Budget 2010/11: Fiscal Consolidation Gets Under Way as Indian Economy Rebounds

Shifting Focus from Crisis Management to Medium-Term Fiscal Consolidation

The Congress-led United Progressive Alliance (UPA) coalition delivered its first full-year budget since its resounding victory in the May 2009 elections, squarely targeting a return to 9% economic growth. The government temporarily abandoned fiscal consolidation over the last two years to focus on supporting domestic demand during the global financial crisis and the worst drought in 37 years. Last year's budget (and subsequent fiscal stimulus packages) had continued the highly expansionary fiscal policy, boosting demand with tax cuts and spending increases on the rural sector.

In fiscal year (FY) 2010/11 (ending in March 2011), the government is attempting to direct fiscal policy prudently. The government continues targeted spending on key areas such as infrastructure, agriculture, health, and education, while reducing oil and other subsidies. On the tax front, it lowers taxes for the middle class, and raises customs and excise taxes on petroleum products. It expands divestment and privatisation initiatives to increase government revenue receipts.

The budget targets an increase in non-plan expenditure of 12.6% in FY 2010/11 from last year, while planned expenditures will rise 18.4%. Expenditure programmes reflect Congress's core constituency among the rural poor, who are also the most affected by 2009's severe drought. Total revenues, meanwhile, are targeted to rise 18.2%, on higher overall direct and indirect taxes, divestment receipts, customs and excise duties, and corporate tax revenues from a rebounding economy.

Prior to the budget speech, the government raised the prices of gasoline and diesel, a move which would fan already-high inflation but not offer much relief to oil companies beyond offsetting the impact of higher petroleum taxes outlined in the federal budget. Authorities raised the price of gasoline 6%, or 2.71 rupees a litre, and diesel 8%, or 2.55 rupees per litre. The prices of kerosene and cooking gas remain unchanged. The government also changed its fertiliser policy to implement a nutrient-based pricing policy, which will reduce the total size of fertiliser subsidies and fertiliser bonds.

Key Elements of the 2010 Budget

• New and wider tax initiatives lower taxes for the middle class, raise custom taxes for petroleum and related products, and set a firmer timetable for introduction of a nationwide sales tax: Broader income-tax brackets reduce income taxes on average for middle-class taxpayers, with wider ranges of income levels falling under lower income-tax rates. Meanwhile, corporate income-tax surcharges fall from 10% to 7.5%. The minimum alternative tax will go back up from 15% to 18%, reversing the temporary cut. Petroleum products face higher custom duties, with 5% custom duties on petroleum products, 7.5% on diesel and petrol, and 10% on other refined petroleum products. With the planned introduction of the Goods and Service Tax (GST) in April 2011, the government for this coming year has increased the central excise duty from 8–10%, matching the 10% rate of the service tax, as a pending move until the nationwide GST takes effect.

• Targeted infrastructure spending receives continued priority: Overall capital spending rises 30% in the budget, with infrastructure targeted in particular. Allocation for road transport increases by 13%, railways by 6%, and power by 100%. The government is also introducing a competitive bidding process for allocating coal blocks and establishes a Coal Regulatory Authority to improve transparency.

• Investment environment improves: Measures to simplify the foreign direct investment (FDI) regime will enhance efficiency. Liberalisation of pricing and payment of technology transfers, brand names, and royalty payments ease FDI restrictions. On the financial front, there will be a new Financial Stability and Development Council whose mandate will be to strengthen and institutionalise the maintenance of financial stability and to monitor supervision of the economy and financial institutions. A new Companies Bill will address regulatory issues and a changing business environment.

• Environmental concerns receive redoubled attention: The outlay for the Ministry of New and Renewable Energy increases 61% and funding expands for new solar, hydro, and micro power projects in designated areas. The new National Clean Energy Fund will fund research and projects in clean energy technologies, and funding doubles for the cleanup of the Ganga river.

• Agricultural policies aim to enhance efficiency: The government seeks to extend the green revolution to the eastern states, focusing on water harvesting, watershed management, and soil health to improve productivity. Improved distribution channels and storage facilities will reduce costly wastage of produce. Banks' agriculture credit targets have risen, farmers' loan repayment deadlines are extended, and interest-rate incentives increase. New mega-food-park projects will be set up, providing impetus to the food processing sector.

• Social spending rises to promote inclusive growth: Expenditures on education and health initiatives increase, and allocations for women and child development rise 50%. Rural development spending rises through rural employment guarantees, rural infrastructure, and drought mitigation schemes. Urban development funding rises 75%, including poverty alleviation initiatives, concessionary housing loans, and other targeted programs.

• Transparency and public accountability will improve with the establishment of new commissions: The Financial Sector Legislative Reforms Commission will streamline financial sector laws, while the Technology Advisory Group for Unique Projects will investigate technological issues for effective tax management and financial governance. An Independent Evaluation Office chaired by the Planning Commission's Deputy Chairman will evaluate the impact of flagship programs.

• Security and legal environment reinforced by targeted spending: Defence allocations increase 8% from last year, with a particular emphasis on capital expenditures. On the legal front, the National Mission for Delivery of Justice and Legal reforms will help reduce legal backlogs in courts from an average of 15 years currently to three years by 2012.

Outlook and Implications

The new fiscal consolidation plan will reduce the central government's fiscal deficit from a revised estimate of 6.7% in FY 2009/10 to 5.5% in FY 2010/11. The announced budget includes rolling targets of central deficit, at 4.8% in FY 2011/12 and 4.1% in FY 2012/13. Since the central deficit is direct linked to states' deficits through shared revenues, the consolidated deficit will improve as well. Indeed, given the arguably conservative projections for revenue growth, the actual deficit may actually come close to meeting targets, at least in FY 2010/11. The government also indicated changes to a new Fiscal Responsibility and Budget Management Act (FRBM), which would replace the current FRBM legislation due to expire in end-March.

The much-anticipated new budget from a reform-minded administration did not disappoint. The government attempts to manage the revenue-expenditure balance judiciously. Private consumption, India's main growth engine in recent years, will benefit from the widening income tax brackets, which will increase disposable income. Consequently, consumption demand and organised retail will gain. Authorities have reprioritised investment, particularly infrastructure investment, which will improve the operational environment. Simplified FDI policies and easing restrictions will boost investment inflows. The government has also widened privatisation and divestment initiatives, as it seeks to raise revenue by selling stakes in government-owned companies. A successful implementation of the GST in 2011 would substantially expand government coffers. But ambitious projected receipts from auctions of the 3G spectrum (currently scheduled for April) might not materialise, however. Most glaringly, the budget, though comprehensive, remains silent on critical and thorny reform issues such as fuel subsidies, labour laws, and FDI in retail and insurance.