Budget 2016 – Reining in Fiscal Deficit at 3.5%

At first glance, this may not appear like a very big achievement. The reason we are underscoring this point is that most experts were of the view that the time was ripe for a pump-priming of the Indian economy. While the likes of Kaushik Basu and Arvind Panagriya were in the pump-priming camp, Dr. Rajan was in the fiscal discipline camp. Thankfully, the government chose to err on the side of caution and chose to maintain fiscal discipline. This is important because any laxity in fiscal discipline will result in potential sovereign downgrades by rating agencies. Also rising fiscal deficit is a trigger for FII outflows. India needs to be careful on both these fronts. Therefore, the decision to rein in fiscal deficit has come at the right time. More so, as the pressure of OROP and 7CPC is likely to put a pressure of another Rs.115,000 crore or nearly 0.6% of GDP on the fiscal deficit.

There is pressure on Fiscal Deficit…

This is likely to be the year of pressure on the fiscal deficit. The One Rank One Pension (OROP) is likely to put a burden of Rs.10,000 crore on the budget annually. In addition, the Seventh Central Pay Commission (7CPC) will add another Rs.105,000 crore per year on the exchequer. Both of them put together will add up to nearly 0.6% of the GDP. In addition, this budget has given a major thrust to rural allocation and provided Rs.36,000 crore for the same. In addition, the total allocation for road and rail infrastructure itself comes to Rs.218,000 crore this year. Banks have already been given Rs.25,000 crore and the government stands ready to add if required. In the light of all these conditions, the pressure on fiscal deficit was always going to be there.

There has also been pressure on revenues…

Direct tax collections this fiscal is likely to fall short of target by nearly Rs.50,000 crore. There is likely to be considerable shortfall in disinvestment targets too. Not surprisingly, the government has cut its disinvestment target by nearly 20% for the coming year. There is also a rational argument for this cut. With government restricting its recapitalization provision for banks to just Rs.25,000 crore, there is going to be pressure on banks to constantly tap the capital markets. Under these circumstances, an aggressive divestment program is likely to crowd out banks from the capital markets.

What has the budget 2016 done – Encourage cross subsidisation… 

On the personal taxation front, the government has used the higher levies on the rich to fund the benefits to the low income groups. So the rich pay higher surcharge of 15% instead of 12% on their incomes. The wealthy shareholders also pay a 10% tax on dividends received above Rs.10 lakhs. In addition, the rich have been forced to subsidize by imposing a higher cess on cars in general and luxury cars in particular.

Corporate taxation is another example of cross subsidization. The companies are being made to fund their tax rate reduction through forfeiture of exemptions. By 2020, most of the exemptions are likely to go and a tax rate of 25% is what will remain. This will ensure that the burden of subsidizing the corporates does not fall overtly on the government.

Excise is another area where the budget has played the cross subsidy game. For example, products like cigarettes and ATF are being used as a proxy for taxing non-core consumption to subsidize core consumption. Similarly, the government has played the excise card astutely in tune with oil price movements. The government was consistently hiking the excise duty on petrol and diesel as the prices were falling. Now that the price appears to be bottoming out, the government has shifted the basis of levying duties on crude oil to ad valorem. That means as price of crude rises, the companies will automatically pay a higher duty on crude oil.

In a nutshell the government has done the right thing by sticking to fiscal discipline. But the real achievement is outside these numbers. The government has managed a huge funding gap by astute tweaking of rates and rate structures. Fiscal discipline stands out as a very important theme of Union Budget 2016. The real benefits of this fiscal discipline in terms of portfolio flows, global confidence and benign interest rates will be seen more clearly in the coming quarters.

Read about Union Budget 2016 highlights at Religare Online.

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