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Budget 2001-02

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Budget to step up aggregate demand
by Dr Ila Patnaik
The columnist is a senior economist at the macro modelling and forecasting division of the National Council of Applied Economic Research (NCAER). Since completing her doctorate at the University of Surrey she has been tracking developments in the Indian economy. She is editor of the "MacroTrack", NCAER's quarterly update on the economy.

Contrary to the expectations, Yashwant Sinha presented an interesting budget. Given his fiscal and political constraints, most people had expected a lot less. The budget should help improve business sentiment and also push up demand and growth in industry.

Two-way strategy
Indeed, the draft fulfilled two roles that a budget in today's India needed. First, it formed part of the long-term reform process that the finance minister outlined in the first part of his speech.

This year's Economic Survey had, for the first time, indicated areas that need to be addressed and the long-term reforms that are required to lead the Indian economy on a higher growth path. The reforms relate to infrastructure, small-scale industry reservation, labour etc. Though most of the changes the minister proposed have to come through other bills, some steps such as those relating to infrastructure and movement of food grains will be put in place right away.

Second, the budget attempts to increase aggregate demand. Currently, the economy is suffering from slack aggregate demand manifested in low capacity utilisation, slow growth of imports and production and a sluggish growth in prices. As I have argued earlier in this column, when demand is low, fiscal policy can be expansionary without raising prices significantly.

The budget has taken a much needed expansionary fiscal stance by removing the 10% surcharge on corporate and personal income tax. It has brought the marginal direct tax rate back to the more rational rate of 30% (except for the 2% earthquake surcharge). It has increased the credibility of the minister who had promised, two years ago, that the surcharge was going to be temporary.

Looking towards a better GDP growth
Reduction in the dividend tax from 20% to 10%, tax exemption for primary issues and removal of the surcharge should boost investment.

In fact, a study by the NCAER shows that though the removal of the corporate surcharge will reduce tax revenue receipts of the government in rupee terms, as a percentage of GDP it can have a positive effect.

If the business sector responds positively to the minister's gesture and invests the amount that becomes available to them by not having to pay the surcharge, GDP will grow by 0.36%. In this event, fiscal deficit as a percentage of GDP will reduce by 1.5%. Though there may by some increase in prices, it is likely to be marginal as inflation may rise by only about 0.2%.

Good aggregate demand
In addition to this, there will be an increased spending impact of the removal of the surcharge on personal income. Thus on the whole, aggregate demand is likely to be boosted. In the current scenario, wherein we are witnessing a slowdown in industrial growth coupled with low inflation in manufacturing and food prices, this is a positive step.

Since not too much was expected from the budget this may also help to improve business sentiment and so the increase in investment demand could actually be higher than the investible funds released from removal of the surcharge.

Other incentives for increasing demand have also been offered. For instance, by increasing the interest repayment exemption for housing loans to Rs1.5 lakh, housing and construction is expected to get a boost.

Further, the reduction in the small savings rate by 1.5 per cent should reduce interest rates in the economy. It may be expected that RBI may respond by cutting the bank rate further (it had cut the bank rate by 0.5 per cent recently). Thus this will reduce the cost of capital for the Indian industry, a long-standing demand.

Some loopholes too
But some important questions still remain unanswered. One such question is how the government is going to increase the preparedness of Indian agriculture for the new regime when quantitative restrictions (QR) will be removed in April under the WTO requirements.

The remedy, which Mr Sinha has offered in the budget, is to increase the custom duty on edible oils. This would provide relief to farmers cultivating oil seeds. But clearly this is a short-term solution. One hoped to see a more long-term strategy in place.

With opening up of markets, volatility in global agricultural commodity prices will get transmitted to the domestic market. In the transition period, producers can be protected by higher custom duties but if the economy is to move towards an internationally competitive agricultural scenario, the government must have a longer-term policy frame. Hopefully, the honourable minister will answer this question, on which the livelihood of nearly 70% of the Indian population depends, during the course of the year.

To view more articles by the author, just type Patnaik in the Keywords search and hit go!

Copyright © 2000 Sharekhan.com & SSKI Investor Services Pvt. Ltd. All Rights Reserved.

The views expressed in this column are those of the author and not of the institution to which she belongs. Also, Sharekhan may or may not concur with the views of the author. We do not represent that it is accurate or complete and it should not be relied upon as such.


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