The interim budget had overstated tax revenues and nominal GDP growth, understated expenditures in order to ostensibly reach a fiscal deficit target in the revised estimates for FY14, and set out a tougher target for FY15. The actual tax revenues are turning out to be lower because neither the growth nor the tax buoyancy assumptions are likely to be met. The new government will inherit considerable postponed expenditures as also new expenditure commitments that have not been provided for. Subsidies postponed to FY15 from the previous, committed expenditure on account of DA hike for central government employees and committed but unpaid compensation for CST to the state governments will constitute an immediate expenditure headache for the new government.
Furthermore, both direct and indirect tax collections are likely to be below the revised estimates of the 2013-14 interim budget. Real growth could turn out to be just about 4.6% which, combined with an inflation rate of about 6% as measured through the implicit price deflator, may give at best a nominal growth of 11%, rather than what was assumed in the interim for FY15 at 13.4%. The tax buoyancy assumed for FY15 was 1.4. It is turning out to be less than 1.
The growth prospects for FY15 may be further beset by poorer agricultural growth with forecasts of an impending EL Nino. Neither industry nor services are showing any signs of revival. WPI and CPI inflation have shown signs of increasing again in March 2014, stalling any comfort from the monetary side.
From its FY08 peak, the savings rate had fallen nearly 7 percentage points by FY13. This trend has continued in FY14. All three sectorshousehold, private corporate, and public sectorare responsible for some of the fall in their saving rates, but the biggest fall, amounting to nearly 4 percentage points, comes from the public sector. This is directly linked to the tardy progress in reducing central government revenue deficit, which was a little less than 4% in FY13. It is estimated to be 3.3% in the interim budget RE for FY14 but would turn out to be more when the relevant actuals become available. This was the result of a conscious policy of excessively increasing government consumption expenditures and driving down government capital expenditure, while the tax-to-GDP ratio remained stagnant. Private corporate sector investment has fallen by nearly 8 percentage points of GDP in FY13 from its previous peak in FY08. With such structural weaknesses, it will be difficult to design a non-inflationary fiscal stimulus policy.
The first budget of the new government must spell out a strategy for the revival of growth while maintaining fiscal prudence. It should aim at immediate revival and signal an effective medium-term strategy.
As the first step, the continuing slide in government capital expenditure should be reversed. From a level of 3.5% of GDP, the central governments capital expenditure has fallen to about half of that by FY14. Instead, a sustainable path of increasing capital expenditure focused on removing the infrastructure gap should be put firmly in place. This should be done not by increasing overall expenditure but by reducing government consumption expenditure. This will have three advantages: it will add to both capacity and expenditure and thus will be non-inflationary. It will also reduce revenue deficit and government dis-savings. As a result, governments draft on the surplus savings of the household sector, kept in financial form, will be reduced, which has fallen by nearly 5 percentage points since FY08, creating space for interest rate reduction and stimulating private sector investment.
Second, investment sentiments should be revived by showing commitment to completing the long-pending tax reforms. A time-bound programme for implementing GST and direct taxes code should be announced. A clear strategy for reducing the regulatory overload on project clearances should be announced and implemented.
Third, there should be equal commitment for medium-term expenditure reforms by the central government. Without this, the much-needed fiscal space cannot be created for the central government to make strategic interventions and run an effective macro-stabilisation policy. Central government should rationalise and limit the number and size of central ministries, departments and agencies. This would be consistent with the constitutionally assigned tasks of the central government.
Fourth, the state governments must be co-opted as effective partners in stimulating the economy. The interim budget had made provisions for shifting resources to the states for implementing plan schemes. This should not become an additionality. The central government should limit its expenditures on items listed in the State List and the Concurrent List. Both fiscal prudence and the federal spirit requires that states, who are currently in a better fiscal position, be allowed and induced to fulfil their constitutionally-mandated responsibilities, including providing education, health and internal security as well as state-level infrastructure.
The author is chief policy advisor, EY India. Views are personal