Union Budget 2010-11: Too Many Gambles

Union Budget 2010-11: Too Many Gambles

Arun Kumar

CESP, SSS, JNU

Mainstream, March 5, 2010

Union Budget 2010-11 was expected to be an innovative exercise given the difficult circumstances in which it was being framed and that the most experienced politician of the present government was at the helm. There have been uncertainties about growth, high rate of inflation (especially in food items) and pressures for withdrawal of the stimulus. The Indian economy is recovering but the global situation remains uncertain given that the major world economies are plagued by persistent high rates of unemployment and even higher under- employment. Even the IMF is forecasting anemic recovery in 2010. Other experts are worried that the premature withdrawal of the stimulus in the advanced countries (and for this there is considerable right wing pressure) could lead to a double dip recession. Just as in 2008, this would immediately jeopardize Indian economy’s growth as well. This would certainly transpire if the stimulus is withdrawn in India also. After all, the FM has himself agreed in the budget speech that the stimulus helped India to maintain growth when in the rest of the world most economies were in decline.

Growth and Inflation: Background to the Budget

There appears to be an attempt at talking the economic sentiment up by constantly presenting a bright picture of the economy. This works some of the time but not all of the time. In 2007-08, it was argued that India would not be affected by the impending global crisis because it is de-coupled and that India would provide the stimulus to the rest of the world. As it turned out, Indian economic growth declined along with that of the rest of the world and the Indian policy makers were proved to be wrong. Could the policy makers again prove to be wrong in their belief that the economic growth will keep rising? Would the dream of 10% plus growth and that India would be the fastest growing economy in the world remain pipe dreams?

There are reasons to doubt the official growth rates being put out. It is stated that the rate of growth of manufacturing was 18.5% in December 2009 and that exports have started rising in the last few months so that the rate of growth is likely to have accelerated to 7.2% for the year 2009-10. If this is so, then for the previous year when industry as a whole was stagnant for more than 10 months, agriculture was showing zero or negative growth and large parts of the services sector were experiencing nil or negative growth (like, hotels, finance, real estate, air travel and commercial transport) then how could the economy have been growing at 5.1%? Be that as it may, only time will tell what the real story of growth for this period was.

The likelihood of lower growth (than official rate) in 2008-09 is corroborated by the tax data in the budget. The gross tax revenue for 2008-09 was projected at Rs.6,87,715 crores, in revised estimates but it turned out to be Rs.6,27,949 crores, about Rs.70,000/- crores less and in the actuals now released, it is Rs.6,05,298 crores, that is about Rs.82,000 crores less. Customs duties were less by about Rs.19,000 crores because of decline in imports, excise collections declined by about Rs.30,000 crores due to both the decline in output and tax cut and direct taxes were down by about Rs.44,000 crores.

This picture suggests that many parts of the organized sector, which pays the bulk of the taxes was in a state of decline in 2008-09. Reports suggest that the spill over effects of this decline on the unorganized sectors were strong. Consequently, employment in urban areas was impacted adversely due to these trends. The rural areas were spared due to the implementation of the NREGS. The corporation tax collections which were rising in the previous years at 25-35% hardly rose 10% (less than the GDP growth rate). This suggests that the additional purchasing power in the rural areas due to NREGS and loan waiver was not enough to stem the decline in the profits of industry. In other words, while these rural schemes only prevented the demand from falling rapidly but could not keep up the demand in the economy. Some use the argument that the share of consumption in the economy has risen to support their contention that consumption rose. This is not quite true since the share of consumption rose because the share of capital formation fell sharply and the two have to add up to one (if one falls the other has to rise). So the 5.1% growth remains a mystery.

Data from the Economic Survey 2009-10 indicates that in 2008-09, there was strong growth in three components of the economy belonging to the services sector – firstly, Transport, Storage & Communication (11.6%), secondly, Financing, Insurance, Real Estate & Business Services (10.1%) and finally, Community, Social and Personal Services (13.9%). How there could have been such strong growth in these sectors when Transport was down as indicated by automobile and especially commercial vehicle sales showing a down trend, finance sector was in a crisis globally and also in India and real estate, advertising and other business services were in a crisis and on the decline. Yes, communication and government services continued to grow as earlier but that could not have compensated for the general decline in all major sectors, like tourism, hotels, private education services and so on.

