Budget 2015 has features to stimulate investment; fiscal consolidation will need another look: C Rangarajan

By C Rangarajan, Former Governor, RBI

The new government presented its first full-fledged Budget on Saturday. The Budget has several features to stimulate investment, particularly in the area of infrastructure. While Finance Minister Arun Jaitley stuck to his commitment to contain fiscal deficit at 4.1% of GDP in the current year, he has extended the period over which the fiscal deficit will be brought down to the mandated 3% of GDP.

For the year 2015-16, the fiscal deficit is set at 3.9% against the earlier announced target of 3.6%. The budgeted deficit for next year will only be 0.2% less than in the current year. Significantly, the reduction in the revenue deficit is only 0.1%. Revenue deficit for the coming year continues to remain high at 2.8% of GDP.

While Jaitley has reiterated the government's commitment to fiscal consolidation, the smaller reduction in fiscal deficit is bit of a disappointment. The reduction in fiscal space occurs always in the year after the presentation of the Finance Commission’s recommendations. Taking all transfers together, the reduction in space is only between 1-2 % of the divisible pool. One can only hope that the present road map will not undergo further changes.

Even to ensure that the fiscal deficit remains at the budgeted level, the revenue projections must hold good. In the current year, the revised estimates show a significant shortfall from the Budget estimates. The Budget projects a tax revenue growth of 15.8% over the revised estimates against a growth of 9.9% in the current year. With nominal income growing at around 11.5%, this is going to be a difficult task. The required tax buoyancy is 1.37. If the growth rate falls below 8%, the task will be rendered even more difficult.

The tax changes to stimulate investment are well-designed. As far as infrastructure is concerned, there is a clear recognition that government will have to play a bigger role. The proposed National Investment and Infrastructure Fund is meant to help infrastructure companies. In fact, in this context, it is worth considering whether we should revive the idea of setting up financial institutions focused exclusively on providing longterm capital resources to industries.

Rate changes on the direct tax side are minimal, particularly as far as individuals are concerned. Some incentives for savings could have been thought of. On corporate tax, the reduction in the rate must be accompanied by reductions in exemptions. This has been talked about for a long time. But reducing exemptions has always been found to be difficult. On the indirect tax side, adjustments in Customs duties to prevent inverted duty structure are again a welcome measure. The increase in service tax is also appropriate as it is a prelude to the introduction of GST (Goods and Services Tax).

There are several measures to monetise gold. In fact, a reasonable rate of return on financial assets, primarily bank deposits, will by itself act as a disincentive to hold gold as an 'asset'.

The expenditure programmes of the government have been laid out in detail. Several measures are a continuation of existing policy. As regards subsidies, it should have been possible to reduce them even further, given the recent reduction in oil prices. A modified system, which will result in reduction in fertiliser subsidies, is very much needed.

The Budget, as it was presented yesterday, has many attractive features. Several measures have been introduced to stimulate investment. There is an emphasis on increased social spending and creating additional social safety nets.

But much depends on the economy growing at 8% and tax revenues increasing at 15.8%. In the last few years, revenues have always fallen short of Budget estimates. The proposed reduction in fiscal deficit is below what it had been indicated earlier.

The revenue deficit continues to remain high. Growth with stability requires even stronger action on the fiscal consolidation front.