 2011-12. It would either increase the Budget deficit if the government decides to keep the petroleum products’ prices unchanged or would increase the cost of production if it decides to pass on the increased prices to the end-users. The government can take pre-emptive actions by reducing import duties on crude oil and excise duties on petroleum products.

Expectations from the Budget (2011-12)

THE Budget is a statement of sources of revenue and various heads of expenditure by the government. It is an instrument to give a direction to the economy through various fiscal measures, such as tax rates, expenditures by the government, various social schemes for giving benefits to the poor citizens of the country etc. More often than not, it is also an opportune time for the government to announce policy reform initiatives. The Budget 2011-12 is significant for the economy as it is supposed to make the hard choice between low inflation and high growth rate. It is also to initiate the consolidation of the fiscal deficit by rolling back the stimulus packages initiated at the time of the crisis, rationalisation of import duties and excise duties, agricultural reforms etc.

The government will face the uphill task of maintaining the balance between low inflation rate and high growth rate. As textbook knowledge says it is difficult to maintain low inflation rate and high growth rate once the economy reaches the potential level of output, it would be a challenge for the government to achieve a nine per cent growth rate and a 4.6 per cent inflation rate, which is hovering presently at about nine per cent.

For achieving both targets, the government will have to take some hard decisions including rationalising the subsidies by targeting them better to select beneficiaries, phasing-out subsidies on all petroleum products and LPG by aligning their prices to market prices, adopting nutrient-based fertiliser subsidies, charging market price for power and water from big farmers etc.

The money saved on these unproductive subsidies can be utilised for investment in the agricultural sector, which has been neglected for a long time. This would help augment the supply of farm products on one hand and give increased income in the hands of farmers on the other hand. This, in turn, would be spent on manufactured products, giving an impetus to overall economic growth. Expansion of extension services to farmers, investment in research and development in agriculture, investment in cold storages and warehouse facilities, reforms in the agricultural sector, including scrapping the Agriculture Produce Marketing Committee (APMC) Act, etc. would go a long way towards augmenting the supply of farm products. All these concerns about the agriculture can also be used to open up the FDI in multi-brand retail.

The above-mentioned measures would also be helpful in consolidating the fiscal deficit that is expected from the current Budget. The stimulus packages initiated at the time of the crisis to combat the slowdown had increased the fiscal deficit to 6.3 per cent in year 2009-10, albeit it has been brought down to 5.1 per cent this year (2010-11), thanks to windfall receipts out of the 3G spectrum and broadband wireless auctions. However, further lowering down the fiscal deficit would be an uphill task unless again the government assets are sold above the target level. The above-mentioned measures, like better targeting of subsidies, phasing-out the unproductive subsidies etc., would be a better option to prune the fiscal deficit further. But, the new initiatives by the government, like right to food and right to education, are likely to put further upward pressure on the fiscal deficit. Some portion of money saved by phasing-out the unproductive subsidies can be spent on these new schemes.

Pruning-out the fiscal deficit would be helpful for boosting private investment and bringing down the inflation rate. As the government borrowing would be lowered, more money would be left for the private sector for investment. This would bring down the interest rate in the economy. Reduced fiscal deficit also means low inflation rate. This would further help in decreasing the interest rate.

The increased inflow of volatile foreign capital is resulting in appreciation of the domestic currency, which is making our exports compe-titive. It is also putting upward pressure on inflation and interest rates in the economy. Some restrictions on short-run capital, like Tobin Tax, can be a viable option at this juncture.

The Middle-East crisis is posing the risk for the world economy. This is already manifest the increased price of crude oil. This may further go up, putting a downside risk on the growth of the world economy in general, and Indian economy in particular, as the latter is dependent largely on imported oil. This might jeopardise the attempts to rein in the fiscal deficit or result in cost-push inflation in the economy if the increased price of crude oil is passed on to end-users. In any case, rationalisation of import duties by reducing it on crude oil and slashing excise duties on petroleum products would be a good option at this point of time.