Since early 2008, inflation in food prices has plagued the economy even though the general rate of inflation based on the WPI was showing a declining trend since mid 2008 due to the global price trends. The severe drought in 2009 accelerated food inflation. However, the situation is puzzling given that the country had ample foodgrain stocks of 52.5 million tons of rice and wheat in July 2009 when according to buffer stock norms the requirement was 26.9 million tons. To begin with, the anticipated shortage of food grains during Kharif was about 16 million tons but now the shortage is anticipated to be only about 9 million tons. Even if the shortage was the higher figure, the buffer stocks were adequate to control the prices of cereals if not pulses. But the rice prices shot through the roof.

The government was slow in admitting that the drought was severe and that production would be short. Consequently, it was slow to intervene and the situation got aggravated due to inflationary expectations building up. In the past when the foodgrain output declined but stocks situation was good, prices rose but moderately unlike in 2009. The situation also deteriorated because now in the foodgrain markets, there are those with deep pockets who can hold stocks. Unfortunately, there is no data on private stocks so one can only guess how the speculators made a bad situation worse. Even then timely action by the government with its huge stocks could have kept the situation in check and prevented the private players from hoarding. In the case of pulses and oilseeds the situation is different since there is hardly a buffer stock for these and import of pulses is not easy.

It is not that per capita consumption of food has risen which could have raised demand and prices. The per capita availability (proxy for consumption) after peaking in 1991 at 510 grams per day has been down (by up to 20% in 2001). It has risen thrice to come close to the peak figure - in 1995 (495.4 grams), in 1997 (503.1 grams) and 2002 (494.1 grams). Each of these years corresponded to a good harvest. The lows were in the years of poor harvest. In 2008, the crop was good and NREGS and loan waiver had pumped in purchasing power but the net availability in 2008 remained low at 436 grams. In 2009, with a drought and lower production, less work on farms and lower incomes of the workers, the demand for foodgrains cannot have risen. NREGS may at best compensate for the loss of purchasing power of rural labour. The ruling high prices are likely to ensure that per capita consumption this year will be low.

The middle category of farmers do not go for NREGS so their demand could not have risen for this reason. They would have benefited from the farm loan waiver schemes and this could help them to retain their stocks and wait for a higher price rather than sell them immediately in the market. However, foodgrain procurement in 2008 was a record 54 million tons and even in 2009 Rabi season, it was good enough to leave 52.5 million tons of stocks in July 2009. So, loan waiver did not make a difference to the amount of foodgrain marketed by the farmers and this could not be a reason for the higher foodgrain prices. The situation could indeed have been different in the case of pulses and oil seeds.

Key Aspects of the Union Budget

The Union Budget projects expenditures of about Rs.11 lakh crores. It amounts to 18% of GDP and about Rs.10,000 per person. This is large enough to give something to every section of the population. No wonder, the FM announced, as is the case every year, allocation to every section of society – women, SC/ST, unorganized sectors, middle classes, corporate sector, farmers, small scale and so on. However, as the FM notes in the beginning of the speech, “The Union Budget cannot be a mere statement of Government accounts. It has to reflect the Government’s vision and signal the policies to come in future.”

The vision is incorporated primarily in the macroeconomic framework underlying the budget. It is also expressed in statements like, “ … the focus of economic activity has shifted towards the non-governmental actors, bringing into sharper focus the role of Government as an enabler”. It is this last statement that is crucial to understand the overall focus in the budget and the reason why the budget complicates the situation regarding the twin problems of sustained growth and inflation.

The stimulus provided by the high fiscal deficit and lowering of indirect taxes (in 2008-2009) are sought to be reversed. Services tax is being extended to more services. All this would jeopardize the possibility of sustained high growth as well as raise the already high rates of inflation. More than anything else, they would further fuel inflationary expectations and also lower demand resulting in slow down. Indeed excise duties could have been raised selectively on a few luxury products but an across the board rise would be inflationary. Further, the increase could have been postponed to when the economy was on a more firm footing.

Additional taxes could have been raised through increases in direct taxes rather cutting them. The loss of revenue due to this is about Rs.26,000 crores. This is being partially made up through increased indirect taxes. It was possible to raise more taxes through curtailing of tax expenditures of which a large part goes to the corporate sector. According to the Receipts Budget, the total concessions to all sections amounted to Rs.5 lack crores in 2009-10. While the FM is keen to lower the subsidies offered to the common man but he is not willing to touch the tax expenditures for the corporate sector and the well off sections.

