Why the next budget will test the UPA's reformist agenda

THE BUDGET PRESENTED BY Pranab Mukherjee this year has been variously described as positive, a balancing act, aggressive, forward-looking, and lacklustre. But the finance minister’s real test will be next year, warn economists. “Any substantial jump in the oil subsidy bill will be enough to throw out all plans of fiscal consolidation—bringing down the fiscal deficit to 4.6% and revenue deficit to 3.4% of the GDP in 2011-12,” says Sunil Sinha, senior economist at credit rating agency Crisil.

Other experts are doubtful about achieving the projected 9% growth rate. The reason: Mukherjee has factored in 5% inflation for the year, which seems unlikely given that between April and December 2010, the average rate of inflation was 9.4%. “Both the borrowing and fiscal deficit numbers have been worked out taking into account the most optimistic macroeconomic scenarios, which, in all likelihood, will not be the real situation,” says Rupa Rege Nitsure, chief economist at Bank of Baroda.

Mukherjee could have taken some bold steps in Budget 2011 with regard to diesel price deregulation. This would have helped shrink the ballooning oil subsidy bill, as well as the fiscal deficit. He has not done this, making the task next year that much more difficult.

Even more striking is that the government has actually budgeted for a reduced subsidy bill for oil, food, and fertiliser by 12.5 % from last fiscal in spite of the hike in petroleum, food, and fertiliser prices. Even the food subsidy bill has been kept at Rs 60,600 crore despite the government’s assurance that it will provide cheaper rice and wheat to millions of people below the poverty line. If food prices shoot up, not only will the food subsidy bill go up but inflation and interest rates will follow.

The government will also have to deal with the possibility that the Rs 23,600 crore oil subsidy bill budgeted for next year will not be enough. This is a real fear, given the continuing turmoil in West Asia and the fact that the price of Brent crude is around $112 (Rs 5,068) a barrel. The actual subsidy bill in 2010-11 was around Rs 38,400 crore—more than 12 times the budgeted Rs 3,100 crore.

With no hike in tax rates and no big bang reforms, generating the necessary revenues could become a problem. Also, many of the factors that cushioned the economy this year will be missing. For instance, the government gained a windfall of Rs 1.1 lakh crore through the sales of 3G and broadband wireless access spectrum. This helped bring down this year’s fiscal deficit to 5.1% of the GDP from last year’s 6.8%. There will be no such support next year.

Chances of the government meeting its target of Rs 40,000 crore through disinvestment in 2011-12 are also remote, given the state of the capital markets. Many foreign financial institutions have already pulled out huge sums from the stock market and are sending it back to the U.S. Last fiscal, the government raised some Rs 22,144 crore from the capital market.

Since the proceeds from disinvestment will go to finance social sector projects, there is no real cushion to take care of a sudden steep hike in oil or food prices. “What the government should have done,” says D.K. Srivastava, director, Madras School of Economics, “was to keep part of the money as a strategic fund for emergencies.”

Again, most issues regarding the simplification of the tax structure and moderation of tax rates have been left for the next Budget. The Direct Tax Code will come into effect only in April 2012. Also, the implementation of the general goods and services tax (GST) has been left till later—and definitely not before the next Budget.

A surge in oil prices, a widening trade deficit and erratic foreign funds flow could play havoc with the current account deficit. “Unless there is a strong revival in the U.S. and European Union and exports pick up, the current account deficit will be a long-term liability,” says Srivastava.

The finance minister who presents the next Budget will have his work cut out for him; the numbers may go horribly wrong.