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A new policy outlook guides the Indian Budget

Panna Lal Chowdhury - 3/7/2005

The new Indian budget for fiscal 2005-06 was presented on the last day of February 2005. It deserves special attention from the business circles, economists and the politicians. The present Indian Government is formed with the coalition of a number of parties. The main coalition partner, the Indian National Congress, initiated the economic liberalization and reform programs since early nineties. The present Prime minister and the present Finance minister is the architect of this economic liberalization and globalization polices of India since 1991. But unlike the past, the present government at the centre today depends heavily on the support of the leftists and communist coalition partners in the parliament. The leftist parties are supporting the Government to implement their pro-poor economic agenda keeping the privatization, reform and liberalization programs in the back burner. The Communists and the Congress party have been frequently at loggerheads over economic policy issues relating to the pace of globalization and the entry of foreign capital. The communist Governments in a few provinces of India and the Communist members in its central parliament are the only democratically elected communist regimes in the world. As such India's coalition government at the centre cannot afford to ignore the pro-poor and leftist economic agenda.

Moreover the present government needs to avoid the pitfalls of the economic policies followed during the tenure of its previous regime when India went through a phase of positive growth but the growth was without any noticeable impact on employment scenario. So the government now clearly wishes to emphasize poverty alleviation and development of the rural infrastructure as the cornerstones of its economic strategy. It was a tough task for the Harvard educated Finance minister Chidambaram to accommodate in a single budget platform, the economic policy of the leftist on the one hand and the programs for liberalization and reform to support the expanding market economy of India on the other hand.

Today India is one of the fastest growing economies in the world. The budget for 2005-06 has assumed that its economy would grow at an impressive nominal GDP growth rate of 12-13 percent, a real growth of 7-8 percent and a 5-6 percent rate of inflation. This assumption is not particularly unrealistic considering the fact that India's gross domestic product (GDP) increased by as much as similar percentage during the recent years. Current forecasts of global economic growth and trade, strong growth sentiments in domestic manufacturing and services sectors, backed by the ongoing investment boom and the likelihood of a favorable monsoon make the growth estimates look achievable. It is assumed that there will be a 21 percent increase in tax revenues and this will permit the Government to meet the demands for increasing social expenditures, keeping subsidies in place, reinvigorating the rural economy and allocating resources for infrastructure development

A positive aspect of the budget is the emphasis given to investments for development of infrastructure. The importance of infrastructure for rapid economic development cannot be overstated. Concluding his presentation, the Finance Minister had pointed out " The most glaring deficit in India is the infrastructure deficit...If our cities aren't renewed, they'll die," Special attention has been given to Telecommunications, National Highway Development Project, Rural Electrification, Indira Housing Scheme etc. Measures announced for improving rural connectivity is also impressive. Investment in infrastructure will continue to be funded through the Budget. However, there are many infrastructure projects that are financially viable but, in the current situation, face difficulties in raising resources. He proposed that such projects may be funded through a financial Special Purpose Vehicle (SPV). When large infrastructure projects are implemented, the foreign exchange resources could be drawn for financing necessary imports. Accordingly, it has been proposed to establish a SPV to finance infrastructure projects in specified sectors. Roads, ports, airports and tourism would be sectors that can benefit most from the SPV. India's present huge foreign exchange reserve will be utilized to support the SVP.

Emphasis on tax reform is another important aspect of the new Indian Budget. It proposed a major overhaul of the direct tax structure providing relief to the lower and middle-income groups. The simplification of personal income tax and lowering of customs duties gives this Budget its strong reformist credentials. The proposal to exempt income tax up to an income of Rs. one lakh, to do away with all deductions and to give saving-related exemptions for another Rs. one lakh will boost savings and also increase purchasing power of the consumers.

Further for the corporate sector, the corporate tax rate has been lowered from 35 to 30 percent and the depreciation allowance reduced from 25 to 15 percent. However, the introduction of the Fringe Benefits Tax has raised concern, as it may hike the cost of transactions.

The smokers are very unhappy with this Budget since the specific excise rate on cigarettes was hiked by 10 per cent along with a surcharge of 10 per cent on ad valorem duties on other tobacco products including pan masala. Similarly the finance minister's proposal to levy a tax of 0.10 per cent on single withdrawal of Rs. 10,000 and above from the bank has created some unpleasant reactions.

Chidambaram has cut customs tariffs to bring these more in line with those prevailing in the fast-growing economies of Asia. Proposing major changes in the customs and excise duty rates in petroleum sector, the budget seeks to reduce the customs duty on crude petroleum from ten to five per cent. LPG for domestic consumption and subsidized kerosene has been exempted from the duties. The reduction of customs duties on non-agriculture products is a move towards the reform of import duty structure. It is hoped that, import duties will be lowered further with the progress in the Doha Round. Lower import duties on capital goods, crude oil and selected machinery will check inflation and promote capacity modernization and expansion. The planning commission of India pointed out that the many schemes and customs duty cuts announced in the Budget underlined the government's commitment to continue with reforms. The reform process would be pushed forward in the coming months.

