Private investment could get crowded out

Budget News

Mon, Mar 3 02:17 AM

The goal of Budget 2008 appears to be to recharge the economy through strong domestic consumption and ensure that there are no further dips in GDP (gross domestic product) growth as India faces the challenge emanating from a possible global recession. The Economic Survey clearly highlights the fears of slowing manufacturing and agriculture growth and the impact of rupee appreciation on the export-driven textile and technology sectors.

Although not a big-bang Budget, the final effort is actually more than satisfactory as the finance minister attempts to appease the voting populace ahead of the elections and at the same time looks to boost consumption by reducing duties and personal taxes. The cut in peak excise duty from 16% to 14% and the reduction in duties on a number of items is aimed at reducing the inflationary pressure on the economy.

Duty cuts in the auto segment and the increased outlay in health care, education and irrigation are also major positives in theBudget. The waiver of almost $15 billion (Rs60,000 crore) in outstanding loans to marginal and small farmers came as a surprise and should put pressure on financials, especially with the additional burden expected from the Sixth Pay Commission recommendations not accounted for in the Budget estimates.

However, the waiver needs to be seen from a couple of perspectives. The first is that although the absolute amount is large, it is unlikely to "break the proverbial camel's back" (the financing is not clear yet but could be in the form of bonds); thus it is not a big negative.

The other perspective is that of the implicit moral hazard that is involved. Unfortunately,India now seems to be following the global trend of taxpayers picking up the tab for negative outcomes in the capitalist process.

To put the Indian Budget's development spending plans and financial position within a regional context, it's useful to compare it with China. In 2008, China plans to invest roughly $21 billion (+16.

6%) in agriculture-related fixed assets, with total expenditure targeted at 20% of GDP. By comparison, India plans to invest $8.

4 billion (+14%) in agriculture, allied activities and rural development during its fiscal year 2008-09, while budgeting for a total expenditure of 14.2% of GDP.

Most recently with the snow storms, the total distributions to farmers in China have increased by more than 50% year-on-year. Additionally, China continues to be ahead of India in providing free education at the primary levels but China's fiscal situation is a lot better than India's.

In terms of its finances, India needs to improve its finances before offering more subsidies. India runs a current account deficit of 1.

1% of GDP and a fiscal deficit of 2.5% of the GDP.

This compares with China's current account surplus of 10.5% of GDP and fiscal surplus of 1.

1% of the GDP (trailing four quarters). Moreover, India's fiscal deficit would rise to 4.

2% of GDP if one were to adjust for fertilizer and oil bonds and the agriculture loan waiver (which one must). The numbers would also be worse if some provision is made for the pay commission as well.

Thus, we have a real threat of crowding out of private investment, and interest rates are at risk of remaining high. In short, on the fiscal discipline side, the Budget leaves much to be desired.

The market had an instantaneous negative reaction to the increase in capital gains tax. But given the relatively low penetration of retail ownership, the move should only impact high net worth individuals.

The short-term capital gains at 15% is still only half of the highest tax slab in India and remains lower than that of many other marketsglobally. Punita Kumar-Sinha issenior managing director,Blackstone Group.