THE NEW BUDGET INVESTS IN RURAL INDIA, BUT POSTPONES FISCAL

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TAGS: ECON EFIN EINV ETRD EAGR EPET PREL PGOV IN
SUBJECT: THE NEW BUDGET INVESTS IN RURAL INDIA, BUT POSTPONES FISCAL
CONSOLIDATION

REF: NEW DELHI 001237


1. (SBU) Summary. Finance Minister Pranab Mukherjee presented a
rural-oriented 2009-2010 central government budget on July 6 which
many say reflect his style: pragmatic, not flashy, and indifferent
to market expectations. Indeed, the initial reaction of many to the
budget was one of disappointment for not laying out a reform
roadmap, especially in disinvestment and FDI. Dashed expectations
aside, the budget did sketch out realistic growth and revenue
projections and mainly responsible budget allocations. The
government had to boost spending on government salaries, per the Pay
Commission, and spend more on interest payments for the oil and
fertilizer bonds it issued over the last three years. Where the
government had discretion to spend, it focused predominantly on
increasing funding for the National Rural Employment Guarantee
Program and rural and urban infrastructure. The allocations
represent a desire to sustain rural consumer spending in the short
term while the economy continues to recover from the global crisis,
while also laying the groundwork for long-term growth and
productivity increases through better roads, electricity, and
housing.


2. (SBU) Summary continued. On the revenue side, the Finance
Minister proposed minimal personal income tax cuts, which have been
offset by a modest expansion of the service tax net and a higher
minimum alternative tax for large corporations. The central
government's fiscal deficit is projected to hit an 18-year high of
6.8% of GDP, rising from 6% in the fiscal year just ended March 31.
The higher deficit will require more market borrowing, which could
push up interest rates, or lead to monetizing some of the debt,
essentially printing additional currency, which would expand the
money supply and fuel inflationary pressures. Other economists also
worried that the higher deficit might endanger India's sovereign
debt rating, but a Standard & Poor's spokesperson commented that the
deficit was within its expectations, suggesting India's investment
grade rating is safe for now. The Finance Minister's budget speech
also committed to introducing the national goods and service tax
(GST) by April 2010, submitting a draft new income tax code in 45
days, and restructuring the fertilizer subsidy away from producers
to consumers, namely farmers who often receive only a fraction of
the intended benefit. There is plenty of reform to take on in the
budget, when much of the reform action will take place outside the
Ministry of Finance anyway. End summary.

Budget 2009-10
--------------


3. (U) In a speech to Parliament , Finance Minister Pranab
Mukherjee unveiled the central government's budget on July 6 for the
Indian Fiscal Year (IFY) 2009-10, which began on April 1. The
budget assumes a nominal GDP growth of 10% for IFY 2009-10, 12.4% in
IFY 2010-11 and 13% in IFY 2011-12. Real GDP in this scenario for
IFY 2009-10 would be around 6.5%, with an assumption of a normal
monsoon. The budget focuses on addressing three challenges:
returning to the higher growth trajectory of 9%, deepening and
broadening the agenda for inclusive development, and improving the
delivery and monitoring mechanisms. The budget's thrust is on
infrastructure, rural development and export oriented sectors, while
offering marginal relief to taxpayers to spur consumer spending.

Focus on Infrastructure Development
--------------


4. (U) Minister Mukherjee in his budget speech told Parliament that
he intended to increase India's infrastructure spending to 9% of GDP
by 2014. In this context, he proposed spending significantly higher
amounts to build urban and rural infrastructure, including highways,
irrigation projects, rural housing, electrification and roads. The
Indian Infrastructure Finance Co. Ltd. (IIFCL) will refinance 60% of
commercial bank loans made to public-private partnership (PPP)
projects, which could catalyze investment up to Rs 1 trillion
(roughly $21 billion). The Budget allocates Rs 129 billion ($2.7
billion) for urban infrastructure, 87% higher than a year ago, and
provides Rs 40 billion (about $8.3 billion) for housing and basic

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amenities to the urban poor. Mukherjee also proposes increased
spending for national highway development program by 23% over IFY
2008-09 to reach $2.8 billion (Rs. 136 billion).

