BUDGET REACTIONS

Fiscal consolidation gets stimulus, FM delivers goods: T K Arun


The finance minister has delivered the single-most significant expectation from the budget: fiscal consolidation. With this, India joins a select
band of countries that have begun to exit the extraordinary stimulus governments unleashed to combat the global crisis.

While partially reversing the tax giveaways, the government has unified the rates of tax on goods and on services, and expanded the scope of service tax a bit, achieving tax reform in the process and facilitating the proposed move to a goods and services tax (GST) next fiscal.

The FM proposes to bring the fiscal deficit down to 5.5% of GDP in 2010-11 and further down to 4.8% and 4.1% of GDP over the two subsequent years, and commits to follow the Finance Commission prescription to bring public debt down to 68% by 2014-15. He also proposes sharp cuts in non-Plan expenditure and rise in Plan spending.

Such earnest display of commitment to quantitative and qualitative fiscal responsibility is bound to impress foreign investors.

Rise in excise duties and petrol and diesel prices will upset consumers across the board, but the FM has bought peace with the vocal middle class by giving them unexpected income-tax concessions.

Moving to macro-economic balance and moving to tax and petro-price reforms are welcome; omission of other big reforms is a worry.

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Not quite as good as it looks, Pranabda

Mythili Bhusnurmath, ET Bureau

On the face of it, Pranab Mukherjee’s first full Budget in the UPA government is an improvement over his July 2009 Budget. The main macro number,
fiscal deficit (FD)/GDP ratio, is a tad below the Budget estimate (BE) of 6.8%. Even better, it is slated to come down to 5.5% by March 2010.

Add to that the FM’s apparent willingness to move away from the smoke-and-mirrors practice of the past, and present more transparent accounts, widen personal income-tax slabs, set a more ambitious target for disinvestment, hold out the prospect of additional banking licences to private players and make a beginning in the direction of legal reform, and it would appear that the stock market is not the only one with reason to cheer.

On the flip side, there is the small (2%) roll back of the reduction in central excise duties allowed last year as part of the stimulus package, expansion of the service tax net to cover more services, increase in central excise duty on petrol and diesel and on non-smoking tobacco, and some unwanted tinkering with tax rates on a host of items.

But none of this takes away from the general sense of Budget 2010 being a workman-like, no-nonsense Budget; one that will set the economy back on the track of growth along with fiscal consolidation. Or so it seems.

Until you look a little closer at the assumptions underlying the Budget, particularly fiscal consolidation. To begin with, the improvement in fiscal health reflected in the lower FD/GDP ratio conceals the worsening in the quality of the FD, not only in the revised estimates (RE) for 2009-10 but also in the BE for 2010-11 compared to 2008-09.

Thus, the revenue deficit/fiscal deficit ratio (RD/FD), which shows how much of the borrowing is going to finance current consumption (rather than investment), has increased from just 41% in 2007-08 to 79% in 2009-10 (RE), and is to go down only marginally to 73% in 2010-11. What this means is that every Rs 100 the government borrows will have to be serviced from whatever it earns by investing Rs 27. The balance Rs 73 would be spent on consumption and will not earn anything. This is a nigh impossible task that means the government will have to borrow more and more just to keep its head above water.

Second, the improvement in the FD/GDP ratio is premised on a sharper-than-warranted increase in net revenue and a lower-than-warranted increase in expenditure, especially non-Plan expenditure. Net tax revenue to the Centre grew only 5% in the current year, according to revised estimates for 2009-10. Yet, Budget 2010 projects a far more robust growth of 15%. On the expenditure side, though non-Plan expenditure grew 16% over actuals in 2008-09, it is expected to grow by a far more modest (unrealistic?) 4% in the next fiscal year.

Last but not least, unless inflation comes to the government’s rescue, the GDP number for 2010-11 is likely to be an over-estimate. The reason is third-quarter GDP numbers released by the CSO on Friday show third-quarter growth at just 6%, which means the economy must register growth of about 8.8% in the fourth quarter if we are to live up to the CSO’s advance estimate of 7.2% for the year.

