Strong economic growth and buoyant tax collections have given finance minister P. Chidambaram room to offer incentives and concessions to a wide range of constituencies in the new Budget. For the urban middle class, the reductions in taxes and excise duty cuts on some products are welcome news. Indebted farmers have been given relief and there is a focus on enhancing rural incomes. The reduction in the Cenvat rate will give Indian companies some cheer, although they would surely have hoped for more.
Investment demand has been strong. But there have been concerns over flagging consumption growth, even as there is a slowdown in the global economy. The Budget attempts to stimulate consumption by putting more money in people’s hands and by cutting excise duties on items such as small cars and two-wheelers.
Increasing government spending and off-balance-sheet liabilities, however, continues to pose risks to the fiscal situation. On the surface, deficit targets for 2007-08 have been comfortably met: The revised budgetary estimates peg the revenue and fiscal deficits at 1.4% and 3.1% of the gross domestic product (GDP), respectively. However, if one adds to this the off-balance-sheet liabilities from oil, fertilizers, and food, the fiscal deficit is estimated at a more substantial 3.7% of GDP. In 2008-09, there is likely to be the additional impact of the implementation of the 6th Pay Commission. Moreover, the fiscal impact of the debt waiver for farmers of Rs60,000 crore is not completely clear. The projected fiscal deficit for 2008-09 is 2.5%. Adjusting for oil and fertilizer bonds as well as the likely impact of pay increases for government employees, the fiscal deficit number could balloon to around 4%. Maintaining the momentum of revenue buoyancy is, therefore, critical for the fiscal situation.
The increase in tax exemption limits and changes in the slab structure will give the middle class more purchasing power; this should boost consumption. For example, the effective tax rate for a man earning Rs3 lakh per year would some down to just 5%, from the current 13%; that of a person earning Rs5 lakh per annum would reduce to 11% from close to 20%.
Slow growth in the farm sector and growing indebtedness and suicides in rural India have been a cause for concern. But the debt waiver creates a significant moral hazard for existing and future borrowers. It could lead to uncertainty in the banking system.
The expansion of the National Rural Employment Guarantee Scheme to the whole country, with an outlay of Rs16,000 crore, would create more jobs for the rural poor. Education and health care are other focus areas. The establishment of more institutes for higher studies, 16 Central universities, and the proposed linking of all knowledge institutes through a broadband network would all help increase the pool of employable workers. The government’s thrust on education should yield long-term dividends. In health care, Chidambaram has proposed a five-year tax holiday?for hospitals?and a?15% increase in the budgetary outlay.
The Budget did not have much for industry. The 2 percentage point reduction in the Cenvat rate, and excise duty reductions on some products should bring some cheer to the manufacturing sector. The reduction in Central sales tax to 2% is also a good move towards an integrated goods and services tax. The proposed national fund for reforms in power transmission and distribution, and the higher allocation for the National Highway Development Programme signal a commitment towards infrastructure development.
The proposed measures to deepen the secondary market for long-term debt are a strong positive: the ambitious infrastructure projects proposed in areas such as power, urban infrastructure, etc., will require large amounts of long-term debt. Moves to improve the tradeability of corporate bonds, remove tax deduction at source on listed debt securities, launching exchange-traded currency and interest rate futures and developing a transparent credit derivatives market are steps in the right direction. The initiative to encourage market-based system for classifying financial instruments based on their complexity and implicit risks is welcome. Recent developments in the global capital markets have shown that investors would find such tools very useful.
Equity markets have reacted negatively to the increase in the short-term capital gains tax to 15%, from 10%. However, the benefits of the move in terms of favouring long-term investing over short-term speculation could turn out to be positive for the market in the longer term.
Considering this an election-year Budget, populism has not completely overridden fiscal management considerations. Nevertheless, the risk of a higher fiscal deficit, reversing the recent trend of reduction, has increased. The finance minister has said that after the obligations on account of the 6th Central Pay Commission become clear, he intends to request the 13th Finance Commission to revisit the road map for fiscal adjustment. This could be an indication of what lies ahead.
(Roopa Kudva is CEO of Crisil Ltd. Comments are welcome at email@example.com)