Social Programs Get Boost
--------------


5. (U) After infrastructure, the budget provides greater
allocations to the flagship programs which have done well. The
National Rural Employment Guarantee Scheme (NREGS) which guarantees
100 days of work to every rural household has been pledged an
allocation of Rs. 391 billion ($8 billion) in IFY 2009-10, an
increase of 30% over the revised estimates of IFY 2008-09. Other
programs that will create rural employment and spur demand in the
country include the Bharat Nirman rural infrastructure program,
which had its overall allocation raised by 45%, and its component
schemes such as the Acceleration Irrigation Benefit Program and
Indira Niwas Yojana, a rural housing scheme, increased by 75% and
27% respectively compared to last year. (Note: The government has
not provided revised IFY 2008-09 estimates for the flagship schemes,
except NREGS. Instead, it has compared spending levels for the new
budget to the proposals made in last year's budget, which at the
time grossly underestimated spending. Such comparison creates a
larger apparent increase in spending. End note.) The rural road
component of Bharat Nirman also proposes to ensure full
farm-to-market connectivity by upgrading more than 100,000 miles
worth of existing small roads, with an investment of Rs 480 billion
($10 billion). The Pradhan Mantri Gram Sadak Yojana - a separate
rural roads program - is slated to receive an increase of 59% to Rs.
120 billion ($2.5 billion). Mukherjee has also promised a 40% hike
in the health insurance scheme for people below the poverty line and
increased money for the Integrated Child Development Scheme and
female literacy. The Rajiv Gandhi Grameen Vidyutikaran Yojana
(RGGVY) program for rural electrification has seen its allocation
increased by 27% to Rs. 70 billion ($1.5 billion). Spending on
family and health welfare has gone up by 22% from Rs 173 billion
($3.6 billion) last year to Rs 211 billion ($4.4 billion). The
government's proposed expenditure on education has increased by 11%
from Rs 260 billion ($5.4 billion) last year to Rs 291 billion ($6
billion).


6. (U) The Finance Minister also reiterated the Congress election
campaign promise to enact a National Food Security Act to ensure 25
kilograms of rice or wheat per month at Rs. 3 per kg to every family
living below the poverty line in rural or urban areas. A draft Food
Security Bill will be put on the website of the Department of Food
and Public Distribution for public debate. No allocation has been
made for this expenditure, which the Prime Minister explained in an
interview was because the drafting and passage of the Act, along
with identifying the targeted households, would take more than a
year.

Expenditures Rise
--------------


7. (U) Total spending for IFY 2009-10 is estimated at Rs 10,208
billion ($213 billion),an increase of 13.3% over last year's
revised spending figures. Plan (developmental) expenditure gets a
major boost in the Budget, reflecting the government's commitment to
accelerating the growth process. At Rs 3251 billion (approximately
$68 billion),the Plan expenditure will rise by 14.9%, while
non-plan expenditure is expected to rise by 12.6%. While higher
plan spending is due to social sector/infrastructure spending,
non-plan expenditure factors in implementation of the Pay Commission
recommendations (also reflected as an increase in defense spending)
and interest payments. The net borrowing program has increased from
Rs 3,086 billion to Rs 3,980 billion, a 29% increase to roughly $83
billion. However, Finance Secretary Ashok Chawla clarified after
the Budget Speech that, of the proposed government borrowing, only
half would be raised from the market. The rest would be picked up
by India's central bank, the Reserve Bank of India, implying a
return to monetization of the deficit (read printing currency).


8. (U) The budget also provides incentives for the export sector.

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The Budget provides a special fund of Rs. 40 billion ($800 million
approximately) for banks and state finance corporations to
facilitate lending to micro, small, and medium enterprises. The
allocation for the Market Development Assistance Scheme for
exporters has been increased by 148%. The existing 2% interest
subsidy on pre-shipment credit to employment-oriented export sector
has been extended until the end of this fiscal year (March 31,
2010).

Direct Taxes
--------------


9. (U) The Finance Minister has proposed modest increases in the
personal tax exemptions by Rs. 10,000 ($208) and Rs. 15,000
($312)for senior citizens (above 65 years). Women will receive an
additional relief of Rs 10,000. The 10% surcharge on personal
income tax has been proposed to be removed and the fringe benefit
tax (FBT),which was imposing considerable compliance burden on
companies, was also abolished. Removal of the FBT and the surcharge
on personal income tax will cost the exchequer about Rs 100 billion
($2 billion)and Rs 50-60 billion (roughly $1-1.25 billion)
respectively in the current year, which will be offset by increasing
a tax on corporations and increasing the service tax net. Mukherjee
also promised to simplify tax returns by coming out with a new
direct tax code within 45 days for discussion to introduce a bill in
Parliament in the winter session.


