We don’t need big bang policies

The Indian economy faces five major structural issues. First, saving and investment rates have eroded from their peak levels of 37-38 per cent in 2007-08 to 30 per cent. Second, the tax-GDP ratio (Centre-State combined) has been stagnating in the range of 16-17 per cent of GDP.

In FY 2015, as acknowledged by the finance ministry’s mid-term review, the Centre might be looking at a tax revenue shortfall of more than ₹100,000 crore amounting to close to 0.9 per cent of GDP. Third, India’s manufacturing and infrastructure sectors remain deficient. Fourth, regulatory bottlenecks continue to discourage investment. Fifth, India’s exports face a major slowdown.

Can the Budget address these key structural issues?

India’s export demand has weakened on account of lower global demand and depressed mineral prices. The recent trade data for January 2015 indicates a contraction in exports by 11 per cent (yoy). This may continue in the medium-term forcing India to rely more on the domestic market. That is why policies that support domestic demand are critical.

Along with the fall in the overall saving rate, household financial savings have plummeted by nearly 5 percentage points from its peak of more than 12 per cent in 2009-10. Overall investment in net fixed capital formation has fallen by about 6 percentage points in this period.

The Budget has to focus on stimulating private saving and/or consumption and government investment even as private investment may take more time to turn around. Raising the income tax exemption limit from the existing ₹2.5 lakh to ₹3 lakh will increase household disposable incomes.

Alongside enhancing the 80C limit from ₹1.5 lakh to ₹2 lakh will stimulate household financial savings . A separate limit for deduction for investments in life insurance products may also be considered. Higher returns in terms of real interest on inflation-linked savings instruments will further encourage savings. Infrastructure Debt Funds (IDFs) tax savings bonds for investors will help attract investment to this sector.

Private investment is likely to respond only with a lag. The government needs to increase its own capital expenditure by at least 1 percentage point of GDP. Given that tax revenues may remain stressed, government expenditure needs to be restructured by limiting subsidies to less than 1 per cent of GDP.

Revenue expenditure may further be curtailed by scaling down large central bureaucracies in ministries handling State or concurrent subjects such as rural development and Panchayati Raj institutions now that fiscal transfers are slated to directly go to the States.

Further, the public sector and departmental enterprises should be persuaded to undertake expansion plans thereby increasing overall investment demand. The Railways should activate ambitious expansion plans. Their financing, even if based on borrowing, would be outside the Centre’s fiscal deficit limit. Investment in infrastructure will provide a threefold advantage of boosting overall demand, creating greater employment both for skilled and unskilled workers, and providing the much needed push to the manufacturing and exports sector.

The uncertainty surrounding land acquisition and auction of coal mining licences, power deficit and bureaucratic hurdles are some of the key factors impeding businesses in India .

Increasing tax-GDP ratio

A tax-GDP ratio of 16-17 per cent is not going to be enough to finance India’s growing education, health and infrastructure needs. Increasing the tax-GDP ratio should rely primarily on broadening the tax base, improving compliance and taxing at differentially higher rates polluting goods including petroleum products and coal and demerit goods such as tobacco products. Final calibrations can be done when the GST gets introduced.

It seems the government may introduce some cesses which may not need to be shared with the States. Any revenue gains may be used to extend the investment allowance to the infrastructure sector and providing relief to SEZs from MAT and DDT.

India shows a promising growth potential which can be achieved with the right policy initiatives. Instead of big bang reforms, the Budget can be a sum of many micro issues which will cumulatively drive the economy forward.

Srivastava is Chief Policy Advisor and Mathur, Director (Tax & Regulatory Services), EY. The views are personal

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