The Macroeconomic Implications of Budget 2005-06
The Macro-economic Implications of the Budget 2005-06
Dr. Tejinder Singh Rawal
Chartered Accountant
tsrawal@tsrawal.com
This Budget is presented at a time, when, to quote the Finance Minister, “all engines are running at full speed.” In the area of foreign exchange management, during the last three years India has experienced a surplus in both Current Account and Capital Account, and we are faced with a very unfamiliar problem: the problem of managing this surplus to maximize its contribution to the GDP. The tax-GDP ratio has been above 10% for the first time ever. Compound Annual Growth Rate of tax revenue has been 18% during the past three years while the CAGR of corporate tax has been as high as 30%. GDP has grown at the rate of 6.9% while the rate of Industrial growth has been an impressive 8.9%, which is no small achievement for an economy, which was on the brink of a virtual bankruptcy in not-too-distant past.
While the GDP growth has been high, we are still way behind China, which has overtaken our economy in terms of growth, absolute as well as in percentage term, in a very short period after the opening up of its economy. Economists have predicted that this rate of growth will be sustainable in the year 2005-06 also, with GDP growth being predicted at 6.5-7%. While industrial growth is likely to slow down to 7%, chiefly because the growth last year was on a smaller base, inflation is likely to hover around 5-5.5%
While the engines are certainly running at full speed it becomes all the more important that due attention is paid to the meters on the dashboard. One danger alarm that has been constantly flickering is that of revenue and fiscal deficit. During this year, the fiscal deficit declined marginally from 4.5% to 4.3%. This decline was marginal only because borrowings of Rs. 29000 Crores have been transferred from the Centre to the State. But for this exercise, the figure would have been over 5.1%. Combined fiscal deficit of the Centre and the states has been a whopping 10% of GDP. This has been a major cause of concern to the economists and international agencies. Credit rating agencies have been reluctant to give a higher rating to India because of this one factor.
The revenue deficit figures are even more alarming. . In the previous budget the Finance Minister had projected that he would bring revenue deficit down to 1.8% in 1905-06. The actual figures are 2.7%. This is 31777 crores higher by Rs. 31777 Crores: too alarming to be ignored. Therefore, while the slippage on fiscal deficit is only 0.2% or Rs. 10600 crores, slippage on revenue deficit is 0.9%, which means that the capital account has once again been sacrificed to feed insatiable monster called the Government’s revenue expenditure. The revenue expenditure is up by 15% while capital expenditure is down by 43%
Let us understand the implication of fiscal deficit. There is a limited pool of savings available in the country for the Centre, the states and the private enterprise to borrow from. In order to meet the deficit the Govt has to access this pool. As long as there is a comfortable liquidity situation in the country, there is no problem, but when the liquidity deteriorates, borrowing by the Government has an effect of increasing the interest rates, which might throw out of gear the efforts of the Government to keep inflation under control.
One may argue that there is nothing wrong in the borrowings by the Government, if there is nothing wrong in private enterprises borrowing money from the market. This situation would have been comfortable if the Government borrowings had resulted in the creation of new capital investments, thus providing an impetus to growth. However, when the borrowings are used to finance the revenue spending, it defies all norms of financial prudence. Already 22 paisa of every rupee the Government earns towards meeting interest obligation of the debts contracted by the Government.
The Finance Minister has taken a U-turn in the implementation of the Fiscal Responsibility and Budget Management (FRBM) Act 2003. FRBM Act had provided for the gradual reduction in deficit to zero by 2007-08, the Finance Minister had proposed this date to be 2008-09, so that it is conterminous with the term of the present Government. The Finance Minister knows that meeting this target is not possible. He confesses of having “pressed the pause button to the FRBM Act”. What is apprehended is that it might turn out to be the ‘stop’ button instead of the ‘pause button’
If the commitment the Government has made under FRBM Act is to be honoured, the Revenue Deficit will have to be reduced by Rs.90000 in three years, which is a Herculean task. It means a reduction of Rs. 30000 every year: this is something unheard of in Indian economy: only twice in last 20 years has the deficit fallen in comparison to the previous figures in absolute terms, on both occasions the reduction was less than Rs. 1000 crores.
While effective steps have been taken to attack the problem of deficit by increasing revenue, more efforts are required on the expenditure side. Government needs to address issues of downsizing itself, tighter control on Governmental spending, and reduced allocation to certain sectors. For example, the expenditure on defence has been upped from the Rs. 77,000 Crores to Rs. 83,000 Crores, out of which Rs.34,000 would go towards capital expenditure. Defence consumes as much as 14 paisa of every rupee earned by the Government. It certainly makes a case of improving relationship with our neighbour, since defence allocation has been eating into the resources of our as well as our neighbouring country’s economy.
If FRBM commitments are to be honoured, the Revenue deficit will have to be reduced by Rs 90000 in three years time, which means a reduction of 30000 every year. This is something unheard of in Indian economy: only twice in last 20 years has the deficit fallen in absolute terms, and that too by less than 1000 crores each time!
The Finance Minister and the Prime Minister seem to be serious about the reforms. The FRBM Act is only the beginning of the reform process, and shall have to be backed by actions. Moreover, similar financial prudence will have to be defined and implemented for the state governments. Only then can we think of competing with China, which the Finance Minister talked about in his Budget speech.