While the US dollar has weakened against the Indian currency in recent months, exports have continued to expand at an impressive pace, by more than 25 percent. The country currently has a problem of holding a huge foreign exchange reserve. It has more than $120 billion in the form of foreign exchange reserves. A debate is raging among economists and policy-makers on how these funds could be utilized for development of India's much required infrastructure. One may recall that during the period of mid eighties India with a lame duck coalition government at that time was facing serious problem as its foreign exchange reserve was totally used up and turned nil. Its Central Bank had to use its gold reserve for a short period that time to obtain foreign currencies to support its imports. But with the gradual liberalization and reform of Indian economy it experienced remarkable growth since nineties and today India holds one of the largest foreign currency reserves in Asia side by side with China and Hong Kong.

The Budget has proposed significant increase in allocations for focus sectors like agriculture, health and family welfare, education, roads and social sector. For successful implementation of many of the ground level schemes like mid-day meal, food-for-work and employment guarantee, budget stressed on the need for active involvement of local authorities and the Panchayati Raj."India is not a poor country, yet a significant proportion of our people are poor," said the Finance minister during his Budget speech, adding that his government's most important goals were to tackle problems associated with "illiteracy, disease, infant mortality, malnutrition, absence of skills and unemployment".

Roughly one out of four Indians survive on less than one US dollar a day and one out of three cannot read or write their own name. The Budget includes several targets for reinvigorating the rural economy. Measures focused on the rural sector will make growth more inclusive and also sustain domestic demand for industrial products.

The National Food for Work Program will be converted into the National Rural Employment Guarantee Scheme. About 15 lakh houses will be constructed during the next year under Indira Housing plan. A National Rural Health Mission will be launched for training health volunteers, providing more medicines and strengthening the primary and community health system. Total Sanitation Campaign will be extended to all districts. National Fellowship will be introduced for Schedule Cast and Schedule Tribe students for pursuing M. Phil and Ph. D courses in selected universities. A Backward Regions Grant Fund will be established with an allocation of Rs. 50 billion for 2005-06. A number of measures have been announced for the welfare of minorities especially for their educational development. Equity support for the National Minorities Development and Finance Corporation will be increased. An amount of Rs80 billion will be provided for the Rural Infrastructure Development Fund (RIDF).

The Finance Minister spelt out the goals of the Government under the "Bharat Nirman" plan to be implemented over a period of four years for building infrastructure especially in rural areas. These include bringing an additional one crore hectares under assured irrigation, connecting all villages that have a population of 1000 with a road, constructing 60 lakh additional houses for the poor, providing drinking water to the remaining 74,000 habitations, reaching electricity to the remaining 125,000 villages and offering electricity connection to 23 million households and giving telephone connectivity to the remaining 66,822 villages.

The budget proposal has also identified some leading employment-intensive industries such as textiles, construction, food processing and IT for special assistance.

The solid 21 per cent growth in taxation revenue in 2004-05, and an expected growth of similar proportions this year, may be regarded positively in relation to India's ability to service its debt burden. However, fiscal deficit remains a problem for countries like India, Pakistan and Bangladesh. Global rating agency Standard & Poor's said India's new Budget shows a lack of success in reducing the country's deficit burden. Because the 2005-06 Budget does not provide for any significant reduction in the fiscal deficit, though there was a rather modest reduction in the previous year. S&P said the combined central and state government deficits would amount to 10 per cent of GDP in the near term, leading the consolidated debt of the central and state governments to rise gradually for the next few years. Given the strong growth being experienced by the Indian economy, it is surprising that better progress could not be made. There should have been bolder measures to lower the revenue deficit.

The Finance Minister proposed introduction of some amendments to the Banking Regulation Act, to remove the lower and upper bounds to the statutory liquidity ratio and to allow banking companies to issue preference shares. Amendments will also be introduced to the Reserve Bank of India Act to remove the limits of the cash reserve ratio (CRR).

The Minister also announced steps to strengthen the capital market. FIIs will be permitted to submit appropriate collateral when trading in derivatives on the domestic market.

Chidambaram has rewarded investors showing that he would cut taxes in the face of a stubbornly high fiscal deficit. The benchmark stock index soared to a record after the minister reduced the levy on corporate profits to 30 percent, from 35 percent. In spite of recommendations from the communists for levying new corporate taxes, the finance minister used his budget to give a clear signal that he favors cutting the tax burden on companies for the reason that doing so would boost India's global competitiveness.

The new Budget pleases both markets and communists. By and large, it has been approved by the communists as well as the country's capital markets - which is indeed a good achievement

In his concluding remark on Budget Chidambaram said --One of India's proudest sons, Dr. Amartya Sen, argues in his book "Development as Freedom" that development is a process of expanding the real freedoms that people enjoy. He says, Growth of GNP or of individual incomes can, of course, be very important as means to expanding the freedoms enjoyed by the members of the society. But freedoms depend also on other determinants, such as social and economic arrangements (for example, facilities for education and health care) as well as political and civil rights. "The Government accepts this ethical dimension to the discussion of economic issues, and in this Budget I have attempted to reflect that dimension."

India is the largest economy in the region of South Asia. India's experience in managing its economic growth positively will be useful for other countries in the region. With its fast growing economy today it has a major role to play for the South Asian Association for Regional Cooperation. At times it seems that compared to SAARC India is more active with ASEAN as its full dialogue member. India's Free trade arrangement with Sri Lanka, Nepal, Bhutan and also with Thailand & China has an impressive and successful outcome. Similar form of economic partnership is required to implement the South Asia Free Trade Agreement and various other initiatives for bilateral and regional cooperation for this sub-continent.