Now stay within the red lines

Budget keeps the focus on fiscal consolidation,and its promises sober. Now,responsible economics must trump Congress instinct

Finance Minister P. Chidambaram presented his budget on a note more sombre than might be expected for a pre-election budget. With growth and inflation being major concerns,his main focus was on delivering fiscal consolidation. Given the political pressures of the year to come,this was an especially fraught promise. The extent to which the budget boosts growth will depend on the functioning of government as a whole and of crucial ministries like roads and environment. The quarterly growth numbers for the GDP at 4.5 per cent,also released on Thursday,are a grim warning that India could be slipping into a deeper recession. But a sharp expenditure contraction in a pre-election year was an unrealistic expectation.

Days before the budget,Chidambaram announced red lines for the fiscal deficit for 2012-13 and 2013-14. These announcements were important in shoring up the confidence of the private sector,and arguably,in keeping down the spending pressures mounted by his cabinet colleagues. Expenditure,on the whole,is proposed to grow by 16 per cent. Tax revenues are projected to grow at 19 per cent,two per cent above the rate at which they grew last year. A sharp growth is planned from non-tax revenue,mainly from disinvestment. This is something that Chidambaram,with an eye on maintaining his credibility on fiscal consolidation,is likely to be able to achieve. If the fiscal target is met,the finance minister would have created the space for monetary easing by the RBI,as inflation comes under control.

Tax revenue is expected to grow because of higher rates. Corporations will pay more,dividends will see higher taxes and the super-rich will pay more tax for a year. In order that the higher taxes dont hurt investment,the budget proposals compensate for them by giving an investment allowance of 15 per cent for a two-year period. Rationalisation of tax laws,such as those relating to royalty,to increase the tax base,have been proposed. A level playing field between trading in equities and trading in non-agricultural commodities has been planned. How private firms choose to allocate labour and capital to trading equities as against commodities should be shaped by market forces,not by tax considerations,and so this is a move in the right direction.

The finance minister promised a focus on infrastructure,with a number of initiatives to give the sector better access to funding,better regulation,such as in roads,more government projects and spending,and more public-private partnerships,as in coal,which has suffered due to the limited capacity of the public sector Coal India Limited. The key here will lie in implementation. Will the Cabinet Committee on Investment be able to solve problems? More projects can deliver higher growth only if they actually get off the ground.

Chidambarams promises are limited to the reforms he can deliver on,those that are implemented by the finance minister,rather than by other ministries. He has removed the ban on FII participation in currency futures trading. His ministry will work with SEBI to implement the Qualified Financial Investors framework proposed by the Working Group on Foreign Investment,chaired by U.K. Sinha,set up in 2009. India will adopt the international norms for defining FDI and portfolio flows. Exchanges will have a debt segment where banks can participate more easily. For longer-term reform,the finance minister promised to analyse and implement the recommendations of the Financial Sector Legislative Reforms Commission FSLRC,which has indicated that it would propose very ambitious changes to reform financial regulation in India. The budget speech also promises the setting up of a new Standing Council of Experts to analyse the international competitiveness of Indian finance and propose solutions. This is reminiscent of the focus on international competitiveness that began in Indian manufacturing in 1991. If these two initiatives are played through with vigour,we may finally be at the beginning of financial reform in India.

The coming year is,however,freighted with risk. The world economy could fare badly. Indias economy has been losing momentum and acute stresses have started appearing in numerous firms and sectors. As yet,there is no sign of revival of investment or business cycle conditions. The inflation that matters CPI inflation continues to rage at double digit levels,inflicting a substantial inflation tax on households that hold nominal assets. The budget speech represents a basic promise that the government must deliver on to prevent the economy from slipping further. But the struggle between Congress instincts and responsible economics is far from over.