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Is the extent of fiscal adjustment enough? - Outside View by S.S. TARAPORE

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Is the extent of fiscal adjustment enough?
Mar 1, 2013

With the growth rate in 2012-13 at a low of around 5 per cent, the balance of payments Current Account Deficit (CAD) hovering around 5 per cent of the GDP and the consumer price inflation in double digits, the central question which needs to be addressed is whether the fiscal adjustment set out in the budget for 2013-14 is enough? On an instant analysis, India Inc. would breathe easy, though the predictable grumble would be that more incentives should have been provided to the industry to stimulate growth.

With the sprinkling of some goodies, the Common Person would be appeased, but the unanswered question would remain as to whether the Common Person would see a significant and enduring reduction in the inflation rate.

Macro-economic Framework

The budget is based on the premise of a nominal GDP growth in 2013-14 of 13.4 per cent. Even if the real growth in 2013-14 is 6.5 per cent, the increase in the wholesale price index (WPI) would be 6.9 per cent. While the authorities find it convenient to continue focusing on the WPI, it bears recognising that the Consumer Price Index (CPI), which at the present time is 10.8 per cent, gives ominous signals of choppy waters in 2013-14. While the nominal GDP growth in 2013-14 could well be 13.4 per cent, as projected in the budget, the split between real growth and inflation could result in very different outcomes.

The budget projects the 2013-14 Gross Fiscal Deficit (GFD)-GDP ratio at 4.8 per cent, as against 5.2 per cent in 2012-13 and this could, prima facie, be considered a reasonable adjustment, but slight variations in the GDP could substantially alter the deficit ratio. It is useful to look at another indicator. The GFD-Total Expenditure ratio in 2013-14 is projected at 32.5 per cent as against 36.2 per cent in 2012- 13. Financing one-third of the total expenditure via a deficit is a cause for great anxiety.

The increase in tax revenues in 2013-14 is projected at 19.1 per cent, while the total expenditure is projected at 15.9 per cent. There could be expenditure overruns and there could well be a throw-forward of expenditure in 2012-13 to 2013-14, which could erode the fiscal adjustment.

Assessment of Some Measures

The budget is framed against the backdrop of a serious drop in gross domestic savings from 36.8 per cent of the GDP in 2007-08, to 30.8 per cent in 2011-12 and the drop is largely in the household sector's financial savings. In this context, the government's exhortation of the need for monetary easing is difficult to appreciate. Lower interest rates discourage financial savings of the household sector. To the extent investments are stimulated and savings fall, the CAD would widen and not shrink.

Some of the measures in the budget are discussed below.

Rajiv Gandhi Equity Savings Scheme: Allowing first time investors in the stock market/mutual funds a tax incentive is a good gesture, but it is unlikely to have any significant impact. An analysis of taxpayers and their involvement in the equity market would reveal that most taxpayers are already involved in equities and as such, the scheme would not have any material impact on encouraging savings.

Deduction from Income for Housing Loan Interest: Allowing for deduction from income up to Rs one lakh, for housing loan interest for loans up to Rs 25 lakh, is a salutary measure, as it would not only stimulate investment in housing, but also support industries closely linked to housing.

Inflation Indexed Bonds/Certificates: This is a felt need and should be quickly implemented. There could be a limit of, say, Rs 5 lakh per year and the bond/certificate should provide for indexation of both interest and capital. The scheme would succeed if it is designed to genuinely protect small savers from the ravages of inflation. The bond/certificate would be an incentive to bring down inflation, which should be a top priority for macroeconomic policy.

A Public Sector Bank for Women: Setting up yet another public sector bank, even if it is exclusively for women, is a scatter-brained idea, which should be unceremoniously discarded. The Rs 1,000 crore allocated for this purpose could be better utilised to support self-help groups and co-operatives organised for women.

Modernisation of the Post Office: The issue of setting up a Post Office Savings Bank has been under discussion since 1987, but little has been done to set up such a bank. If the government considers financial inclusion to be the top priority, it should expedite the setting up of such a bank. The Post Office system has a rural network, which is unmatched by existing banks and such a bank should be a necessary prerequisite for successful financial inclusion.

Surcharge on Income and Dividend Distribution Tax: The issue of a somewhat higher tax burden on the upper income groups had been mooted in recent months, but evoked strong protests by India Inc. The surcharge of 10 per cent on incomes over Rs one crore and the enhancement of the surcharge on dividend distribution tax are extremely mild measures.

Absence of measures on Gold: The absence of any significant measures on gold is most unfortunate. The budget was an opportunity to expedite the implementation of some of the measures in the K.U.B. Rao Working Group on Gold, particularly the setting up of a Gold Bank, to activate idle domestic gold hoards.

While the budget deserves credit for some of the measures, the extent of fiscal adjustment is possibly not enough and the macroeconomic framework does not instill confidence that the CAD will be brought down to sustainable levels.

Please Note: This article was first published in The Freepress Journal on February 28, 2013. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.


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