The Union budget for 2012-13 is likely to be presented against a backdrop of difficult economic outcomes during the current year. The growth rate for the year is turning out to be weaker-than-expected and the fiscal deficit is likely to be much higher than the forecast of 4.6 per cent at the beginning of the year. The fiscal slip is an outcome of both — revenues falling short of forecasts and expenditure exceeding targets.
The slowdown in manufacturing has hurt the governments tax revenue growth. Also, a likely shortfall in divestment targets is affecting the non-tax capital receipts. High oil prices, in the absence of reforms to pass on the increase to consumers, have compounded the subsidy problem.
One of the offshoots of high fiscal deficit has been the persistently high inflation for most part of the year. This is despite the fact that the spike in oil prices has not been passed on to the end users. All this has led to a fall in the savings rate in general and financial savings in particular. This along with high fiscal deficit have crowded out private investment.
In the upcoming budget, it is important for the government to reverse many of the macro-economic trends seen last year and target higher growth while reigning in fiscal deficit.
The arithmetic for achieving this will be a challenging one. It requires the government to do several things right, including the formulation of a tighter fiscal policy for the coming year. The government must invigorate investment and incentivise higher savings. It will have to accept that there is no single optimal solution for the short term as well as the long term.
No gain without pain
Improving the long-term fiscal health involves enduring some short-term pains.
The government must bring indirect tax rates to levels existing in 2007, which were cut in the crisis years to stimulate demand. It also needs to move those rates towards the proposed GST framework.
The government must also look to reduce subsidies in general and oil subsidies in particular. This is required even if it means that the suppressed inflation so far becomes explicit inflation.
While the measured inflation of some goods and services will go up in the short term, improvement in government finances and reduced borrowing will put downward pressures on interest rates that will benefit all borrowers and stimulate investment demand.
To reverse the decline in savings rates, particularly financial savings, the government should consider giving strong tax incentives to the household sector to save more for a longer duration. This is in addition to the non-tax incentives of lowering long-term inflation expectations.
During the last two years, the household savings rates have not kept pace with nominal GDP increases and even then, a larger share of those savings have been going into physical savings, such as property and gold. The life insurance industry has the largest mobilisation of long-term financial savings from the household sector.
Fiscal consolidation is not merely an issue of whether government finances are sound. It is more about laying the foundation for a sustainable and higher growth rate that will improve opportunities for everybody. Higher tax revenues that ensue from higher growth rates will enable the government to spend more on poverty reduction, improvement in healthcare and education levels.
The author is executive director, ICICI Prudential Life Insurance