Restarting the growth cycle

Updated: Jul 9 2014, 15:56pm hrs
Arun JaitleyJaitley should lay down a roadmap for reforms by announcing liberalisation of FDI in insurance and defence.
The fiscal deficit target of 4.1% for FY15, announced in the interim Budget, seems unrealistic. One, the nominal GDP growth assumption at 13.4% based on a real GDP growth rate of 6% is unlikely given the ongoing industrial sector and export weakness, and the possible El Nino impact on agriculture sector. A GDP growth of 5% is more likely. Weaker GDP growth implies lower than targeted tax and non-tax revenues and a higher fiscal deficit.

Two, the assumed growth in total tax and income-tax revenues for FY15 at 20% and 30%, respectively, cannot be achieved. Tax revenue elasticity to nominal GDP growth has averaged 1-1.2% for the last five years. Given this elasticity and weaker GDP growth, tax revenue growth of 13-14% is more realistic.

Three, the assumptions in the interim Budget about reduction in subsidy allocations require tough decisions that, on present record, even this government may be unable to undertake.

n The oil subsidy of R63,427 crore includes a roll-over of R35,000 crore from FY14. This leaves only R28,400 crore for oil subsidy for the three quarters of FY15. With the hardening of global oil prices on account of instability in Iraq, oil subsidy bill will rise unless the government bites the bullet and removes the APM for oil products.

n Food subsidy will be higher given the roll-over and the prospect of a poor harvest that may require higher releases of subsidised foodgrain. The fertiliser subsidy of R68,000 crore may be inadequate, on the basis of assessed spillover from the previous year and higher compensation required for urea manufacturers once gas prices are revised.

So, in our base case scenario, with a shortfall in tax revenues of R30,000 crore and increase in subsidies by another R25,000 crore, a fiscal deficit target of 4.4% could at best be achieved. Even this may require further cuts in revenue expenditure.

Options available for Jaitley

Discarding fiscal discipline at this juncture will hurt investor sentiment, raise doubts about the governments commitment to undertake needed policy reforms, and force RBI to raise interest rates to tame inflation. At the same time, the finance minister cannot let growth slip by cutting capital expenditures and dampening investment demand. So, revenue enhancement, though difficult in a weak growth environment, would be the preferred option.

Expanding direct tax base: At 15.5%, India has the third-lowest tax-to-GDP ratio among G20 countries, just ahead of Mexico and Indonesia. India has a mere 350 lakh taxpayers3% of the populationand only 15 lakh of them declare annual earnings of over R10 lakh.

Overhauling direct tax administration: The I-T department needs to be more taxpayer-friendly, less corrupt and not used as an instrument for harassing political opponents. It will help widen the tax net to cover at least 5% of the population, improve compliance and generate additional revenues. A 2006 paper titled Shadow Economies of 145 Countries All over the World by Friedrich Schneider states that the size of Indias shadow economy was at 26% of GDP in 2003. This is huge. The services sector contributes 60% of the GDP but provides only 10-12% of tax revenues. This implies that a large number of service professionals remain either untaxed or undertaxed. Combining the gentlemen farmers and 50% of rural population who use agriculture income to evade taxes, we have a large chunk of potential taxpayers.

Continuing the surcharge on the super-rich: Last year P Chidambaram proposed a temporary 10% surcharge on taxpayers with annual income higher than R1 crore that was applicable on a mere 43,000 people. This is a travesty because at least three times that many people are believed to be multimillionaires. According to the Credit Suisse Global Wealth Report, India has some 1,500 ultra-high net worth individuals with wealth of at least $50 million and 700 who have a net worth of over $100 million. Temporary surcharge on the super-rich can be continued for one more year and should cover at least 1 lakh multimillionaires.

Recovering taxes stuck in litigations: Over R1 lakh crore of revenues as indirect tax remain unrealised due to appeals and litigations. According to finance ministry, a whopping R4.72 lakh crore in direct taxes is locked up in arrears. Around R2.2 lakh crore of direct taxes is locked up in litigation that includes tax dispute of Vodafone, Royal Dutch Shell and Nokia. Even if 30% of these cases are resolved, it will add R1.5 lakh crore in tax revenues.

Increasing disinvestment receipts from non-banking PSUs: It is possible to raise disinvestment receipts by another R20,000-30,000 crore. The market is at a record high and decent proceeds can be expected. We recommend privatisation of loss-making PSUs and break-up of public sector monopolies like in the coal sector that will encourage thermal power production.

Divesting government shareholding in banks: Recently, the RBI committee recommended sale of governments shareholding in PSBs to below 50%. A 5% reduction in governments holding in the SBI and PNBthe two largest bankscan alone bring in R11,000 crore. The government should then consider bringing forward legislation to lower its equity in PSBs to below 50%.

The new FM is expected to not only achieve fiscal consolidation but also improve the quality of consolidation and stimulate growth. Jaitley should use this opportunity to reform the direct tax system and raise much-needed tax revenues. He should use his Budget speech to not merely repent about the past but lay down a roadmap for fiscal and structural reforms by announcing liberalisation of FDI in insurance and defence, and clarify governments position on retrospective taxes. This is essential to reignite investment sentiments and restart the growth cycle.


Rajiv Kumar & Geetima Das Krishna

Kumar is senior fellow and Das Krishna is senior researcher at the Centre for Policy Research, New Delhi