Our import duties are still on the higher side in comparison with the world standard, though they have been brought down a great deal in recent years under the WTO regime. It is advisable to further bring them down to the East-Asian countries’ level. This, in turn, would make our exports competitive in the international market. It would also help initiate network production, the latest mode of organising production, by inviting foreign investment.

The ambit of the services tax should be increased by including more services in it. This covers almost 100 services right now, and can be extended to all services with a negative list. The rate of service tax should be restored to the pre-crisis level of 12 per cent. This would help meet the target of the fiscal deficit.

Budget Proposals (2011-12)

THE Budget proposals for year 2011-12 are broadly on expected lines. The Finance Minister must be commended for finely balancing the three main tasks expected from this Budget. He attempted to contain the inflation rate without compromising on the growth front with an inclusive approach. It other words, he adopted the approaches of both Prof J. Bhagwati and Prof Amartya Sen.

The Budget gave due cognisance to the fact that good weather means savings for bad times. Hence fiscal consolidation was given high priority. The fiscal deficit (as a ratio of the GDP) was proposed to be slashed from 5.1 per cent in year 2010-11 to 4.6 per cent for the next year 2011-12. However, if one excludes the one-time bonanza from the auction of 3G spectrum and broadband wireless, last year’s fiscal deficit works out to be 6.3 per cent. Bringing it down to 4.6 per cent from 6.3 per cent would be a difficult task.

In fact, the Budget was prepared on the basis of the hypothesis that there would be a nine per cent or more growth rate in the real GDP and a 4.6 per cent inflation rate for year 2011-12. This means there would be almost 15 per cent growth in nominal GDP. It is expected that this would give rise to an 18 per cent or more revenue collection growth on the basis of better compliance and administration of taxation, albeit the excise rates and import duties have not been increased on most commodities. However, the ambit of the services tax has been widened by including more services in it. The services tax rate has been kept unchanged. This might be for reducing the pressure on inflation from the cost side.

On the expenditure side, the total government expenditure has been increased by only three per cent, which is lower than the projected inflation rate of 4.6 per cent. This implies that in real terms, it has, in fact, got reduced. The government’s borrowings have been marginally increased to Rs 3.43 trillion from Rs 3.35 trillion. In real terms, it has also shrunk. Less borrowings by the government implies that it will leave more liquidity in the market to be lent to the private sector, thus bringing down the interest rate.

A start has been made for the better targeting of subsidies. This time it is only on kerosene and LPG. Next time it can be extended to other areas also after the completion of the Unique Identifi-cation Project. Better targeting is likely to save money by infusing efficiency in administering the subsidies.

To tackle inflation from the supply side, investment has been stepped up in agriculture and infrastructure, which have been, especially agriculture, neglected for a long time. However, no big promise was made to remove the structural problems of the agricultural sector. These include restrictions on movements of agricultural goods and vegetables from one State to another State, the high margin between wholesale prices and consumer prices, fractured PDS system and FDI in multi-brand retailing.

Following the inclusive agenda to share the gains from growth among the larger populace, the Budget has graduated to the second stage. It has indexed the wages under the NREGA to the inflation rate, increased expenditure on literacy and education, doled out scholarship to the SC/ST students in classes 9 and 10, increased outlay on the social sector, increased the target of credit flow to farmers, given three per cent interest subsidy to farmers etc.

The increased outlay on education would also be helpful for growth in the long run. The demographic bonanza, which is expected to be the basis of long-run growth in India, can be realised only by converting the young population into skilled experts by imparting education to them.

Thus, it seems to be an anti-inflationary, growth-oriented and inclusiveness-promoting Budget. Nevertheless, the downside risks, which might jeopardise the whole calculation, include the likely persistence of the Middle-East crisis, fear of double-dip slowdown in Western Europe and America, and corruption plaguing the Indian public offices at large.

Dr Anshuman Gupta is the Head, Economics Department, University of Petroleum and Energy Studies (UPES), Dehradun.

Table 1: GDP Growth

Table 2: Inflation Rate

Table 3: % Growth in Manufacturing Sector

Table 4: % Growth in Exports

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