This looks a trifle far fetched at the moment, so the final GDP number for 2011 may be somewhat lower; in which case we may end up with an FD/GDP ratio of more than 5.5%, and the much-celebrated improvement in fiscal health will turn out to be no more than wishful thinking. In course of time, markets will wake up to that realisation. But till then, it is party time.

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Fiscal health gets a booster shot

Swaminathan S Anklesaria Aiyar , ET Bureau


It’s a middle-of-the-road budget,neither harsh nor soft, neither left nor right. Finance minister Pranab Mukherjee is neither a populist nor radical
reformer. Curbs on non-Plan spending rather than stiff taxation (net additional taxes are barely Rs 20,000 crore) will reduce fiscal deficit to 5.5% of GDP next year, with further reductions to 4.8% and 4.1% in the next two years.

This conforms to the targets of fiscal consolidation in last year’s budget. Banks are relieved that they will be able to fund the reduced borrowing requirement of the government. Disinvestment of public sector shares will fetch Rs 40,000 crore, and the 3G spectrum auction another Rs 35,000 crore or so.

This exceeded the markets’ low expectations, and the Sensex zoomed 175 points. Reliance Capital was a top gainer, after the finance minister’s statement that more private sector banking licences would be given out.

Conditions today were good for a reformist budget. Only one state election (in Bihar) occurs this year, and the current coalition partners lack the muscle to topple the government unlike the Left Front in the 2004-09 coalition.

But Mr Mukherjee avoided any significant reforms. FDI could have been allowed into retail and the FDI limit hiked in insurance; foreign investors could have been given voting power in line with their bank shareholding.

The budget assumes 8-8.5% real growth and 4% inflation, giving 12.5% nominal GDP growth. This very optimistic scenario assumes that the global economy will not slow down. If it does, all bets on deficit reduction are off.

The surcharge on corporate tax has been cut from 10% to 7.5% while the minimum alternative tax (MAT) has been raised from 15% to 18%. This will raise the overall effective tax rate. The tax break for software parks has not been extended, so the likes of TCS will now be taxable, but for the refuge they get in SEZs.

The aam aadmi will get more rhetoric than cash: NREGA gets just a marginal boost to Rs 40,100 crore from Rs 39,100 crore last year. The fiscal stimulus was rolled back very partially. Cenvat went from 8% to 10%, well short of the pre-stimulus 14%. Cenvat and service tax now stand unified at 10%, preparing for the transition to a single-rate goods and services tax next year.

Import and excise duty on crude and petroleum products were cut in 2008 when crude hit $112/barrel, and these cuts have been reversed in the budget. Petrol and diesel will go up in price by Rs 2.67/litre and Rs 2.58/litre, respectively. But petrol and diesel prices remain to be decontrolled.

The Economic Advisory Council recently said the fiscal stimulus comprised accelerated spending much more than tax cuts, suggesting that the rollback should focus on spending. Mr Mukherjee has followed this advice—non-Plan spending is up only 6%, and non-Plan outlays are actually down for several sectors, including defence, subsidies, police, economic services, social services and other general services. Plan spending is up 15%, a desirable trend change.

The middle class will be angry with the rise in petrol and diesel prices, and Mr Mukherjee has sought to mollify it with a widening of income-tax slabs, which will provide some relief. But inflation remains a major concern, and the budget hope that inflation will fall to 4% over the next year is a triumph of hope over experience.

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'Markets cheer Budget 2010', screamed one headline. 'Sensex salutes Union Budget', said the other. Clearly, bouquets far outweighed the brickbats in response to the Union Budget 2010 that was tabled in the parliament today. Count us amongst the one offering the bouquets! Of course, it would be too premature to pass any judgment right now. But the budget clearly showed that the Government is in no mood anymore to drive down the wrong path. Most of all, in the field of fiscal prudence. And it also showed that the previous two years were an aberration. An aberration that had arisen as a result of political compulsions and a severe global economic turmoil.

