The finance minister has the luxury of formulating the 2008-09 Budget in the background of robust economic performance. The economy is expected to record a growth rate of over 9 per cent in 2007-08 and this comes after the 9.4 per cent growth in the previous year.
The wholesale prices are well below 5 per cent though consumer prices, particularly the prices of foodgrains, are a cause for concern. Indeed, 2007-08 has been a reasonably good year for foodgrains production, which may ease the situation to some extent.
Despite a significant hardening of the rupee and deceleration in exports, the current account deficit is well within manageable limits. The continued surge in capital inflow has caused the appreciation of the rupee and attempts to sterilise the inflow has had its costs.
This problem will continue and with it the debates will rage on the right mix of policies on exchange rate appreciation, sterilisation of capital inflow and control over capital inflows and encouraging outflows.
Most importantly, the fiscal situation has shown a marked improvement, though when off budget liabilities are considered, the situation no longer looks optimistic. The aggregate gross fiscal deficit relative to GDP has declined from 9.9 per cent in 2001-02 to 6.4 per cent in 2006-07 and is estimated at 5.6 per cent in 2007-08.
Improvement in the revenue deficit has been even more impressive. It declined from almost 7 per cent to 2 per cent in 2006-07 and is estimated at 1.2 per cent in 2007-08, which implies an improvement of almost 5.8 percentage points.
Rarely do we come across such an impressive record, certainly not in democratic societies. Indeed, South Korea achieved a six percentage point compression of expenditures during 1969-73 by abandoning the heavy and chemical industry strategy and Vietnam compressed its expenditures by six percentage points to GDP during 1991-95 to tame its inflation rate from almost 800 per cent to single digits.
But these are fairytales and, as we always affirm, India is different! Surely, achieving fiscal consolidation of such a magnitude within the framework of a democratic polity by a coalition government is impressive.
Notably, fiscal consolidation has been achieved on the improved performance of both the central government and states. The decline in the revenue deficit (as a percentage of GDP) by 5.8 percentage points over the period from 2001-02 to 2007-08 has been contributed equally by both the Centre and states.
Of course, states' improvement of three percentage points was contributed mainly by increase in tax devolution and grants (1.4) and lower interest payments due to debt swap and the Twelfth Finance Commission's debt restructuring plan (0.5) and the remaining one percentage was contributed by higher revenues from states' own taxes, thanks to the VAT reform.
The most important and impressive source of improvement, however, has been the sharp increase in the buoyancy of central taxes, particularly the personal and corporate income taxes, due mainly to better compliance arising from networking the tax information and the service tax due to expansion in the base.
According to the Budget estimate for 2007-08, the gross central tax revenues relative to GDP would be close to 11.8 per cent, which is almost 3.7 percentage points higher than in 2001-02 and as the actual collection of income tax during the nine months of the current fiscal has been higher by 40 per cent, the implication is that the gross central tax collections could exceed 12 per cent of GDP in 2007-08.
Thus increase in income tax collections alone contributed to fiscal consolidation by over four percentage points to GDP.
There are some important caveats to this fiscal consolidation story. While most would attribute it to the fiscal responsibility legislation at the central and state levels, the reality is that the adjustment has come about mainly by setting up the information system.
As fiscal adjustment has been achieved by increasing the revenue productivity and not by hardening the Budget constraint, the allocative and technical efficiency of public spending has not shown any improvement.
In countries which did not have the luxury of buoyant revenues but had to make the adjustment, fiscal adjustment by compressing expenditures led to improvements in expenditure efficiency, though some may argue that in India, political economy might have displaced productive expenditures.
The important point is that the revenue buoyancy enabled continued indulgence in spending on a variety of schemes and programmes, some of them with doubtful utility. The year 2008-09 probably could see further escalation in populist spending as part of the electoral cycle as continued buoyancy will provide the fiscal space for indulgence in profligacy.
For the same reason, off Budget liabilities have shown a sharp increase. Given the reasonable comfort level on the revenue front, the government could decide not to increase the prices of petroleum products even as international prices have increased sharply and this has resulted in mounting off Budget liabilities.
The soft Budget syndrome, on the one hand, and the attempt to show adherence to the FRBMA, on the other, have resulted in postponing the payment of food and fertiliser subsidies even as they have accrued. Altogether, these off Budget liabilities could amount to about 3 per cent of GDP during 2007-08 and if the losses of state electricity utilities are added, the open and hidden aggregate fiscal deficit could well be close to 9 per cent of GDP.
In the long term, the lopsided adjustment undertaken mainly by raising revenues and hiding the real deficits may be counter-productive.
This, however, does not mean that attempts to rationalise the tax system to impart greater revenue productivity should be given up.
One important lesson from the fiscal developments so far is the importance of the information system in raising revenue productivity. The time has come to focus on building the modern information system for Union excise duties as well as for the State VAT, which would help in the introduction of GST in 2010.
The National Security Depository Limited has played an important part in building the information system in income tax. The most important initiative the finance minister could take is to entrust the task of building the information system for Union excise duties to the NSDL or any other modern information technology firm.
This reform would not have political difficulties and hopefully, both the Centre and States would act on it.
The author is Director, NIPFP.
