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CUTTING THE FLAB
- The finance minister must show that he can take bold steps

After a few years of languishing in the home ministry — a period during which he did not quite distinguish himself — P. Chidambaram is back in charge of the finance ministry. This is perhaps his ideal position. This is where he earned applause from virtually everyone because of the 1997-98 “dream budget”, which ushered in an era of low tax-rates with drastically reduced personal and corporate income tax rates as well as the removal of the surcharge on corporate taxes. Mr Chidambaram will soon need all his fiscal acumen when he presents the budget for 2013-14 in a few days’ time.

This has been labelled a “make or break budget”, both for the United Progressive Alliance government as well as the Indian economy. This is going to be the last full year’s budget before the next Lok Sabha elections, due sometime in 2014, if not earlier. Beset with various allegations of corruption and labels of “policy paralysis”, it is imperative for the government to come up with a credible budget, which demonstrates that this is a government that can take bold steps when required. Paradoxically, it is particularly difficult to present a bold budget in a pre-election year. The temptation to pander to various vested interests, to pursue short-term goals, all point in the direction of a populist budget.

Fortunately, the drastic state of the economy counteracts the short run compulsions to present a populist budget. This may be one of the few occasions when good economics makes sound political sense. There are strong signs that the economy has slowed down drastically — the latest figures show that the rate of growth of the economy has slowed down to just over 5 per cent. The slowdown has been practically across the board, with no sector being spared. The little growth that we have witnessed has come to be called “jobless growth” since there has been hardly any increase in organized sector employment. The level of inflation continues to be above comfortable levels, though it has come down slightly. Perhaps the most worrisome sign has been the continuing inability of the government to control the fiscal deficit. This is alarmingly large, and the country faces the very real danger that international credit rating agencies may pull the plug and downgrade the Indian economy.

It is foolish and short-sighted beyond belief to claim that we should not care about a certificate issued by a rating agency because their downgrades can have potentially large adverse effects. In particular, foreign institutional investors are less likely to invest in Indian stocks if the economy receives a thumbs-down signal from these rating agencies. India cannot afford a drying up of portfolio investments because we need these dollars in order to pay for the yawning gap in the current account — we import much more than we export.

So, the main requirements of the budget are clear enough. At the top of the list must be the need to slash the fiscal deficit. Mr Chidambaram must have a credible plan to bring down the deficit to below 5 per cent. He must also ensure that the growth process is revived. This will involve at least some increase in infrastructure investment and perhaps some stimuli to the capital goods industries. Finally, Mr Chidambaram will have to cater to some minimal political compulsions and ensure that the overall “slant” of the budget is pro-middle class. Of course, this is a formidable task-list because these objectives may conflict with one another in the short-run. For instance, tight control over expenditure — which is necessary to slash the fiscal deficit — makes it that much better to pursue pro-growth policies.

Recent policy changes have made the finance minister’s job considerably easier. The government seems determined to slash the subsidy bill. It has raised prices of petroleum products and has also announced that their prices will keep adjusting in line with international trends. This will have a huge positive impact in reducing the subsidy bill. Passenger fares on the railways, which were static for as long as one can remember, have also been increased. Mr Chidambaram has also made a conscious effort to control government expenditure. Newspaper reports suggest that he has succeeded in cutting back expenditure quite significantly. Finally, the government has announced that the much-hated General Anti-Avoidance Rules are being pushed back to 2016. This will appease the foreign institutional investors so that foreign exchange inflows will continue.

Of course, the pre-budget moves can only be a small part of the required package. The budget must contain steps to reduce the gap between government revenue and expenditure. However, it is difficult to suggest obvious measures that will raise additional tax revenue. With the rate of growth being so sluggish, this is simply not the right time to impose new taxes on the corporate sector. Much has been written about raising the income tax rate for the “super rich”. I would not be surprised if the finance minister does introduce such a tax. It will be more of a political statement to the effect that the UPA government is anti-rich and by implication pro-poor. However, the actual additional revenue raised through such a tax would be a minuscule amount, given the overall size of the government budget.

In recent years, the government has tightened up the tax administration quite considerably — computerization, the increasing use of PAN in most financial transactions, have all helped to improve tax compliance. The flip side of the coin is that the government can no longer hope to get very large returns from greater tax compliance — all the low-hanging fruit have already been plucked. This means that the only source of additional revenue for the government can be through disinvestment of public sector enterprises. To the extent that the other measures help to improve the health of the stock exchange, the government can hope to raise a tidy sum through disinvestment.

The real test for Mr Chidambaram must be in what he proposes on the expenditure side of the budget. He cannot propose a uniform, across-the-board cut in expenditure since that would have a severe impact on growth. In fact, there may be a sizeable increase in social sector spending — surely, he has to make realistic provisions for the food security bill. But, he has to be ruthless in slashing expenditure in all non-productive spheres. And there is tremendous scope for that. One item that comes to mind immediately is the amount spent on travel. Why can’t more meetings be through video-conferencing? How many foreign trips of government officials are actually necessary? And what are the perks enjoyed by these officials when they travel abroad?

In all probability, the budget may be boringly routine on the revenue side, with tax-rates remaining more or less unchanged. Hopefully, Mr Chidambaram will be merciless on the expenditure side of the budget.