No policy steroids needed

Behind the headline numbers, how next year's budget is financed will matter. This year, budget financing turned out to be reasonably benign, with the RBI helping out with large purchases of government bonds and subdued credit demand. This may not be true in FY'14. If there is any marked upturn in the credit cycle, which is likely if corporate investment rises even modestly, then interest rates could come under pressure if both the government and private sector compete for the same pool of deposits. One way of mitigating this is to materially increase foreign holdings of government securities and reduce the ineffectual withholding tax. Some have been exhorting the government to issue US dollar debt. This is a veritable can of worms that should not be opened. Many countries have paid a heavy price for eyeing this as an easy financing option.

But more than the numbers or the financing, people will be looking to this budget for policy and reform guidance. If there is just one thing expected from the FY'14 budget, it is a road map on the GST. Just like the direct cash transfer, the GST is game-changing. It will establish a single national market for the first time and greatly enhance the medium-term fiscal space warding off a credit downgrade. But having witnessed many false dawns, the market's and investors' faith is running thin. If the budget is silent or sketchy on the details, serious questions will arise about the government's commitment to consolidation. Cutting the fiscal deficit to 3 per cent of the GDP over the medium term is neither tenable nor advisable on expenditure cuts alone. New revenue measures are needed, not via some ad hoc increase in the income tax rate on the "super rich", but by expanding the tax base through the GST.

... contd.

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