The forthcoming budget is expected by some to be make-or-break or path-breaking, by others, to provide a legislative or economic roadmap for the rest of this government’s term. Most likely, it will focus on issues within the purview of the finance ministry, namely, macro management, taxation, expenditure, the financial sector and balance of payments.
The abolition of the Planning Commission and the 14th Finance Commission recommendations on tax devolution make it possible for this budget to initiate a structural movement back to the principles of federalism embedded in the Constitution as well as its Central, State and Concurrent Lists. Though the Concurrent List gives the Central government overall policy responsibility for many sectors, the administrative responsibilities are fairly well defined. The states are responsible for basic health, education, social welfare (poverty) and security (police).
The Finance Commission has recommended increasing non-discretionary tax devolution by 10 percentage points, from 32 per cent to 42 per cent. This calculation accounts for the actual and potential revenue receipts and expenditures of the states in all sectors that fall under their administrative and financial purview. This effectively means that instead of an extra 10 per cent being channelled through the Central government and the former Planning Commission into Centrally sponsored schemes (CSSs) on health, education and social welfare, these resources will be transferred as untied funds to the states, to be allocated in any manner that the state feels is most appropriate to its needs. The budget will tell us how quickly the old schemes in these sectors are to be phased out or abolished. This is the essence of federalism: financial funds, allocation rights and administrative responsibilities must be located in the same level of government, whether it is the Centre, state or local government.
The fiscal recommendations of the Finance Commission, a constitutional body, have removed some of the uncertainty about the government’s stance. It now has clear backing to ignore demands for a fiscal stimulus beyond the earlier targets of 3.6 per cent in 2015-16 and 3 per cent in 2016-17. It can also focus more on reducing the revenue deficit, something I have argued for years. The revenue deficit mirrors net dissaving. A reduction in the revenue deficit is therefore critical to raising the national savings rate. This, in turn, is linked to India’s net international asset position, the stability of capital flows and the international credit rating of the country. The budget is expected to spell out its approach to fiscal responsibility legislation and possibly to raising India’s credit rating over a decade.
The growth rate of the Indian economy accelerated by about 0.9 percentage points in 2014-15 from 2013-14. This is accompanied by (or partly due to) an acceleration in the growth rate of private consumption and gross fixed capital formation. However, available indicators also show that the growth of demand for the corporate sector is weak. In the case of automobiles, housing and other consumer durables, high real interest rates are an important contributor. A clear and credible fiscal consolidation path will make it imperative for the central bank to reduce high nominal policy rates, which are partly responsible for choking consumer demand.
The budget is also expected to lay out a clearer approach to and a roadmap for the government’s new flagship programmes, such as the Jan Dhan Yojana, Sagar Mala, smart cities project, Digital India, Make in India, Skilling India, Swachh Bharat and Beti Bachao, Beti Padhao. The move from price-distorting subsidies to direct transfers to the deserving poor should gather steam and help reduce corruption and administration costs. The consequent fiscal space could be used to increase spending on public goods infrastructure that can attract complementary, job-creating private investment.
Tax administration and appellate procedures, their speed and effectiveness, are known to be an important concern for the government, especially since the BJP manifesto used the phrase “tax terrorism”. Both domestic and foreign taxpayers are looking for more concrete measures to further these objectives, end the antediluvian practices of the tax administration and replace them with a more modern, accounts-based, customer-focused approach. Business is also looking forward to the first steps towards implementing the GST as well as a clear statement on the simplification of income taxes and the direct taxes code. I am also hopeful the interrupted journey to a simple, uniform customs duty structure will resume. For instance, the elimination of dozens of specific duties on textile products is overdue. Some steps towards the rationalisation of agricultural import and export duties would also be welcome.
An interesting question is the extent to which the government will go back to the pre-1990s practice of using deductions and exemptions to stimulate the demand for or investment in certain sectors, like defence, electronics, real estate and automobiles. I expect it to follow a middle path of some simplification coupled with modest incentives, which many budgets since 1991 have done. An increase in the housing (interest) deduction in personal income tax can probably be justified on the grounds of inflation adjustment and is likely to occur. Electronics suffer from an inverted customs duty structure because we bound ourselves to an International Trade Organisation agreement that eliminated tariffs on many final goods, but not on imported inputs. Tax incentives may be used to stimulate job creation and employment opportunities in labour-intensive sectors like tourism
As financial and external sectors come directly within the purview of the finance ministry, I would expect the budget to address the legacy problems of the public-sector banks, such as the non-performing assets accumulated by them because of government-forced lending to unviable infrastructure projects. Private banks recognised that these projects had too many policy and regulatory risks to be viable for debt financing. On the positive side, one expects new policy and institutional reform initiatives around the financial and external sectors. For instance, the stalled proposal for creating a global financial centre in India is likely to be revived in a new form. Similarly, some reduction in the controls on the external/ balance of payments account can also be expected. Overall, I expect the budget to give us a sense of the government’s approach to fiscal and financial policy and an indication of economic reforms to accelerate and sustain the growth of the economy, jobs and employment opportunities.
The author is former executive director, IMF, and former chief economic advisor, Union ministry of finance.