The changes in the slabs of Personal Income Tax benefit only about 3% of the population and effectively about 1 % of those who pay significant amounts of income taxes. In contrast, the increases in indirect taxes adversely affect the entire population. The rise in the inflation rate consequent to raising indirect taxes is like a tax on the common man. For the poor, a 20% rise in the food prices is like a 13% tax on them. This is more than any benefit the budget could provide to the poor. The tax changes suggested in the budget reflect the government’s bias in favour of the well-off sections who are not really in need of any concessions given their high living standards compared to the poor and the lower classes.

Issues Related to Petroleum Product Prices and Taxes

Why the increase in the indirect taxes on petroleum products? It is being stated that this is to only reverse the tax cuts that were offered earlier and that too only a part of the tax cut is being restored. It is argued that earlier in 2008 the price of crude was high and that is why the customs duties were lowered in 2007-08. It is also being argued that the petroleum companies are running up losses at current prices and they need to be tackled. What is so sacrosanct about restoring earlier tax rates? Why can’t the indirect tax rates be permanently brought down? Finally, are the losses of the oil companies related to the excise and customs duties?

It is true that the lowering of the excise and customs duties resulted in less revenue for the government but that can always be made up from different sources. The direct taxes which are non-inflationary could be tapped and as suggested above, tax expenditures could be reduced for this purpose. This is also suggested in the Direct Tax code which is to be implemented from next year. Thus, there is nothing sacrosanct about raising the indirect taxes to get additional revenue that was earlier sacrificed by the government.

Some argue that GST requires a uniform rate of tax so that tax rates have to be brought in line with each other. However, in this budget the various tax rate changes suggested do not seem to have a pattern which would harmonize the rates. Further, why should they be harmonized to a higher rate and not a lower rate? Again, the loss in revenue, if the tax rates are lowered, can be more than made up through higher direct tax collections, say, by tackling the very large black economy. Hence there is no necessity that the FM has to move towards higher indirect tax rates.

Regarding the losses being suffered by the petro companies, these are not just due to the final price of the petro goods. The government treats these goods as a tax cow and levies high excise and customs duties so that higher prices are required to make a profit. If these duties are lowered, at lower prices also the petro companies can make a profit. In general it is desirable to keep petro goods prices high so that their consumption can be moderated and not only this precious good but the environment can be saved. However, in an inflationary period, these prices should not be raised since their inflationary potential is high.

An alternative would have been to raise taxes on all automobiles so that their prices could be higher and consumption moderated. Simultaneously, the prices of public transport could be subsidized to shift traffic to this mode. This way both travel of people and transport of goods could be cheap without an inflationary impact and the budget could have collected more revenue. But the elite and the automobile lobby oppose these steps. Thus, vested interests come in the way of a more rational policy. This also explains the macro vision of the budget.

Other Aspects of the Budget

Prior to the presentation of the budget the government had announced the move to curtail the fertilizer subsidies by moving to a Nutrient Based Subsidy (NBS) system. The real intent of the change is to cut the rising subsidy bill rather than any rationalization of fertilizer use. A play with words is being used to make this change sound reasonable and acceptable. However, in a difficult year for agriculture the time is not right to shift to a new system. In India, given poor governance and how businesses take advantage of deregulation to make a fast buck, the possibility is that fertilizer prices would rise and their consumption could decline leading to lower agricultural production. The opposite of what needs to be done.

This year’s Economic Survey suggests that food subsidy be managed through a voucher based system. Without a proper distribution system for vouchers, is this feasible? The potential for corruption could go up so that the scheme may work to the detriment of the poor. Have we forgotten how easily Telgi printed fake stamp papers and in educational institutions how easily fake income and caste certificates and degrees are presented to take advantage of concessions. The genuine people, the poor and the illiterate are then left out and the corrupt make a killing.

The problems in the country are basic and sophisticated solutions come a cropper. Putting a lot of money into new fangled high sounding schemes in the end has only complicated matters as has been seen in the case of issue of election cards. In spite of this exercise going on for the last 15 years, it is still facing difficulties. Usually the procedures in new schemes are so complex that even the literate are left floundering. Take the introduction of the simple tax forms; most people involved were literate but they found the procedures put in place difficult to follow.

The government is placing great faith in computer and IT based solutions like, UID, computerization of income tax returns, etc. One only need remember that if the spirit is not willing then machines cannot do much and their operation can be circumvented. A law is as much in letter as in spirit. The experience with PAN cards suggests that the crooked got multiple cards and the income department stopped issuing them. Similarly, in case of demat accounts people have been found to have up to 10,000 accounts. Banks in spite of the KYC requirements help the rich clients in various illegalities. In the ongoing Koda case, a bank branch enabled Rs.600 crores of rupees to be moved.

