No new direction, lot of tinkering

No new direction, lot of tinkering
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First Published: Thu, Mar 01 2007. 04 30 AM IST
Updated: Thu, Mar 01 2007. 04 30 AM IST
Exactly 10 years after he slashed tax rates in what has gone down in history as his Dream Budget, finance minister P. Chidambaram presented a tepid Union Budget that increased tax rates for individuals and companies. These hikes were announced despite a smart 27.8% jump in tax collections because of strong economic growth and low tax rates.
The finance minister also said that the fiscal deficit for 2006-07 was a bit lower than he had originally budgeted for, even as he tinkered with tax rates and increased planned spending on key social services such as education and health. The spending on education and health has been increased by 34% and 22%, respectively. Spending on the National Highways Development Programme, which is involved in several inter-state highway projects, is up from Rs9,945 crore to Rs10,667 crore, an increase of Rs722 crore.
But Chidambaram seems to have given up the opportunity to take advantage of a buoyant economy to make deeper cuts in the fiscal deficit and push through more economic reforms. The difference between 1997 and 2007 is quite stark—and that explains the subsequent reactions to the government’s annual financial statement.
The Budget was greeted with disappointment by industry and the stock market—though the reaction could change in the days ahead as the fine print of the tax proposals is analysed. “The finance minister has lost an opportunity to reduce tax burden on the corporate sector, when there was so much buoyancy in the overall tax collection. The government has sent the wrong signal to industry by increasing education cess by one percentage point, and the dividend tax from 12.5% to 15%,” says H.F. Khorakiwala, chairman of pharmaceutical company Wockhardt and president of the Federation of Indian Chambers of Commerce and Industry, an apex industry association.
However, “the increase in spending on agriculture and social sectors like education is a positive trend,” he added.
In a late evening interview with Mint, Chidambaram said the broad direction of the Budget is “that the growth story is unfolding and there is no reason to interfere with that growth story but there is every reason to ensure that the growth is distributed among a larger section of the people. That’s the message of the Budget.”
While the minister cut the peak customs duty on non-agricultural goods from 12.5% to 10%, he said a national goods and services tax would be put in place by 1 April 2010, and hiked the exemption limit on taxes paid by individuals by a modest Rs10,000. He also increased the education cess paid by all taxpayers and imposed a heavier tax burden on several parts of the economy—cement companies, software companies, ore exporters and mutual fund investors, for example. It was these latter moves that upset an already rattled stock market.
The Bombay Stock Exchange’s bellwether Sensex index closed at 12,938, a drop of 540 points. The index, which was at 13,165 when Chidambaram began his 103-minute speech, also tumbled because of a drop in equity prices across the globe since Monday, opening the day 434 points below its Tuesday close.
“The fall in the market is partly a result of global factors. Even as far as the domestic factors go, I think this has been a bit of an emotional reaction. Investor sentiment has been hit more than corporate fundamentals because of the Budget,” says Vallabh Bhansali, chairman of investment bank Enam Financial Consultants.
The new Budget was crafted against the backdrop of a booming economy that has been trying to come to terms with resurgent inflation. The economy is expected to grow at 9% this year even as wholesale price inflation has stayed above 6%. There has been political pressure on the government to control price rises, and these pressures are likely to grow in the months ahead. The finance minister has cut import duties on a whole range of products, following up on a series of duty cuts that he announced in January to fight inflation. He has also cut the specific duty on petrol and petrol products, a move that is likely to reduce fuel prices in the weeks ahead.
There were expectations in the days leading to the Budget that Chidambaram would be emboldened by buoyant tax revenues to cut taxes; and especially the extra surcharges on corporate tax that were imposed in 2001 at a time when tax collections were limping along because of low growth and a large deficit. Instead, there have been hikes in a range of taxes that are collected directly from companies and individuals, though the headline corporate and income-tax rates have been untouched. An additional 1% cess to fund secondary education, an increase in the dividend distribution tax and the imposition of the minimum alternative tax on software companies will also hurt. “The tax burden on individuals and companies has gone up,” says Ketan Dalal, senior partner at tax and audit firm RSM and Company.
But there has been good news as well. The finances of the Union government are now in better shape than they have ever been in the past 30 years, and this improvement in fiscal fitness could go a long way in ensuring that high economic growth in India is less inflationary and more sustainable than it currently is. Some economists have been worried that a growing trade deficit, high inflation and soaring asset prices are warnings that the economy is overheated, and needs to slow down. A lower government deficit could assuage some of these fears.
Chidambaram announced that the Union government’s fiscal deficit—the broadest measure of budgetary imbalances—for 2006-07 is now estimated at 3.7% of GDP, its lowest level since 1977-78. It is also significantly less than the 6.18% of GDP level that it touched in 2001-02.
Chidambaram also signalled that the sea of red ink in the government’s books would recede further, when he said that he would budget for a fiscal deficit of 3.3% of GDP in 2007-08. The Fiscal Responsibility and Budget Management Act compels the government to bring the fiscal deficit down to 3% and its revenue deficit to zero by 2009.
While economists say the government deserves some credit for the progress it has made in cutting its deficit, they are not completely impressed. The improvement in the country’s public finances is because of strong economic growth and tax collections, and not because of lower spending.
“It’s a bit like winning a boat race when the wind is in your favour,” says Ajit Ranade, chief economist of the A.V. Birla Group, who adds that the finance minister has missed an opportunity to push for more economic reforms such as pension reforms and higher foreign investment limits in the insurance sector.
Chidambaram has planned for a further drop in the fiscal deficit (the broadest measure of budgetary balance) from 3.7% to 3.3% of GDP. The absolute fiscal deficit too is expected to drop—from Rs 1,52,328 crore in 2006-07 to Rs 1,50,948 crore in 2007-08. Lower government borrowings to finance the deficit could take some pressure off interest rates in bond markets and keep down the cost of funds for companies and individual borrowers.
Many observers expected this Budget to be the last one presented by this government when economic reforms would be aggressively pursued, before the run-up to the national elections in 2009 commenced. That was not to be. In a statement, Vishwavir Ahuja, managing director and CEO of Bank of America’s Indian operations, describes the Budget as “a populist one with the elections round the corner.”
(Monica Gupta contributed to this story.)
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First Published: Thu, Mar 01 2007. 04 30 AM IST
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