New Delhi: This should have been the year when the Congress-led United Progressive Alliance (UPA) made that extra effort in its annual budget ritual. It wasn’t.

So, while the government made all the right noises on the issues at hand—governance, inflation and creation of jobs—it did very little to back these up with policy action.

Budget 2011 could further stoke inflation. An additional round of indirect tax levies will net the government an extra Rs11,300 crore revenue, but will cause a cascading effect on prices, especially since it affects even public utilities such as hospitals. The Rs11,500 crore in direct tax sops have been reserved for the tax-paying segment of the restive middle class. Surprisingly, this budget caps social spending, and virtually ignores the aam aadmi.

A closer perusal of the fiscal numbers suggests that there is more to them than meets the eye. So, the initial stock market euphoria (at one point, the Sensex was trading 3.4% higher), after finance minister Pranab Mukherjee announced in his sixth budget that the government’s borrowings would be substantially lower, might have been misplaced. The fiscal arithmetic does not explicitly factor in another surge in international oil prices and seems to grossly underestimate the government’s annual subsidy payment.

Further, the revenue numbers in the budget implicitly assume continued buoyancy in growth. That’s a fair assessment, given the present momentum in the economy; yet, there is need to factor in caution in two imponderables: that the country keeps its annual tryst with the monsoon and that oil prices do not spiral out of control.

Yogesh Kumar/Mint

What also caught the immediate fancy of the stock markets were the finance minister’s offerings for financial markets, including a provision for foreign investors to put money in local mutual funds.

Still, even as it focused on financial markets, the budget seemed to ignore the real economy. That may be good economics from the point of view of foreign investors, but it is bad politics.

A missed opportunity

This year’s Union Budget offered a struggling UPA a chance to get back in the groove. Though expectations were muted, there was a general feeling that the government would use the budget as a platform to relaunch the coalition’s fortunes. Speculation had also gained ground that the government, intent on fiscal consolidation, would continue with the roll-back of the fiscal stimulus in place since 2008-09—and that the mean excise rate would be raised to 12%. The finance minister disappointed both constituencies. The only difference is that the latter triggered a relief rally in the stock markets when companies realized that no harm had been done.

The bigger concern is in the fiscal arithmetic. On the face of it, the numbers sound glib: The fiscal deficit, or gross borrowings, is to be reduced to 4.6% of gross domestic product (GDP) in 2011-12, an improvement over the reduction to 5.1% managed in the current fiscal. The concern is that this is based on the assumption that total expenditure will grow by only 4% over the revised estimates of 2010-11 to Rs12.5 trillion. The state of fiscal health is apparent from another metric. If revenues were paying for expenditure, then the government should have been enjoying a primary surplus—which is the revenue deficit less interest payments. However, the UPA has projected a level of 1.6% in 2011-12, down from 2% of GDP in 2010-11.

Further, the fiscal correction has been managed, not by a radical overhaul of government spending habits, but by the capping of social spending on marquee programmes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme and the promise that the subsidy would be pruned by around Rs20,000 crore. Either the finance minister is signalling that the UPA has come to the end of the road with its entitlement strategy that had sought redistribution of wealth or the budget is engaging in window dressing. If it is indeed the former, it will presumably set the government in direct collision with the National Advisory Council headed by Congress president Sonia Gandhi.

The finance minister signalled unambiguously that India is poised to move to direct cash transfers to replace the current subsidy regime. The thinking, detailed in the Economic Survey for 2010-11 released on Friday, is that this is the only way to reduce leakages and ensure more effective bang for every buck the government puts into its social programmes. This will be dovetailed with the Aadhaar project (to give every Indian a unique ID) and is expected to be in place by April next year.

The biggest surprise from the political front was that the budget did not include any direct measures to contain inflationary pressures. A range of new indirect tax levies, intended to be in preparation of the proposed GST, are potentially inflationary; at the least they will stoke inflationary expectations. At the same time, the social spending, though capped, continues; it will continue to stoke rural demand and, with supply unlikely to increase in the short run, will create an inflationary bias in the economy.

Intent to reform

The biggest reformist signal in the budget is the reiteration of the government’s intent. By announcing that it will introduce several items of financial legislation, including the constitutional amendments for the introduction of GST, the UPA reaffirmed that it is committed to reforms. It is another matter that navigating such Bills through Parliament will require better floor management by the UPA, especially given that it is now in a minority in the Rajya Sabha and enjoys only a slender majority in the Lok Sabha.

Both Mukherjee and the Prime Minister highlighted this problem on Monday.

Similarly, the changes in direct taxes were intended to rationalize the rates and structure ahead of the introduction of DTC; so, was the case with indirect taxes, though they are potentially inflationary. The finance minister held out an olive branch to the states by seeking their assistance, and also announcing that a model legislation on Central and state GST would soon be readied.

The finance minister also made the right noises about corruption and promised wholesale changes in the way the government does its business. In fact, he referred to the budget “as a transition towards a more transparent and result-oriented economic management system in India".

He also renewed the promise that the unique ID would be the means through which the UPA would cleanse the system.

In the financial sector, the minister announced a reform measure each for the debt and equity markets.

In the former, he took measures to deepen the corporate bond market and in the latter he allowed foreign investors to invest in equity-linked mutual funds.

Business as usual

The UPA has missed out an opportunity to gain an edge over its rivals and put the economy on firmer footing by presenting a business-as-usual budget. Politically, this is bad news for the Congress, with polls in the key states of Tamil Nadu, West Bengal, Kerala and Assam due in May. Before Monday’s budget, the party was in with a chance of, independently or with partners, rewriting history in Bengal, returning to power in Assam and Tamil Nadu, and forming a government in Kerala after a hiatus. Monday’s budget may not have lessened its chances, but it sure hasn’t improved them.