UPA-II brings back CMP in its Second Avtaar

The budget, which aimed to build on its successful election platform and please the aam aadmi, ended up scaring the aam investor: the Sensex tanked 869 points.

The markets had been irrationally exuberant in the run-up to the budget, and were sobered when it proved conclusively that UPA-II was not a radical reformer. The markets were also dismayed that the Centre planned to borrow up to Rs 4,01,000 crore to finance an increased fiscal deficit of 6.8% of GDP.

Even this could be an underestimate as the budget makes no provision for the proposed Food Security Act, and assumes that current global prices of oil and fertilisers will not rise. It optimistically projects a 15% rise in corporate tax receipts, even as income-tax revenue declines 9%. Pessimistic markets sent the yield on 10-year gilts shooting up from 6.7% to 7%.

But finance secretary Ashok Chawla clarified that of the proposed government borrowing, only half would be raised from the market. The rest would be picked up by the central bank. In other words, monetisation of the deficit is back.

The approach of the budget speech, more than its content, was a dampener. It offered no deadline for returning to the discipline of the FRBM Act. It proposed a minuscule PSU disinvestment of Rs 1,200 crore, against the Rs 25,000 crore mentioned as feasible in the Economic Survey. It made no declarations of intent regarding economic liberalisation.

Far from celebrating freedom from the Marxist yoke in the last five years, Pranab Mukherjee presented a budget that could be called Common Minimum Programme-II. He declared that the bank nationalisation 40 years ago was “wise and visionary” and “continues to be our inspiration even as we introduce competition and new technology in this sector”. The markets disagreed, naturally.

The budget treats capital spending in select industries—cold chains, agricultural warehousing, and gas/oil pipeline networks—as fully tax-deductible. In effect, this is a 100% investment allowance, and may confer an enormous benefit on Reliance’s gas network. This could be very controversial.

The budget abolished the fringe benefit tax (FBT)—the burden was passed onto individual beneficiaries—amidst corporate cheer, but that soon died when the minimum alternative tax (MAT) was raised from 10% to 15%. The tax holiday for exporters was extended by a year, till 2010-11. The commodities transaction tax, which was proposed but not implemented last year, has been disbanded.

Given the high consumer inflation, the middle class will barely be mollified by the abolition of the 10% income-tax surcharge, and the increase in the I-T exemption limits.

Goods and Services Tax to stick to April 2010 deadline

This goes up to Rs 1.6 lakh from Rs 1.5 lakh for individuals, to Rs 1.9 lakh from Rs 1.8 lakh for women, and to Rs 2.4 lakh from Rs 2.25 lakh for senior citizens.

Protectionist pressures are high in the middle of a recession, but Mr Mukherjee has been courageous enough to resist pressures to raise import duties. Indeed, in his many minor Customs duty changes, more duties are reduced than raised. Exporters in labour-intensive sectors can now get duty-free import inputs up to 3% of their export sales. Customs duty on gold and silver has been raised.

Central excise duties have been raised from 4% to 8% on a wide array of goods, and this looks like a wise preparation for a more uniform tax structure for the coming goods and services tax (GST). Mr Mukherjee has shown good economic sense, and some courage, in imposing service tax on rail traffic (read Mamata) and water-borne traffic, providing a level playing field with road and air transport; and also on lawyers (a very powerful lobby) and plastic surgeons, putting them on a par with other professionals. Indirect tax changes will fetch the exchequer Rs 2,000 crore more per year. The direct tax changes are tax-neutral.

The finance minister says the GST will be implemented by April 2010. At present, there is no agreement even on the tax rates to be levied, or on abolishing other duties (like octroi and entry tax) in lieu of GST. Experts say it will take time to enact the new laws, finalise the new procedures for collection, print the new forms and educate all taxpayers, and train tax-collecting staff. They fear that GST could be a mess if implemented prematurely.

The budget seeks to stimulate the economy through increases in government spending. IIFCL will refinance 60% of bank loans for infrastructure projects through public-private partnerships, and this could catalyse up to Rs 100,000 crore of investment. Budget allocations have been raised for the National Rural Employment Guarantee Scheme (144%), Bharat Nirman (45%), National Urban Renewal Mission (87%), National Highway Authority of India (23%), Accelerated Power Development and Reform Programme (160%). Plan spending will rise 34% and non-Plan spending 37%. However, spooked markets seemed to view this as an unsustainable spending spree rather than a contra-cyclical boost to demand.

The finance minister said a new Direct Taxes Code would be released within 45 days. A new Saral-II form would make tax returns much simpler, he added. Although the budget speech did not lay down a road map for reducing fiscal deficit, some projections were made in the Medium Term Fiscal Policy Statement. This document estimates that nominal GDP growth—real growth plus inflation—will be 10.05% this year, 12.4% in 2010-11, and 13% in 2011-12.

The fiscal deficit is projected to fall from 6.8% this year to 5.5% in 2010-11 and 4% in 2011-12; the revenue deficit from 4.8% to 3% and 1.5%, respectively; and the Centre’s gross tax revenue is projected to rise from 10.9% of GDP to 11.9% and 12.4%, respectively.

The projections assume a resumption of rapid growth, no impact of rising oil and fertiliser prices on the budget. If that turns out to be the case—a big if—the economy might return to FRBM targets by 2012-13. But the markets are not betting on it.

What do you think?