A Pre-budget Thought: What to Be Done  

Finance Minister Praksha Sharan Mahat is announcing the budget for the next fiscal year 080/81 tomorrow, facing many challenges. In such a situation, the finance minister can make the right decision if he thinks about what are the current special challenges when thinking about what kind of budget to bring. Presenting the specific problems in point by point can be done as follows:

  1. Low investment leading to lower growth and output
  2. High inflation, high interest rates
  3. Debt servicing rising fast
  4. Falling domestic revenue and increasing debt servicing narrowing fiscal space
  5. Higher trade deficit and increasing foreign expenses pressing current account and foreign reserves
  6. Unfavorable external situation on trade and financing.
  7. Projected nano effects of draught and low agriculture production

Against this backdrop, the finance minister is presenting the budget for fiscal 2080/81. Given the challenges as outlined, the fiscal budget has to be tighter in size, strategic in allocation, improving in resource mobilization and expenditures and also signaling reform areas for the future.

In terms of budgetary strategy and focus, the unfavorable external environment suggests for focusing on a domestic demand led strategy.  This will require a relatively inward looking strategy promoting output and income growth in domestic industrial and agricultural production and employment creation, raising tax bracket for easing disposable income, offsetting revenue loss thru increase in tariff and VAT. These actions will also improve revenue collections and tax to GDP ratio catching the level attained in earlier years.

The higher price and lower environmental expectations does not allow investors to be beyond and as such, jumpstart investments in the economy. The policies in the budget and that follows needs to make these environments positive for increasing investments. This will apparently take some time and may provide full results in the next budget only.

As of this fiscal budget, a modest economic growth of 4.1 percent and a 7 percent inflation may be the best one can think of to attain. With the estimated nominal growth of 11.5 % and buoyancy of 1.2 , revenue collection is projected at Rs. 1138 billion – a 13.8% growth in nominal term. With a 3% deficit to GDP and foreign grants Rs 50 billion and loans Rs 150 billion, extra revenue generation of Rs 82 billion will be needed to maintain budget size of 1600 billion (26.7% of GDP).

To generate additional Rs 82 billion of revenue, an increase in VAT to 15%  may generate about Rs 65 billion additional and restructuring in tariff rates to protect some key domestic produce plus increase in income tax exemption limit and reduction in corporate tax to a flat say 20% etc may add another 17 billion or so.

The 4.1% GDP growth will require an investment totaling 23.1% of GDP at 5.5:1 ICOR. The recent finding of about 80/20 ratio of private and public investment, an investment totaling Rs 277 billion will be required in the public sector, meaning a total of Rs 350 billion capital expenditure ex-post will be required for the purpose.  Allocating  Rs 350 billion as transfer to local level and Rs 200 billion allotted for financial provision, there will be room for only Rs 700 billion to allocate for current expenditure needs.

It is clear that the lower resource base does not allow expenditure hike. This will require to contain, differ and also thoroughly prioritize expenditure items that are currently in this years budget and strongly selective as far as the new expenditure items are concerned.

The unbridled current expenditures warrants sharp reduction in unwarranted expenses at the ministry level notably purge in vehicle purchase for at least next three years, liquidating or merging different aayog and offices, eliminating subsidies except for fertilizers, revamping or scaling down unproductive PMs employment program and poverty programs etc and areas where a sharp reduction in expenses could be made.

The capital expenditure, on the other, needs sharp increase in its effectiveness at least, to push capital formation and encourage private sector investment, output and employment growth. The resource constraints does not allow a sharp increase in the budgetary amount of capital expenditure. So focus should be given for improving effectiveness of whatever is budgeted.

It has to be noted that the effective improvements of capital expenditure will require among other a reprioritizing even the so called Rastriya Gaurav Aayojana- focusing only to some projects that help increase economic activities and deferring or cancelling the others even in the infrastructure sector.

It is clear that the budget should also give signal to the future priority areas of its focus. Given the large employment and income generating potential of large mass of the population, agriculture sector definitely tops the list. To build confidence in the sector, the quick income and employment generating areas of vegetables, milk, poultry, fisheries and the dependable sources of income stream of horticulture products etc needs to be promoted.

A 15-20% tariff or banning imports of these items for some time will be required to give confidence to the investors producing these items. Besides, a clear role of government in providing fertilizer, R&D and HYV seeds by central government and extension services, soil testing facilities and support for depot and marketing by state and palikas is necessary to promote the sector. Considering the ineffectiveness of agriculture subsidies it may be prudent to scrap subsidies except for fertilizer and use the saved money on R&D and  HYV seed distribution at a lower price.

Given the potential for creating stable employment opportunities and sustained exportable, a revisit in industrial promotion is of utmost importance. Tariff protection is key in the initial stage of industrial development. Looking at the value addition of the product, a 15-25% tariff on similar imported products will encourage domestic investment in the sector.

On export front, private investments on high demand sector producing micro chips, biochemical and pharmaceutical products, software services etc needs to be promoted in a large scale besides promoting investments on garments, carpets, pashmina shawls and other traditional items.

The fast changing world scenario and those of our neighboring countries, a revamping of the present education system deemed absolutely necessary. More focus needs to be placed in producing high quality and competent technical manpower at the lower as well as at the higher level. Educational institutions should be geared towards producing the high demanding areas of artificial intelligence (AI), micro chips technology and related areas, software design, biotechnology as well as to cater the lower to middle level manpower need for smoothly running medical equipment, agri-machinery etc.

Although the headwind inflation rate of 7%+ resists a sizable reduction in interest rates, the  reduction of such inflation below target in India, our major trading partner with whom we have a pegged exchange system, the down tern in international petroleum prices, the ease in the supply chain of commodities and raw materials as well as the shrinking domestic demand most likely contributing in lowering price expectation,  an accommodative stance in monetary policy – gradually reducing interest rates- will contribute in promoting investments and economic activities. The fiscal consolidation in the coming budget may help lowering headline inflation further.