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Budget 2012: UPA defines a new trade-off between growth and equity
March, 15th 2012

Tomorrow's Budget, more than most Budgets in the past, will be judged by FM's efforts at reversing the deterioration in the government's finances. Many analysts view the coming Budget as a make-or-break one: either the government effects a drastic correction or we are condemned to low growth and high inflation in the near future.

It would be unwise to take such an absolutist position. It is best to recognise that, given the government's orientation towards social spending, correction can happen only over an extended period. The broad direction rather than the magnitude of correction should be the yardstick for judging the Budget.

The fiscal position is challenging but it is useful to note a couple of positives in the situation. One is that sustainability of debt is not the issue. The 13th Finance Commission (TFC) had set a target for total debt-to-GDP ratio (of the Centre and the states) of 68% by 2014-15, with the Centre's share coming down to 44.8%. The Budget for 2011-12 had forecast a ratio of 44.2% for the Centre. This will not happen because borrowings will exceed the Budget forecast but the ratio will still be within 45-46%.

Some commentators say the Centre's fiscal deficit this year is almost the same as it was at the start of reforms. True, but the Centre's debt-to-GDP ratio at the time was 56%. India's debt position looks far more sustainable today. It also looks a lot better than that of many advanced economies where the ratio has crossed 100% of GDP.

Secondly, state finances are in better shape. As the finance ministry's Mid-Year Review notes, prior to the global crisis in 2007-08, the states' fiscal deficit was just 1.5% of GDP and they had a revenue surplus of 0.9% of GDP. According to the latest review of the PM's Economic Advisory Council, the fiscal deficit of states today adds up to 2.1% of GDP - well within the limit of 3% set by the TFC.

The Mid-Year Review notes that the combined fiscal deficit of the Centre and the states, which ballooned to 9.3% in 2009-10, declined to 7.7% in 2010-11. It should end up at around 7.5% for 2011-12. Thus, fiscal consolidation for the economy on the whole remains on track even though it will not be true for the Centre's finances in 2011-12.

How do we carry forward the process of consolidation? Thus far, growth and tax reform rather than expenditure cuts have been responsible for fiscal correction. In this respect, India's experience has differed from that of other countries where fiscal correction has taken place primarily through expenditure correction.

In respect of tax reform, two important proposals are on the table: the Direct Tax Code and the goods and services tax. The latter will involve more discussions between the Centre and the states but the first should go through soon. In addition, there is scope for extending the service tax to all services except for a small negative list.

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