Absent any of these factors, the Government seemed quite intent to take the right steps. Steps that will put the economy on a structurally higher growth path and at the same time strive for financial inclusion.

And clearly, markets seem to have liked this positive gesture by the government. Most of us would remember that during the last budget, it was the ballooning of the fiscal deficit that had perhaps caused the maximum heart burn for the investors, resulting into the markets going into a tailspin on the budget day and the Sensex shedding a massive 870 points. But things were starkly different today. The FM promised that the Government would strive to shave off fiscal deficit by nearly 3% as a percent of GDP by FY13, thus helping lift investor spirits.

Fiscal deficit is not entirely bad in itself. But increasingly in India, more of it has been finding its way into wasteful expenditures that do nothing to improve the long term productivity and economic health of the country. Thus, with the same expected to come down, markets heaved a sigh of relief that money would now be spent towards more productive purposes, thus boosting economic growth.

In a nutshell, while the Finance Minister did nothing that could take away from the near term India growth story, it took further measures like showing a firm resolve to rein in the fiscal deficit that could do wonders to the long term India growth story and put us on a higher growth path. Was it a responsible budget? Tell us what you think.

Talking about fiscal deficit, the budget showed the government's commitment to revert back to the path of fiscal prudence in the coming years. The chart of the day shows the government's fiscal targets in the medium term. Fiscal deficit has reduced from 7.8% of GDP (including oil and fertiliser bonds) in FY09 to a target level of 5.5% in FY11E. This is due to disinvestment in public sector companies and reforms in government expenditure chiefly subsidies. In fact, the targets for FY12E and FY13E are improvements over the suggested roadmap by the 13th Finance Commission.


The budget was certainly not only about the fiscal deficit. The Finance Minister also chose to take away a lot less money from salaried professionals by way of taxes thus boosting their disposable income and further strengthening the Indian consumption story. Also, availability of credit, so very essential for big ticket purchases like auto and homes, is all set to improve what with the Government deciding to give away more banking and NBFC licenses and also strengthening the capital base of public sector banks.

It should be borne in mind that all these measures were over and above the ones that the Government has now started taking on a regular basis and the ones so very essential for the sustenance of the Indian growth story like focus on infrastructure, employment guarantee schemes, greater emphasis on education and health and the like.


What does all this mean for the investor? If one is looking to invest in the markets from a 3-5 year perspective, there is a strong chance that the returns in the region of 12%-15% annually that the investors have come to expect from Indian stock markets from a long term perspective, could well be surpassed. Of course, one will have to stick to companies favorably positioned to ride the India growth story run by a competent management team and available at reasonable valuations. The FM seems to have done his bit. Now, it is your turn to take advantage of it.


The power sector received a lot of attention in the budget. Plan allocation for power sector (excluding RGGVY) has been doubled to Rs 51 bn in FY11. That will aid new generation capacities that had been stalled for want of funds. Competitive bidding for allocating coal blocks will help bring about a level playing field in the sector as more and more generation companies are looking to have their own supplies of coal. Higher outlay for renewable energy will help power companies given the mandatory requirements to source a part of their power distribution requirements from clean fuel sources. However, the hike in the standard rate of excise duty to 10% to make equipments a bit more expensive that will impact the overall project costs for power companies.


Banking was another such sector that received its due importance in the Budget. The RBI will give additional branch licenses to private sector banks and NBFCs that meet the central bank's eligibility criteria. An additional sum of Rs 165 bn will be offered to the under-capitalized public sector banks to ensure that all PSU banks are able to attain a minimum 8% Tier-I capital by FY11. Banks' target for agricultural credit for the year FY11 has been enhanced to Rs 3,750 bn. By ensuring that the banks are adequately capitalized and have enough scope to grow their franchise and loan book, the budget ensured that banks play a major role in the economy's growth in the coming fiscals.

