The lack of bold reforms in the Budget is disappointing. Will the Budget improve the investment climate or is it a better delivered version of Laluís railway budget?
The bright shining mistake, which leaps out of the speech, is the turnover tax. This is a distortionary tax, which sets the clock back on financial sector reforms. It is as wrong as the stamp duty which hobbles the real estate market. When Manmohan Singh was finance minister, he had fought to remove the stamp duty on financial market transactions, as part and parcel of the depository legislation. Mr Chidam-baram and his staff have clearly not understood what they are doing on turnover tax. When they obtain wisdom on this issue, they will back away from this flimsy idea.
The speech, too often, sounded like a 1970s effort at industrial policy, wanting to micro-manage the economy. It lacked a vision for reform. Is this what the UPA stands for? Even though a few small but meaningful initiatives are present, they are hidden away.
The Budget seems to score on one crucial question. It proposes to reduce the resources pre-empted by the government, freeing them up for private investment and reducing the pressure on interest rates. This is to be achieved by cutting the revenue deficit to 2.5 per cent of GDP. In fact, the FM put forward the set of rules for reducing the deficit on Budget eve. The cut means a 1.1 per cent cut from last yearís revenue deficit of 3.6 per cent. This is good news for the macro-economy.
The question is, how will this be achieved? He has budgeted for a 24.7 per cent rise in tax revenues. Such an increase in tax revenue has never been witnessed before. There are only a few months left in the year in which any new decisions can obtain an impact.
It is possible to get much better tax revenues through extensive tax reforms. But the speech was silent on this front. Exemptions have been kept intact. The integration of service tax and VAT is a historic milestone in modernising the tax system. Both kinds of taxpayers will enjoy tax credits for the tax embedded in their raw material purchases. This solves a long-standing problem with the existing tax structure. But there is no mention of a proper system for implementing these.
On subsidies, the FM has promised to examine the issue. The Budget, however, has made no progress. No subsidies were scaled down. Interest rates on tax-avoidance schemes have been left untouched.
The good news is that despite a government that seems to respect the CMP, revenue expenditure is budgeted to grow only by 6 per cent. Since nominal GDP is projected to grow by roughly 12 per cent, this means that the tax/GDP ratio will go up and the revenue expenditure to GDP ratio will go down. This is reassuring to those who watched the speech and got worried by the barrage of spending proposals.
The speech did have flickers of good ideas, which would yield genuine institutional change. A food stamp pilot will commence. SSI dereservation will take place for 85 more items. The new pension system will gain legislative strength - though there was no mention of when the pension fund managers will be up and running. Drinking water schemes are being taken closer to local government. The commodities market will be integrated with the securities markets, thus allowing the farm sector to benefit from the modern institutional development of the securities markets.
For those who were gloomy about modern economic policy coming out with the Left in government, there are a few rays of hope. The FM has clarified that selling shares in PSUs will continue. FDI limits have been raised in telecom, civil aviation and insurance. But, it does not offer big new ideas for institutional change, such as NHAI, in the area of infrastructure.
In terms of expenditure, Manmohan Singh had raised hopes when he talked about government reforms. Yet, the speech went on to send huge resources through the dysfunctional government system.
Yet to be fair, we are already in July 2004, and the government has had very little time. Mr Chidambaram has prom-ised that big changes will be made in the February 2005 Budget. By that time, the PM and the FM, and their policy teams, will be in place. However, reforms and institutional changes should not have to wait for 2005. If policy initiatives are taken there will be no reason to wait for the next Budget to improve the investment climate.