This is magic or make believe?

Finance Minister Chidambaram had a hard act to follow -- his own, the famous "dream Budget" of 1997. Has he succeeded? Not if the Budget is judged by the criterion of hard fiscal consolidation.

Mr Chidambaram has quite explicitly stated that with only 6-7 months of the fiscal year remaining, it would be unwise to launch a major tax reform programme in the current year.

On the other hand, if a "dream Budget" is one where there are only winners, no losers, perhaps Mr Chidambaram has indeed done it again.

The 2004 Budget is a serious attempt at translating the promises of the National Common Minimum Program into specific fiscal measures to address poverty and unemployment, and step up public expenditure on primary education, basic health care, agriculture, irrigation, and other rural infrastructure.

This has been done without much effort at additional revenue mobilisation. Yet, the fiscal deficit and the revenue deficit are both projected to be lower in FY 2004 than in FY 2003. Is this magic or make believe? It is neither.

In an economy projected to grow at 8 per cent, with inflation of around 5 per cent, implying nominal GDP growth of around 13 per cent, and unit revenue buoyancy, revenue can easily grow at 13 per cent a year with no special policy change or revenue mobilisation effort.

Expenditure can also then grow at around 13 per cent, leaving the fiscal deficit unchanged, or grow at a slightly lower rate and yield a reduction in the deficit. It is this high-growth scenario that underpins the finance minister's "winners only" Budget.

There is a small reduction in the projected central fiscal deficit from 4.8 per cent in FY 2003 to 4.4 per cent in FY 2004. Combined with the deficit of all the state governments, this amounts to a total fiscal deficit of about 10 per cent.

This fresh borrowing is added each year to the public debt stock, which is now around 80 per cent of the GDP. Is this too large and unsustainable? For economists, financial analysts and rating agencies a large deficit is a recipe for disaster.

Yet the Indian economy has cruised along merrily at a fairly rapid pace for years despite a persistent large deficit, and so have some other countries. So what's the problem?

Simply that if a large part of public resources is pre-empted to service a large public debt, it essentially crowds out other useful public expenditure.

At the federal level, for instance, total debt service in FY 2004 will eat up about two-thirds of the total expenditure, leaving relatively little for useful development expenditure.

This heavy draft of debt servicing, along with other items of "committed expenditure" such as wages and salaries of public servants, underlines the urgency of additional revenue mobilisation to finance both development and the social safety net.

In the present budget the 2 per cent education cess is estimated to raise about Rs 5,000 crore (Rs 50 billion). The increase in the service tax rate from 8 per cent to 10 per cent, and a small increase in coverage, will increase the yield from this tax from about Rs 8,000 crore (Rs 80 billion) to around Rs 14,000 crore (Rs 140 billion).

Other than these, most of the other tax proposals are relief measures, such as, zero rating the Income-Tax for assessees with up to Rs 100,000 taxable income. The coverage of direct tax exemptions, especially under sections 80 IA and 80 IB, has been widened and there are a whole slew of new indirect tax exemptions.

As a consequence, there is no additional revenue mobilisation from indirect taxes, and the additional revenue mobilisation from direct taxes is estimated at only Rs 2,000 crore (Rs 20 billion).

It is a pity that the Budget has not made a serious effort to raise the tax:GDP ratio, which remains very low by international standards.

In the five-year political "business cycle", hard decisions on fiscal and other reforms can be pushed through only during the first 2-3 years. With the first opportunity lost, the finance minister will now have at best only two Budgets for introducing his reforms.

In contrast to the lack of strong initiatives on the revenue side, measures introduced on the expenditure side are quite significant. Perhaps the most important of these is the thrust on education, especially primary education, combined with a noon-meal scheme, and the proposed health insurance scheme for families below the poverty line.

The high priority accorded to agriculture, rural infrastructure and irrigation is also most welcome, especially the innovative programme to restore about 500,000 out of the 1 million water bodies, which have served as traditional modes of cost-effective irrigation.

The coverage of the "last mile" of irrigation projects under the Accelerated Irrigation Benefit Program is equally important. The emphasis on the Antyodaya Anna Yojana, revamping of the food for work programme implies a new and sharpened focus on poverty reduction.

However, in all of these initiatives, the devil is in the details. A great deal will depend on the design of the programme. Many of them are state subjects, and the resources will have to be channelised through state governments.

The precise modalities will presumably be worked out by the Planning Commission. To ensure that these resources are well spent, it will be useful to link allocation to delivery outcomes, that is, a shift from input-centred management to development outcome-based management.

Much experience has been gathered on the results-based approach to central assistance for states in recent years in different fields, ranging from the Medium Term Fiscal Reform Programme to the Accelerated Power Development and Reform Programme to the Urban Renewal Fund, and the City Challenge Fund.

The lessons learned from these programmes need to be systematically applied, as also the experience gained in using the road cess to finance both the national highway development programme and the rural roads programme.

The significant push to social and rural development programmes notwithstanding, it is important to note there is no increase in the ratio of such spending to the GDP.

Thus, the total central expenditure on education programs in the FY 2004 Budget at 0.4 per cent of the GDP is exactly the same as in FY 2003, as is the case for central expenditure on health programmes at 0.25 per cent of the GDP.

Similarly, central spending on agriculture, rural development, irrigation, and flood control amounts to 2.18 per cent of the GDP in FY 2004 as compared to 2.19 per cent in FY 2003. This does not mean that increased spending on these programmes is a myth. It simply points to the fiscal space provided by high growth.

Despite the burden of servicing a large public debt, a major expansion in development spending can be accommodated, without further deterioration of the deficit, because high growth generates the additional revenues, which can finance the spending.

Mr Chidambaram was reported to have mentioned, soon after taking charge at North Block, that he had inherited a buoyant economy, with huge forex reserves, a strong balance of payments position, and large stocks of foodgrains; and that this could make his job easier.

It was a generous political gesture but, clearly, he was also well aware of the fiscal space a fast-growing economy would provide him for an ambitious and inclusive programme of development. He has used that opportunity well.

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