FY10 turned out to be the year when the Indian auto sector made a grand comeback. The Union Budget for the year 2010-11 did little to disrupt the growth story in the auto sector. Except for the 2% excise duty hike in passenger vehicles, it chose to keep most of the other duties intact and hence, did not roll back any of the stimulus measures. Also, higher allocation towards defence and infrastructure augurs well for the long-term growth story. On the direct tax front, while increase in weighted deduction on R&D expense to 200% was a positive, increase in MAT rates is likely to take some sheen away from it. All in all, a favorable budget for the auto sector.


The Union Budget 2010 brought some cheers to the Indian markets, which had been reeling under fear for the past few days with respect to the government's stimulus withdrawal. The BSE Sensex and NSE Nifty closed with gains of around 175 points (1.1%) and 65 points (1.4%) respectively. Among other key Asian markets, while China closed marginally in the red, Hong Kong (up 1%) and Japan (up 0.2%) were among the gainers. European markets have opened today on a positive note.

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UP IN THE AIR

BY ANIL PADMANABHAN


Finance minister Pranab Mukherjee's second effort in less than nine months is an honest attempt at consolidation and correcting the fiscal abuse of the past, but it may yet fall under the burden of scepticism emerging from the underly- ing macroeconomic risks and what's been left un- said in Budget 2010.

In the trade-off between inflation and growth the minister, risking personal political damage, has opted for the latter and at the same time, to ensure the desired fiscal discipline, targeted subsidies in a manner that could, in the short term, imply an ad- justment cost for consumers.

Together with an across-the-board increase in in- direct taxes, which signalled the rollback of the fiscal stimulus, and bringing new services in the tax net, the Budget creates the basis for inflationary pressures.

Given the politics, especially with the opposition parties staging a walkout, the first in the history of Parliament during the presentation of a budget, it is understandable that the minister stayed away from stating the bare facts about the adjustment (con- sumers will end up having to pay more for a variety of offerings, though Mukherjee has tried to lessen the impact of the blow). The downside is that be- cause he hasn't done this, interpretations are open to exaggeration. This could mean trouble when the message sinks in. This is evident in the reaction of the markets--buoyant at first, muted later.

Politically this can make the Congress-led Unit- ed Progressive Alliance (UPA) unpopular and give the Opposition a rallying point, besides stirring disquiet among allies. It could also make individu- als and companies hold off investments and defer consumption--threatening growth and the core of the government's strategy.

A reforms legacy Still, the UPA has to be complimented for seizing the political space provided by the 13th Finance Commission (TFC) to press ahead with some honest and much-needed (and politically difficult) fiscal re- form even as it continues the stock-market friendly disinvestment programme. If it does not lose its nerve and effect a retreat, the UPA may well find itself in a position to add to its already enviable legacy as the political coalition that helped put in place the building blocks for a modern economy. Mukherjee has, with this Budget, already joined the pantheon of politicians such as P.V. Narasimha Rao, Manmohan Singh, P. Chidambaram and Yashwant Sinha, who pushed difficult but very critical economic reforms.

Budget 2010 also marks a departure from finance bills of the UPA's first tenure (2004-09) when the government failed to take advantage of a booming economy to undertake structural measures to cut back expenditure. This is important because the ac- tion taken report (ATR) on the recommendations of TFC submitted to Parliament on Thursday seemed to suggest that the government had deferred any response to the proposals on expenditure reform.

It emerges that relying on the recommenda- tions of TFC, a constitutional body, the govern- ment has actually moved ahead with a reorder- ing of expenditure and committed itself to a f transparent and binding medium-term fiscal reforms programme. Not only is the UPA going to reduce its borrowing by about Rs1 trillion from 2009-10, it has decided to embark on a new strategy: the government will cap its stock of internal debt at 68% of the gross do- mestic product and derive the fiscal deficit, gross borrow- ings, as a residual, instead of deriving the fiscal deficit from spending excesses as it used to do previously; since the gov- ernment also plans to elimi- nate the revenue deficit, the gap between the government's income through taxes and oth- er revenues and its spending, this means that it will progres- sively reduce its borrowings.

Not only will this guarantee a non-inflationary financing of development programmes, it will also ensure that such fi- nancing does not crowd out private investment and create an upward pressure on inter- est rates.

