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Business News/ Specials / Budget 2013/  Tighten belt to avoid slipped fisc
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Tighten belt to avoid slipped fisc

The debate on the relevance of the fiscal deficit has become impassioned and cacophonous

Finance minister, P. Chidambaram, must simultaneously provide an anti-inflation stance and keep the deficit in check. Photo: AFP (AFP)Premium
Finance minister, P. Chidambaram, must simultaneously provide an anti-inflation stance and keep the deficit in check. Photo: AFP
(AFP)

The debate on the size and relevance of the fiscal deficit has never been settled. In fact, in the post-Lehman world, it has become even more impassioned and cacophonous.

When the US received a historic sovereign ratings downgrade from Standard and Poor’s (S&P) in 2011 it wasn’t so much because of the size of its deficit, but because of a lack of political consensus on how to deal with it. S&P was expressing its dismay that the deficit debate had been so utterly unresolved. To make matters more confusing, after the downgrade, US treasuries rallied instead of collapsing. (If that same fate awaits Indian bonds, we should certainly welcome a downgrade!).

When the conservatives came to office in the UK after defeating Labour in 2010, their first decision was to raise taxes steeply. This was unbecoming of a party known to be anti-tax, but was welcomed by the financial markets. In this case, the markets celebrated the deficit reduction, but the people of the UK rued the tax increase. In Japan, the voters last month handed a thumping victory to a prime minister who promised to raise inflation! Are the Japanese voters naïve, or is this the era of New Economics? Indian politicians would love such inflation-loving voters.

Both Japan and India are targeting inflation, but from opposite ends.

In Europe, too, the austerity camp is losing, and even the International Monetary Fund has admitted that austerity and excessive deficit focus is bad advice. As if in response to the defeat of fiscal hawks, the euro has rallied 15% since July. This is inexplicable given the gloomy outlook for employment and economic growth in the euro zone.

In the light of such evidence from around the world, don’t be surprised if there is an utter lack of consensus on what fiscal stance India’s finance minister should adopt in his Budget. On the one hand, the government needs to find extra resources to fund various social programmes like food security and employment guarantee ahead of a raft of state polls running up to general election due in 2014. On this count, domestic Keynesians will surely point to the global anti-austerity mood for justifying fiscal indulgence.

On the other hand, there is limited scope for raising tax rates in a rapidly slowing economy. The average size of the deficit as a percentage of national income over past five years has been one of the highest for any five-year period. This same period has seen nominal gross domestic product (GDP) grow at

The only real and sustainable push to GDP is to revive investment spending, but how? The opportunity and room for fiscal stimulus is gone. In fact, a lower fiscal deficit will likely help, not hinder growth. To perk up private investment spending we need lower interest rates. That requires a sharply lower inflation scenario. Hence the finance minister must simultaneously provide an anti-inflation stance and keep the deficit in check. The former requires forbearance in raising diesel, cooking gas or minimum support prices, but the latter requires pruning subsidies (i.e. raising diesel and cooking gas prices), finding newer and sustainable sources of revenues and widening the tax net. This provides an extremely narrow leeway, but it can be found.

First, send out an anti-inflation message. A reduction in interest rates by just 0.25% can lead to an annual saving of about 17,000 crore. The Reserve Bank will be persuaded to cut rates if it sees lower pre-emption of national savings, i.e. lower borrowing. This can potentially lead to a virtuous cycle of low inflation and lower interest rates, and a strengthening currency too. Incidentally, this saving in interest expenses equals the revenue expected from duty on gold imports for the entire year at the new rate of 6% (assuming no leakage due to smuggling).

Second, explore ways of unlocking funds from tax disputes—about 4 trillion. An enabling provision, which provides deemed expiry of disputes, upholding the decision of lower courts or tribunals, could be one way. Of course, this is not amnesty, and some legal issues need to be addressed. But this action has the potential of unlocking about 50,000 crore.

Third, extend the “six-cylinder" paradigm on capping cooking gas supply to the fertilizer subsidy. This is a whopping 1 trillion burden on the exchequer. If a quantitative limit can be implemented for the number of bags of subsidized fertilizer, it can lead to significant savings.

Fourth, on the expenditure side, find ways to consolidate and remove overlaps in the various centrally sponsored schemes. India has a relatively low tax-to-GDP ratio compared to other countries. The tax reforms recommendation of the earlier Kelkar committee was to move to lower and stable rates, fewer exemptions and a wide coverage. This continues to be the best guide for tax policy in the medium to long term. The so-called temporary pain of a lower fiscal deficit can be diffused via a wider tax net, but the gains of a non-inflationary, pro-growth budget will be more permanent. This is the appropriate response to the present fiscal crisis.

Ajit Ranade is chief economist, Aditya Birla Group.

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Published: 13 Feb 2013, 09:15 PM IST
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