Tuning in to FM

1

What’s happening on various deficits?

Expenditure is revenue (current) plus capital expenditure and receipts are revenue plus capital receipts. The budget deficit is expenditure minus receipts, but capital receipts may include debt.

The fiscal deficit (FD) is of more interest because it is total expenditure plus current receipts plus non-debt capital receipts. However, current expenditure also includes interest payments on past borrowing. The primary deficit (PD) is FD minus interest payments. Finally, revenue deficit (RD) is current expenditure minus current receipts.

Deficits have costs and the goal of fiscal consolidation is their reduction. The FRBM Act requires 0 per cent RD and 3 per cent (as share of GDP) in 2008-09. In 2006-07, the FM promised 3.8 per cent FD and 2.1 per cent RD in budget estimates (BE). Given that both GDP (denominator) and revenue (part of numerator) have done well, what will revised estimates (RE) be for 2006-07? In all probability, 2006-07 RE will have FD of 3.5 per cent, RD of 1.8 per cent and primary account surplus. This information will be found right towards the end of Part A. There are subsidies (food, petroleum) left implicit and not shown as part of government expenditure. Good fiscal performance may persuade the FM to make food subsidies more transparent by including them directly, then FD will be 3 per cent-plus. I don’t think this will be done for petroleum yet.

2

What will the budget do on inflation?

This is an unfair question; inflation needs addressing outside the budget (hikes in interest rates), although the budget speech is bound to have paras on inflation. Interest rate hikes only slow down growth. Inflation needs to be addressed by allowing the rupee to appreciate, freeing up trade policy and rural reforms that ensure dis-intermediation of agro distribution chains.

On the rupee, this budget will have something on capital account convertibility. On tariffs, the peak customs duty on non-agricultural (manufactured) products is likely to decline to 10 per cent, but reduction is unlikely to happen for agro or petroleum products. On rural reforms, implementation of the recommendations of the National Commission on Farmers is inevitable, but choice will be selective and dis-intermediation seems unlikely.

3

What are the broad expenditure heads?

Expenditure is divided into capital (creation of productive assets) and revenue (non-productive). It is also divided into plan (support to annual plan) and non-plan expenditure. In general, capital expenditure is preferable to revenue expenditure, although one shouldn’t drive this point too hard, since grants and loans to states figure as revenue expenditure at the Centre, but may be used to create assets in states. Similarly, again without driving the point too hard, plan expenditure is preferable to non-plan expenditure. Simplest is to scrutinise non-plan revenue expenditure: What share of total expenditure is this? In BE for 2006-07, this was 61.1 per cent. Has it declined? The largest chunks of non-plan revenue expenditure are interest payments, defence, subsidies, grants to states and pensions. Nothing can be done about these in the short-run. But is there any plan to reduce these in the medium term (subsidy or pension reform)? Unlikely, but worth a check.

The UPA has eight so-called flagship programmes (Sarva Shiksha Abhiyan (SSA), Mid-Day Meal Scheme, Rajiv Gandhi Drinking Water Mission, Total Sanitation Campaign, National Rural Health Mission, Integrated Child Development Services, National Rural Employment Guarantee Scheme and Jawaharlal Nehru National Urban Renewal Mission). Plus Bharat Nirman. Are new flagships being launched? If so, is there budgetary support? Are existing ones being expanded, such as the National Rural Employment Guarantee? Has budgetary allocation to the SSA been reduced, as it should, since Centre/state expenditure ratio should switch from 75/25 to 50/50 this year? Is the Backward Regions Grant Fund finally taking off? Is there a new scheme for social security to the unorganised sector and how is it financed? Finally, is there a mention of the 6th Pay Commission?

4

What is the projected growth rate for 2007-08?

Real GDP growth was 9 per cent in 2005-06 and 9.2 per cent in 2006-07 and the first paragraphs of the budget speech will go to town over this. So the budget should be optimistic about growth in 2007-08.

However, budget papers never give a projected rate of GDP growth directly. Absolute figures are given on various deficits (fiscal, revenue) and these are also expressed as ratios of GDP. From these, one can work backwards and deduce nominal (real plus inflation) GDP figures in 2006-07 and 2007-08. Given growth and inflation trends, this budget should have nominal growth of 14 per cent, if not 15 per cent. This won’t be stated in the budget speech, but will be left implicit in the budget. Nor will the budget tell us how much is real growth and what is inflation. That will emerge from subsequent finance ministry reactions.

5

What is the tax reform message?

There can be only one tax reform message — removal of exemptions. The tax/GDP ratio is low at around 11 per cent, without including state and local body taxes. If these are included, we are probably at 15 per cent. For the ideal, 20 per cent, exemptions have to go. 2004-05 estimates are that tax exemptions cost us Rs 176,000 crore, more than 5 per cent of GDP. The figure today will be around Rs 200,000 crore.

Not all exemptions can be targeted (those related to exports will stay), but the effective tax rate for corporates should be more than the present 17 per cent. So corporates should be on the hit list, sugar-coated perhaps by elimination of surcharge. Ideally, FBT should go, since one taxes individual income and not collective expenditure and doesn’t tax perquisites and fringe benefits simultaneously, but FBT is certain to stay. The surcharge on personal income tax will also go, exemption removal in this case will probably be limited to EET (savings taxed at time of withdrawal and not earlier). There will be minor matters like hiking the annual savings exemption threshold to 1.5 lakh and increase in taxation thresholds.

On indirect taxes, other than customs (mentioned earlier), will there be a roadmap for transition to unified and standardised GST (goods and service tax)? Will central sales tax rate decline to 3 per cent or lower (lower is unlikely)? Will excise be standardised at 16 per cent (decline for large cars)? Will service tax rate increase to 14 per cent? Given inflation, service tax rate hike may not happen.

Beyond this, there will be changes in assorted indirect tax rates. As a logic of the tax reform agenda, such discretionary decisions should be taboo, but which FM has been able to resist them? Since the economy and tax revenue are both doing well, this tax reform message of exemption removal should be the touchstone against which we judge this budget.

6

What are the broad receipts heads?

This isn’t of much interest, unless you keep looking for the missing privatisation/disinvestment figure and don’t find it. Capital receipts are measly and net (after state shares) tax revenue was 81.1 per cent of revenue receipts in BE for 2006-07. Revenue projections for five main components (excise, customs, corporation tax, personal income tax, service tax) are worth a look. Given past trends, excise and customs revenue growth will probably be low and the big ones will continue to be corporation, income and service tax.

7

How is the budget rated?

If instant reactions to the budget on television give it something like 6 or 7 out of 10, reactions have probably got it right. But if people have given it 9 out of 10, they are being misled by form rather than content. If you are not going to read it yourself, wait till people have read the Finance Bill. There is some devil in the detail that is being missed out.

The writer is an economist