Budget 2006

Indian Express 1 March 2006

- Ila Patnaik

Budget 2006 is a tight rope walk between balancing the demands of the
NCMP's large spending programs and giving a signal to the world that
India is still on the path of economic reform. Despite the difficulty
of the job, Finance Minister P. Chidambaram has managed to do both
reasonably well.

Chidambaram's budget speech has some small but firm steps towards
reforms. There are innovative ideas which will deliver much more for
the economy in the long term than meets the eye. But there are also
extravagrant NCMP programs which are actually far more worthless than
is widely understood.

1. The budget estimate for the revenue deficit of 2006-07 has been set
at 2.1 percent, while the fiscal deficit has been set at 3.8 percent,
both indicating that we are on the path to fulfilling the FRBM
requirements. However, damage is being done by the UPA's flagship
schemes as there is an increase in revenue expenditure through the big
spending central schemes. In 2005-06, this rose by 30.5% and in
2006-07, it is budgeted to rise by another 26%. These increases take
the value from Rs.87,500 crore to Rs.145,000 crore over two
years. While the government often pays lip service to the goal of
spending more on capital expenditure, the overall capital expenditure
has dropped from 3.6% of GDP in 2005-06 to 1.9%.

Further, the deficit numbers have been computed assuming that nominal
GDP will grow by 12%. This breaks up to 4% inflation and 8% GDP
growth. While India has been in a patch of rapid GDP growth, prudent
fiscal policy would have stuck with an assumption of trend GDP growth,
which is closer to 7%.
2. Progress has been made in the movement towards the Goods and
Services Tax (GST). The number of services covered by the service tax
has increased. By taking the service tax up to 12%, the gap between
taxation of goods (at 16 percent) and services which were taxed at 10
percent has been reduced. Further, by removing many exemptions in
excise - the tax on goods, the rate differences have been brought
down. This has been also accompanied by imposition of a CVD on
imports, a forerunner to a GST on imports.

The budget speech has put a date - 2010 - for the launch of the Goods
and Services Tax. The date is perhaps disappointingly far
away. However, it is good to have a concrete date, and start putting
in the steps required from 2006 till 2010 in order to get reach the

3. The peak customs rate has been cut, as has been done in many
previous budgets, in the continued effort to move towards ASEAN tariff
levels. Further, cuts have been applied to many customs rates on
important import items.  Equally important, the FM has taken on the
exemption raj in customs and end use exemptions and those requiring
certificates have been removed. The list of items where exemptions
exist runs into nearly 2000. Today the importer gives the appraising
officer the relevant literature and a certificate from one of the 33
approved certifying agencies. These steps involve multiple contact
points with the government, and enormous costs of compliance, since
appraising officers have to get engaged in questions of both valuation
and end-use. Elimination of exemptions will serve to improve
compliance and raise revenues. This would also serve to remove the
involvement of agencies which certify end use. It will remove the
involvement of customs officers who can today choose who qualifies for
the exemption and who does not. This reform is far bigger than meets
the eye.

4. A new idea that has been introduced in this year's budget is the
measurement of the costs of exemptions. Traditionally, exemptions were
a non-transparent way for a politician to favour one pressure group. A
subsidy is too transparent: everyone can see what one pressure group
is grabbing. But an exemption can be tucked away in the finance bill
and nobody knows how much it costs. Now, there is an effort at listing
out the exemptions and attributing a price tag to each of them. The
statement shows that a total of Rs 158,661 crore of revenue was
foregone by the government on account of exemptions for corporate tax,
personal income tax, cooperative sector treatment, excise and customs
duties.  Corporate tax exemptions and custom duty exemptions (after
adjusting for export related exemtions) and the two big items of more
than Rs 57,000 crore each.

5. The structural reforms in finance gives investors a positive
signal. The decisions to increase FII limits on investment in
government bonds and corporate bonds, and the flexibility for mutual
funds to build superior products based on globally diversified
portfolios, are small steps in the long process of liberalisation of
the capital account. However, they have signaling value, especially to
the foreign investor for they depart from the enhanced controls on
capital inflows often sought by RBI. Further, there is an attempt to
build a corporate bond market, by having trading on exchanges and
regulation by SEBI. This will double the impact of the increase in the
FII limit for corporate bonds.

6. An interest rate of 7 percent for farmers, the 2 percent subsidy
   for farmers and an increase in defined benefit pensions of Rs 200 for
   destitute pensioners are a step backwards in the move towards market
   determined interest rates and a DC pension system.


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