India's Tough Balancing Act

With an economy still struggling to recover from the impact of a deep global economic crisis on the one hand and a strong mandate for good inclusive governance on the other, the new government has a tough balancing act to perform. How to design an economic programme that will restore growth and at the same time provide the poor income security and address their basic needs? That is the question.

On restoring growth, there is a view that given the limited space for a fiscal stimulus, it may be better to rely on a reform stimulus. There is indeed vast room for reforms in many branches of the economy, as discussed in detail in the 11th Five Year Plan and elsewhere. However, reforms lead to higher growth only after a considerable time lag. Restoring growth in the short term will depend on fiscal and monetary measures.

Following the slew of monetary measures implemented by the RBI, the main thrust now has to come from the fiscal side in the July budget. The fiscal stimulus introduced in the interim budget has to be fully implemented, if not further reinforced. However, it need not depend entirely on deficit financing. Even a zero-deficit budget can provide a stimulus based on the balanced budget multiplier. The interim budget leads to a total deficit of over 10 per cent of GDP, including off-budget items and state government deficits. Coming on top of a large deficit of 11 per cent of GDP in 2008-09, it will amount to a massive increase in public debt. Depending on how it is financed, this could lead to a public debt trap, crowd out private investment or trigger high inflation.

The Fiscal Responsibility and Budget Management Act introduced to contain the deficit had to be cast aside to deal with the economic crisis. But it is imperative to finance at least a part of the stimulus package through additional revenue mobilisation and contain the deficit. On the tax revenue side, the proposed goods and services tax will not be ready for introduction till 2010 and the options for additional tax revenue at this stage are limited. Barring a possible modest increase in the CENVAT, it would be best not to arbitrarily tamper with indirect tax rates till there is a comprehensive review.

On the direct taxes side, any proposal to raise the exemption limit for income tax should be postponed. The main steps for mobilising revenue have to come from non-tax sources. Administered prices of some items such as petroleum products should be raised. The other major revenue option is partial divestment in select public enterprises, provided there is a commensurate increase in growth-promoting infrastructure and human development expenditure.