If those at the top are corrupt, how can it be stopped at the lower levels? In the US and Europe, there is far more computerization than in India, but tax evasion is taking place through various devices, like, use of tax havens, etc. It has been found that in spite of various regulations and computer controls, banks have been helping their rich clients to spirit money to tax havens.

Central Plan outlays are short by Rs.22,000 crores. Thus, the much trumpeted increase by 18 % has finally turned out to be an increase by about 12%, not too far ahead of inflation. This reduced the impact of the stimulus last year. Such shortfalls are an annual occurrence; expenditures are announced and then not spent to control the deficit. What reliability can be placed on the roughly 25% increase (on revised estimates) announced this year.

The chances of the budgetary calculus going wrong are much more because the revenue account estimates of expenditures are under estimated. Last year they increased by 15% over the previous year’s expenditures and Rs.22,000 crores more than estimated in the budget. This year they are slated to go up by only Rs.1,500 crores or about 0.02 % in spite of the interest burden rising by Rs.29,000 crores. In other words, all other items are likely to fall by Rs.27,500 crores. Partly, this can be attributed to the fact that in the previous two years the Sixth Pay Commission award related arrears were paid out to government servants and these were one shot payments.

The arrear increase was already captured by the budget for 2008-09 so why the increase of 15% in 2009-10? This was not just in the case of interest payments but in all the categories like, police, Defence services, social services, etc. This year none of them are to rise. Defence allocation is static but police are slated to fall by Rs.2,000 crores when major expansion is going on due to internal security problems and social services are allotted Rs.6,000 crores less even though major increases in expenditures are going on in education and health. There is no inflation indexing. Finally, subsidies are slated to fall by Rs.15,000 crores and this may turn out to be in error given the high inflation that confronts us today. This has the potential of upsetting the deficit figures as happened in 2008-09 and 2009-10.

Increase of Rs.5,000 crores for school education is welcome but is wholly inadequate if the nation is to seriously move towards the implementation of the Right to Education. Best school education for all children all over the country is a crying need so that all children have equal opportunity. Children of the poor drop out or do not go to the schools or even if they do go, the chances are that they get such poor education so that they have little chance of competing with the children of the well-off sections who get good education right through. The budget manifests a lack of will for moving in the right direction but then this is true not just of this budget but of all the previous budgets. There is a lack of political will in the nation.

Increase in NREGS is by Rs.1,000 crores when the poor are adversely affected by the food inflation and need higher incomes. There is demand to raise the wages paid to workers. Further, as is universally acknowledged, giving 100 days employment to one family member of a family is wholly inadequate so that the amounts need to be raised further. In contrast, the amount is not even inflation indexed so that next year the expenditures are likely to be higher.

All indications are that the deficit figures are likely to turn out to be higher than anticipated. It is fortuitous for the government that the deficit figures for 2009-10 are lower as a per cent of the GDP because of a rise in the GDP figure for the economy due to a revision of the base year. This statistical device would not be available in the next year and the deficit would turn out to be higher than anticipated.

Conclusion

Many of the assumptions in the budget exercise for 2010-11 seem to be problematic. It is taking a high risk in assuming a continued high growth in spite of the global uncertainties and in prematurely reducing the stimulus by raising indirect taxes across the board which would kick off inflation rather than moderate it. Even if the rate of inflation declines, food prices are already at a high level and unlikely to fall to last year’s levels so that the family budget is likely to remain under stress.

Due to the incorrect assumptions, the revenue deficit is likely to turn out to be higher and this will lead to larger borrowing and interest payments which would cause the fiscal deficit also to turn out to be higher and this could be a vicious trap. The budgetary arithmetic needed to be more transparent.

It is the retreat of the state that underlies the budget formulations and this is what has led to the complications in the budget process, like, the premature withdrawal of the stimulus. It is a pity that in this time of difficulties faced by the citizens the government is thinking of a retreat by cutting subsidies, disinvestment and so on.

The current FM is the most astute politician in this government and also the most experienced one (with no exceptions) and yet he has committed mistakes and is now facing a rising political opposition, including from the allies. It is a surprise that the Left and the Right have come together to oppose the budgetary provisions. The BSP, SP and RJD are seen on the same platform against the UPA. Why did he not anticipate this? Has he become so much a prisoner of the philosophy of retreat of the state (and its corollary, the promotion of the private sector) that he could not see the obvious and presented a flawed vision?

arunkumar1000@hotmail.com