State Of Economy

Stubbornly Middle of the Road

This year’s Budget speaks volumes by remaining silent on critical issues

The economy hopes to survive yet another Indian budget. Devoid of confidence inspiring reform measures, this year’s annual budget pronouncement was barely more than a statement of national accounts and social support measures, much like last year’s. Thus, extrapolating from past experience, and given the continued weak global economic prospects, one would not be surprised if FY12-13 turns out as another damp squib in India’s economic history, at least insofar as growth prospects and investor sentiments are concerned.

The stock market reacted sharply to the budget proposals, tanking over 1 percent or 210 points on the budget day. The capital market’s reaction, however, cannot be attributed to any considered evaluation of the budget proposals. In fact, it is conceivable that it was motivated more by the inclusion of more services in the tax net (as also raising the service tax rates to 12 percent) and lack of pro-business changes in corporate tax structures, rather than a negative view of the investment measures proposed this year. The budget was also sector neutral insofar as there isn’t any specific sector that got preferential treatment, despite the much commented supposed bailout of the aviation sector.

This year’s budget has been rated as middle-of the-road, and most see it as conservative-realistic. Of the few positives, the more important are realistic projections of the nation’s budget deficit and disinvestment proceeds, as also a tentative indication that fiscal consolidation measures will be adopted. The GDP forecast for FY12-13 at 7.6 percent though conservative seems credible in today’s scenario. Also, hiking the excise and service tax rates as well as inclusion of all services into the tax net (save a negative list of 17 services) is a move in the right direction insofar as it paves the way for the eventual introduction of GST, the latter aimed for operationalisation by end-August 2012.

However, post-budget number crunching from most analysts indicate a deep skepticism on the government’s ability to meet the fiscal targets (a fiscal deficit of 5.1 percent and containing subsidies at 2 percent of GDP), also due to the lack of any credible roadmap for the proposed fiscal consolidation. While some economists question the sanctity of the budget figures, most fear a repeat of fiscal slippage as in the current year. Citibank forecasts that the FY12-13 deficit target will slip by ~40bps to 5.5 percent. The arithmetic is based on nominal growth of 14 percent (GDP of 7.6 percent and inflation of 6.5 percent), revenues +22.7 percent and expenditure +13.1 percent. While growth assumptions are deemed realistic, the bank sees slippage on revenues and expenditures.

Slippages, especially those on account of fuel subsidies, and lack of concrete measures for widening the income tax net gives rise to the fear that the dual whammy of expenditure rise (in particular the non-plan revenue expenditure) and limited revenue collection (especially given the weaker prospects of the industrial sector, corporate taxes are unlikely to be buoyant as assumed) will end up sapping the depleting confidence in the Indian economy. It needs to be recalled that the economic slowdown in the current year has been attributed to poor industrial performance. But with nothing in the budget to either boost investor confidence nor any policy support to the manufacturing sector, it is feared that the projected growth rates and revenue targets will not be met. Like the Economic Survey 2011-12, the budget expects India’s industrial sector to rebound during the next financial year, which faith however, is belied by the widely expected steeper European downturn, as a result of the excessive austerity and the Euro crisis, and potential spikes in commodities prices in the international market.

The finance ministry seems to believe that "the weakness in economic activity has bottomed out and a gradual upswing is imminent". That optimism will be tested in the coming quarters. Corporate investment has been slowing quarter after quarter since 2008. And, as JPMorgan’s India chief economist puts it, what started out as a cyclical slowdown has now become much more a structural problem. India also needs to strategically take advantage of global economic developments in areas as diverse as attracting foreign direct investment, securing energy supplies, leading in frugal innovation and achieving food security. None of these were addressed properly in the budget.

Another damning development has been the proposal (as part of the finance bill that accompanies the annual budget) of a legal amendment favouring a retrospective taxation of overseas mergers in which an underlying Indian asset is transferred. The government’s proposal to amend its tax law retroactively to deals since 1962 has dealt a major blow to foreign investor sentiment in India, and by overriding the effect of a recent Supreme Court decision in favour of Vodafone Group also questions the sanctity of rule of law and court judgements in the country. The supporting role of business environment in boosting corporate investment in India has been highlighted in recent IMF research on India, which finds that not only macroeconomic factors, but also structural factors like the business environment affect foreign corporate investment in India. This tax reform proposal is detrimental to both.

It is true that the budget announcement is not the only vehicle through which the government can introduce reforms and other policy measures. However, a budget utterly devoid of the reforms India desperately needs to galvanise private investment and accelerate economic growth cannot be a source of succour either.

Suparna Karmakar specialises in international trade and open economy macroeconomics. Views expressed are strictly personal. She can be reached at suparna.karmakar@gmail.com