Column : The unknown story of fiscal consolidation

Written by Soumya Kanti Ghosh | Updated: Feb 26 2013, 14:45pm hrs
In just a couple of days from now the Budget 2013 will be presented. As critics would tend us to believe, this years Budget is all about fiscal consolidation and spurring investment, specifically in infrastructure. I would tend to believe so, but with a caveat. Contrary to popular perception, I would take a contrarian position and emphasise that most of us miss out on some of the good points of fiscal consolidation during the last one-and-a-half decade. Our objective in this piece is to highlight some of these achievements and link it automatically to priorities in the forthcoming Budget.

A glance at the accompanying table shows that, for the five-year period ended 2003, the average fiscal deficit was around 5.7%. This period also was prior to the implementation of the FRBM Act. Post-2003/post-FRBM, there are two distinct trends. First, if we identify the five-year period leading up to the 2008 crisis, the average fiscal deficit revealed a significant improvement to 3.6%. However, post 2008, the average deficit went up to 4.2%, a slippage of 0.6% from the earlier period. Remarkably, the fiscal consolidation plan envisages exactly a 0.6% reduction in deficit every year till 2017 (when the deficit touches 3%). Thus, based on data trends, the fiscal consolidation plan looks creditable and achievable!

Next, looking at the tax receipts over the comparable period shows the buoyancy in tax revenue was driven primarily by direct taxes doubling their share in GDP from an average of 2.8% to 5.7%. Clearly, plugging the loopholes, increase in effective tax rates for individuals and corporates, expanding the tax base and improving tax administration (tax refunds has increased by 30%) has yielded rich dividends. Alternatively, given the increase in direct taxes, it may not be prudent to think of imposing a new tax on super rich in the forthcoming Budget, as the incremental benefit of such may be limited.

Regarding indirect taxes, there has been a decline from 5.5% to 4.5% over the same period. Hence, the immediate priority is to increase this, and there could be no better way of passage of GST. Interestingly, even if we were to improve this ratio to pre-2003 level, it would add at least R1 lakh crore/1% of GDP.

A look at the expenditure trends reveal an improvement in quality of expenditure, with Plan expenditure cornering a larger pie as compared to non-Plan expenditure (Plan expenditure has increased to 4.9% of GDP post-2008, up from 4% in pre-2003 period). There has also been a steady improvement in government guarantees over the years (down from 3% in mid-2005 to 2% most recently), a trend that has gone almost unnoticed. The only worrying thing, however, is that the increased size of government borrowings in recent years has less to do with redemption of past debt (also helped in part by elongating debt maturity) but more to do with financing of non-Plan expenditure (net borrowings as a percentage of fiscal deficit is now 88%, up from 65%).

Next, apart from fiscal consolidation, what is the next big thing in the Budget We believe, this is pushing investment in infrastructure. As a matter of fact, private investment as a percentage of GDP had touched 12.5% during 2003-08, but has declined thereafter. No wonder, the working group on the sector formed for the Twelfth Five-Year Plan envisages to take up the investment in infrastructure to about 10% of GDP by the end of the Twelfth Plan. Additionally, the share of the private and PPP in such is estimated to go up to 50% in the Twelfth Plan.

In order to move ahead on the set targets, it is important to remove the existing obstacles that mar the process of execution. For instance, introduction of MAT on the infrastructure companies have raised concerns. In effect, the levy of MAT on infrastructure companies not only nullifies the very objective of tax holiday, but also results in cash outflow during the initial period. The concept runs against the tax holiday granted to infrastructure under Section 80IA. Also, infrastructure projects are normally fixed duration projects after which assets need to be transferred to the government free of cost. Hence, developers have limited period for the recovery of their investment, considering the losses in initial years due to lower capacity utilisation. It is important that the government provides fiscal incentive in terms of tax holiday to enable developers to recover money in later years.

Some of the other incentives that can be announced could be (1) withdrawal of DDT, (2) restoring tax concessions to SEZs, and (3) transfer of shares or interest in a company or entity under intra-group restructuring may be exempted from capital gains taxation.

Clearly, there has been indeed a fiscal consolidation over the last decade or so, and it is not correct to write an epitaph of it. Finally, the fiscal deficit target for FY14 could be a positive surprise (no guesses, but it could be even lower than 4.8%). If this is the case, then this may be the beginning of improved tidings in investment climate.

The author is director, economics & research, Ficci. Views are personal