Budget 2011: A tie between deficit and growth

In response, the Sensex initially jumped nearly 600 points, but handed back much of the gains after investors realised some of the Budget’s projections were based on statistical revisions and future optimism rather than fiscal stringency.

Finance Minister Pranab Mukherjee’s Budget lacks tax pyrotechnics, yet it reveals a remarkably improved fiscal position and a conceptual breakthrough in delivering subsidies through cash transfers for kerosene, fertilisers and cooking gas.

He has also boosted reform prospects, pledging to revive seven financial sector bills, including landmark ones to raise foreign direct investment (FDI) in insurance to 49% and lift voting rights of foreign investors in banks.

Mukherjee says he did not highlight this in his Budget speech because his party lacks majority in both houses of parliament, but is optimistic of securing the cooperation of other parties. On FDI in retail, he is non-committal.

A committee under UIDAI chief Nandan Nilekani will suggest ways to implement the proposed shift from physical subsidies to cash transfers, using smart cards. Come October, UIDAI will issue 10 lakh Aadhar (unique identity) numbers daily, and this should make it feasible to bring in cash transfers sometime in 2012. This reform has the potential to drastically curb leakages and malpractices in subsidies.

India’s fiscal position has long worried foreign institutional investors (FIIs), the dominant players in the country’s stock markets. The Budget claimed fiscal deficit was down this year to 5.1% of GDP against the targeted 5.5%, and would decline to 4.6% next year against 4.8% mapped out earlier.

For instance, the oil subsidy is projected to fall to 23,640 crore next year from 38,386 crore this year, but there is no explanation how this will be managed in an environment of high global crude prices. Mukherjee may want high prices to be passed on to consumers, but several of his cabinet colleagues are dead against this. The food subsidy will be virtually unchanged next year at around 60,000 crore.

The reason: the implementation of the Food Security Act has been postponed until 2012-13. The consequent hole in government finances has been postponed, not avoided. Only a small part of the fiscal improvement in the Budget relates to tax buoyancy, with statistical revisions of GDP data producing much of the apparent improvement.

Yet the fact is the central government’s debt-to-GDP ratio, which the 13th Finance Commission had projected at 52.5% of GDP, is now only 44.2%. This is remarkable given that economies across the world are weighed down by large increases in this ratio. Without the spectrum auction bonanza, fiscal deficit this year would have been 6.3% of GDP. Reducing this to 4.6% next year requires a massive effort to check spending.

The Budget projects total spending to rise marginally to 12.57 lakh crore next year from 12.17 lakh crore this year, and such stringency will be politically tough. Investors will be encouraged by the decision to permit foreign retail investors to invest in Indian mutual funds, and to raise the investment limit for foreign funds in infrastructure debt to $25 billion, raising the overall cap for FII investment in corporate debt to $40 billion. But drafting footloose capital into debt has its risks.

Devising clearsighted policies to attract FDI into infrastructure is far superior to FII flows. The government will allow state-run undertakings to raise up to 30,000 crore by way of tax-free infrastructure bonds, a boost for the sector, along with the proposed creation of tax-free debt funds. The decision to press ahead with the Direct Taxes Code and transition to a countrywide Goods and Services Tax is a welcome reform intent. However, the sheer spread and number of indirect tax rates listed in the Budget gave out a whiff of the 1980s, rather than of futuristic reform.