Column: Budget for bold fiscal consolidation

Written by Naresh Takkar | Updated: Jul 8 2014, 02:39am hrs
The strong electoral verdict for the new government has raised expectations that it will deliver on a variety of fronts, including boosting economic growth, infrastructure creation, introducing market reforms, managing inflation and improving fiscal outcomes, among others. The Centre is expected to gradually cull out a definitive medium-term agenda from the vision laid out in the Presidents address to Parliament in June 2014. While a lead-time of six weeks is very short, we expect the upcoming revised Budget for FY15 to deliver some policy specifics to ensure that the rejuvenated animal spirits do not wane.

A clear, predictable and stable tax regime is crucial to an environment supportive of investment. At the same time, it is vital to widen Indias tax base, which is significantly smaller than many advanced nations and EMEs of a comparable size. The revised Budget for FY15 is expected to clarify the new governments vision on tax reforms, including decisions on optimal tax rates, exemptions, surcharges and measures to improve compliance, as well as the way forward for the implementation of the goods and services tax (GST).

It is too early in the term of the new government for it to have devised specific schemes, which we expect would be revealed in the Budget for FY16. But it would be prudent to prioritise amongst various options as large-scale infrastructure projects would compete for scarce financial and other resources, including land. For instance, given limited fiscal space, large scale roll-out of the high-speed bullet trains may be deferred at present.

Trimming unproductive schemes, cutting leakages and paring subsidy expenditure would be crucial to freeing up resources for productive spending. Committing to a cap on subsidies as a percentage of the GDP would help improve the quality of government expenditure and encourage investment-led growth.

Revising administered prices is challenging even at times when inflation is low. However, it is not impossible, as demonstrated by the monthly revisions of diesel prices, which have now been carried out fairly regularly since January 2013. With under-recoveries from LPG retail forming the largest component of fuel subsidies, it may be appropriate to introduce calibrated monthly revisions of R15-20/cylinder in the Budget. This way, the impact on household finances would be small given the vast majority of families are estimated to consume less than one cylinder of LPG per month. A clear policy would help limit the perceived vulnerability of Indias fiscal and current account deficits, as global fuel prices rise in the wake of the tensions in Iraq.

Revising natural gas prices is undoubtedly complicated by the concomitant impact on fertiliser subsidies and power tariffs. However, deferring the decision will further delay the augmentation of domestic gas production and may deter interest in the next round of NELP.

Slow augmentation of coal production in India has constrained the availability of reasonably-priced power for productive sectors while coal imports are widening the current account deficit. Pending issues such as clearances related to environment, forests and mining from various ministries would be resolved over the course of the year. However, the government may consider presenting its vision for private participation in coal mining in the Budget, in addition to providing outlays for enhancing evacuation facilities and wagon availability between coal mines and end-user plants.

The government must urgently work on mitigating the impact of a sub-par monsoon on agricultural output and consumer demand without contributing to a spike in inflation. The recent announcement of a moderate revision in MSP for various kharif crops is welcome. While a number of measures need to be taken outside of the Union Budget, allocation of funds for the release of 15 million tonnes of grains from FCIs stock to dampen cereal inflation, and incentives to the states to augment storage and improve supply-chain management could be included. Additionally, the government may consider dove-tailing MGNREGA with other existing schemes to boost productivity through creation of micro-irrigation facilities, refurbishing village tanks/ponds, etc.

The sluggish economic and revenue growth in the first quarter of this fiscal has reduced the likelihood that the Interim Budgets target of restricting the FY15 fiscal deficit to 4.1% of the GDP would be met. Nevertheless, the government should promptly clear all pending dues of the private sector to ease liquidity and enable fresh investments. Regardless, a sharp slippage in the fiscal deficit is unlikely as infrastructure spending would not ramp up immediately and the pan-India roll out of the Food Security Act is set to be delayed.

An appropriate size and quality of the fiscal deficit and measures to ease supply-side constraints would aid monetary policy in containing inflationary pressures. The government should announce its fiscal consolidation plan in the upcoming Budget, specifying annual targets and a deadline for compressing the fiscal deficit to 3% of the GDP. However, focus on fiscal consolidation should not be interpreted as achievement of annual declines in the ratio of fiscal deficit-to-GDP. Sustainability of the intended consolidation is more important. This would gain credibility if the underlying policy is enunciated in terms of tax reforms, disinvestment plans and a phased reduction of subsidies to improve the quality of expenditure.

The author is MD & CEO, ICRA Ltd