Dr. Tejinder Singh Rawal
Chartered Accountant
tsrawal@tsrawal.com
This Budget is presented at a time, when, to quote the Finance Minister, “all engines are running at full speed.” In the area of foreign exchange management, during the last three years India has experienced a surplus in both Current Account and Capital Account, and we are faced with a very unfamiliar problem: the problem of managing this surplus to maximize its contribution to the GDP. The tax-GDP ratio has been above 10% for the first time ever. Compound Annual Growth Rate of tax revenue has been 18% during the past three years while the CAGR of corporate tax has been as high as 30%. GDP has grown at the rate of 6.9% while the rate of Industrial growth has been an impressive 8.9%, which is no small achievement for an economy, which was on the brink of a virtual bankruptcy in not-too-distant past.
While the GDP growth has been high, we are still way behind China, which has overtaken our economy in terms of growth, absolute as well as in percentage term, in a very short period after the opening up of its economy. Economists have predicted that this rate of growth will be sustainable in the year 2005-06 also, with GDP growth being predicted at 6.5-7%. While industrial growth is likely to slow down to 7%, chiefly because the growth last year was on a smaller base, inflation is likely to hover around 5-5.5%
While the engines are certainly running at full speed it becomes all the more important that due attention is paid to the meters on the dashboard. One danger alarm that has been constantly flickering is that of revenue and fiscal deficit. During this year, the fiscal deficit declined marginally from 4.5% to 4.3%. This decline was marginal only because borrowings of Rs. 29000 Crores have been transferred from the Centre to the State. But for this exercise, the figure would have been over 5.1%. Combined fiscal deficit of the Centre and the states has been a whopping 10% of GDP. This has been a major cause of concern to the economists and international agencies. Credit rating agencies have been reluctant to give a higher rating to India because of this one factor.
The revenue deficit figures are even more alarming. . In the previous budget the Finance Minister had projected that he would bring revenue deficit down to 1.8% in 1905-06. The actual figures are 2.7%. This is 31777 crores higher by Rs. 31777 Crores: too alarming to be ignored. Therefore, while the slippage on fiscal deficit is only 0.2% or Rs. 10600 crores, slippage on revenue deficit is 0.9%, which means that the capital account has once again been sacrificed to feed insatiable monster called the Government’s revenue expenditure. The revenue expenditure is up by 15% while capital expenditure is down by 43%
Let us understand the implication of fiscal deficit. There is a limited pool of savings available in the country for the Centre, the states and the private enterprise to borrow from. In order to meet the deficit the Govt has to access this pool. As long as there is a comfortable liquidity situation in the country, there is no problem, but when the liquidity deteriorates, borrowing by the Government has an effect of increasing the interest rates, which might throw out of gear the efforts of the Government to keep inflation under control.
One may argue that there is nothing wrong in the borrowings by the Government, if there is nothing wrong in private enterprises borrowing money from the market. This situation would have been comfortable if the Government borrowings had resulted in the creation of new capital investments, thus providing an impetus to growth. However, when the borrowings are used to finance the revenue spending, it defies all norms of financial prudence. Already 22 paisa of every rupee the Government earns towards meeting interest obligation of the debts contracted by the Government.
The Finance Minister has taken a U-turn in the implementation of the Fiscal Responsibility and Budget Management (FRBM) Act 2003. FRBM Act had provided for the gradual reduction in deficit to zero by 2007-08, the Finance Minister had proposed this date to be 2008-09, so that it is conterminous with the term of the present Government. The Finance Minister knows that meeting this target is not possible. He confesses of having “pressed the pause button to the FRBM Act”. What is apprehended is that it might turn out to be the ‘stop’ button instead of the ‘pause button’
If the commitment the Government has made under FRBM Act is to be honoured, the Revenue Deficit will have to be reduced by Rs.90000 in three years, which is a Herculean task. It means a reduction of Rs. 30000 every year: this is something unheard of in Indian economy: only twice in last 20 years has the deficit fallen in comparison to the previous figures in absolute terms, on both occasions the reduction was less than Rs. 1000 crores.
While effective steps have been taken to attack the problem of deficit by increasing revenue, more efforts are required on the expenditure side. Government needs to address issues of downsizing itself, tighter control on Governmental spending, and reduced allocation to certain sectors. For example, the expenditure on defence has been upped from the Rs. 77,000 Crores to Rs. 83,000 Crores, out of which Rs.34,000 would go towards capital expenditure. Defence consumes as much as 14 paisa of every rupee earned by the Government. It certainly makes a case of improving relationship with our neighbour, since defence allocation has been eating into the resources of our as well as our neighbouring country’s economy.
If FRBM commitments are to be honoured, the Revenue deficit will have to be reduced by Rs 90000 in three years time, which means a reduction of 30000 every year. This is something unheard of in Indian economy: only twice in last 20 years has the deficit fallen in absolute terms, and that too by less than 1000 crores each time!
The Finance Minister and the Prime Minister seem to be serious about the reforms. The FRBM Act is only the beginning of the reform process, and shall have to be backed by actions. Moreover, similar financial prudence will have to be defined and implemented for the state governments. Only then can we think of competing with China, which the Finance Minister talked about in his Budget speech.
posted by Dr. Tejinder Singh Rawal at 3:50 am
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