It is apparent that a lot of thought has gone into this Budget.

It is not, despite the Rs26,000 crore giveaways in direct tax concessions and the sustained spending on social sector programmes, by any measure a populist budget. A tax concession of about Rs60,000 for anyone earning above Rs9 lakh, a key demo- graphic category among the middle class, would in normal circumstances be construed a sop. Instead, it is, as are the other direct tax changes, de- signed to ready the tax infra- structure for the introduction of the game-changing direct tax code (DTC) in April next year.

Similarly, the minister has gone in for several meas- ures--such as preferring to re- tain the service tax rate at 10%--in the area of indirect tax to prepare ground for the introduction of a single goods and services tax (GST).

Mukherjee has also taken an initiative to usher in the much-needed institutional re- form. Key among these is the move to create the information technology infrastructure that can make a success of efforts such as the implementation of GST and DTC. Another is the implementation of TFC's rec- ommendation to create a na- tional mission for delivery of judicial and legal reforms.

Equally significant is the UPA's decision to press ahead on green initiatives. Accord- ingly, it has effected a 61% in- crease in the outlay to the ministry of new and renewable energy, funded new pro- grammes for river-cleaning and give a big push to use of non-fossil fuels such as solar energy.

Threat of inflation Since previous governments shied away from action on the vexing issue of expenditure re- form, Mukherjee inherited a dubious legacy; matters were worsened because some of his predecessors resorted to cre- ative accounting to mask the fiscal impact of subsidizing consumption, especially when there was a runaway rise in in- ternational fuel prices. Any ef- fort to undo this would inevi- tably imply adjusting prices.

Unfortunately, since this has coincided with the rollback of the fiscal stimuli that the UPA had injected over the last two years, it is likely to lend a price shock to the system--indeed, if not contained, it could spiral out of control.

Inflation, as measured by the Wholesale Price Index, was already high at 8.5% in Janu- ary; more worrying is the fact that food inflation continues to remain in the high double digits.

Some of the inflationary ef- fects of the Budget have al- ready resulted in price rises in some offerings; rises in several others could follow. The list of such offerings includes fuel, cars, air tickets, cement, coal, cigarettes, consumer products, and air conditioners.

The challenge The Opposition has, by seiz- ing on the weak link in the Budget, signalled its intent to throw down the gauntlet on inflation. The UPA has no choice but to take up the chal- lenge; it will find the going difficult since some of its al- lies have very publicly dif- fered with it on politically sensitive reforms. So far, the Congress has demonstrated leadership qualities by refus- ing to bow to such pressures, even as it has, occasionally, passed on the responsibility to politically weakened allies such as the Nationalist Con- gress Party led by Sharad Pa- war. It has been helped, no doubt, by its firm commit- ment to inclusive growth, something that Mukherjee re- ferred to as "an article of faith".

The Congress' spin doctors will have to back Mukherjee and wear down the political criticism to the Budget. To its advantage, the Congress still enjoys credibility with people; but in politics, like in cricket, situations can alter dramatic- ally and often without warn- ing. What would also help is the fact that Mukherjee, as a CVoter survey reported in Mint on 25 February, showed enjoys personal credibility.

Troubleshooters of the gov- ernment have already indicat- ed that they are prepared to take on the political opposi- tion. The Congress has 208 seats in the Lok Sabha, needs 273 for a simple majority in the House, and it still has the backing of 276 members of Parliament--even after the withdrawal of outside support from the Samajwadi Party and the Bahujan Samaj Party.

The real test for Budget 2010, however, will be the ability of the UPA to ensure strong policy response to pre- vent inflationary pressures from spiralling out of control.

So far, it has been found want- ing on that front. But now the stakes, both political and eco- nomic, are very high. Any mis- step in policy would not only set back the Congress as well as the UPA, it could plunge the country into an economic crisis--that could mean miss- ing out on a once-in-a-life- time opportunity to break the economic shackles and deliv- er inclusive growth.