10. (U) Disappointing corporate India, Finance Minister Mukherjee
made no major changes in corporate tax rates in IFY 2009-10.
However, he did away with the Commodities Transaction Tax which was
introduced last year, but not notified, so as to encourage trading
in commodity markets. In the quest for greater equity, the budget
increased the rate of the minimum alternate tax (MAT) to 15% from
10% of booked profits. Mukherjee also pledged that an alternative
dispute resolution mechanism would be created within the Income Tax
Department for the resolution of transfer pricing disputes.
Further, the Central Board of Direct Taxes will be empowered to
formulate 'safe harbor' rules for international transactions. The
budget also proposes to exempt all trading in equity shares and
derivatives by the National Pension System Trust from the Securities
Transaction Tax (STT) to provide the necessary fiscal support to the
much-needed social security system.
Indirect Taxes
--------------


11. (U) In the run-up to a uniform central goods and service tax
(GST) rate of 8% next fiscal year, the excise duty has been doubled
to 8% on many items except for bakery items, drugs, pharmaceuticals,
medical equipment, and rural consumer goods. While the 2% excise
tax on branded jewelry has been eliminated, it has been cut to 8%
from 20% on petrol-driven trucks. Specific component of excise duty
applicable to large cars/utility vehicles of engine capacity 2000 cc
and above has been reduced from Rs. 20,000/ vehicle to Rs. 15,000/
vehicle. High speed diesel blended with up to 20% bio-diesel will
be exempted from excise duties. Widening service tax coverage, a
10% service tax will now be applied to transport of goods by rail,
coastal cargo and goods through inland water including national
waterways; cosmetic and plastic surgery services; and legal
consultancy services. Furthermore, shipment of goods through third
party road transporters that are currently covered under the service
tax regime will be exempted from service tax.


12. (U) Customs duties were tinkered with, although the Finance
Minister chose to delay additional broad duty reductions towards
ASEAN levels that the government had pursued in recent years.
Additional raw material/input items(for sports goods, leather,
textiles and footwear industry, all hit hard by the global slowdown)
have been exempted from custom duty. The customs duty on rock
phosphate will be reduced to 2% from 5%. The 5% customs duty on
unprocessed corals has been totally withdrawn. The customs duty on
permanent magnets used in wind operated electricity generators and
mechanical harvesters for coffee plantations have been reduced to 5%
from 7.5%. While the customs duty on bio-diesel has been slashed to
2.5% from 7.5%, it has been doubled for gold and silver.

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13. (U) On technology products, set-top boxes for televisions will
now attract a customs duty of 5% (earlier zero duty) but the customs
duty on LCD panels is halved to 5%. In response to demands from
mobile phone manufacturers, the budget announced exemption from the
4% special countervailing duty (CVD) on imports of parts and
accessories for one year. On packaged or canned software, a CVD
exemption will be applicable to partial value representing transfer
of the right to use the software. In the health sector, the basic
custom duty has been halved to 5% on influenza vaccine and nine
specified life saving drugs used for the treatment of breast cancer,
hepatitis-B, rheumatic arthritis, etc. and on bulk drugs used for
the manufacture of such drugs; these drugs will also be exempt from
CVD. The basic customs duty has also been reduced from 7.5% to 5%
on two specified life saving devices used in treatment of heart
conditions with full CVD exemption.

Fiscal Deficit Rises
--------------


14. (U) Increased spending on infrastructure and rural programs
coupled with the required increase in salaries and interest payments
has generated a fiscal deficit of 6.8% of GDP, compared to 6% of GDP
in 2008-09. The measures taken by the government to counter the
effects of the global meltdown slowdown on the Indian economy have
resulted in shortfall in revenues and substantial increases in
government expenditures, leading to a temporary deferment of the
attainment of the Fiscal Responsibility and the Budget Management
Act (FRBM)targets with respect to both. (Note: The 13th Finance
Commission has been mandated to review the FRBM roadmap and its
report will be released in October 2009. End note.)

Market Watchers and Business Community React
--------------


15. (SBU) Market investors had been looking to the budget to lay
out an explicit reform roadmap (reftel) and were deeply disappointed
by the Finance Minister. The Sensex market closed down 6% on July
6, the single largest drop on a Budget day, with market participants
bemoaning the lack of divestment specifics or other reform measures.
Dr. Brinda Jagirdar, an economist at State Bank of India, told our
Mumbai consulate that the budget did not live up to the hype created
during the pre-budget period. She said the Finance Minister
consulted with groups from every sector, hearing their wish list and
making them feel important, but did not incorporate these
expectations in the budget. She quickly added, however, that even
though issues of disinvestment, FDI were not included in the budget,
it did not mean that these reforms would not be carried on. Dr.
Bandi Ram Prasad, President of FT Knowledge Management Co., opined
that the market was focusing on one or two areas while missing that
the budget had maintained its conventional priorities. The measures
in infrastructure were consistent with growth objectives. He also
pointed out that the budget reflected Mukherjee's "old school style
without any sparks". The budget was supposed to be a document that
indicated financial allocation for a year but in recent years, it
had become over-glamorized, he added.

Comment
--------------


16. (SBU) The ruling United Progressive Alliance's (UPA) budget
elicited strong opinions across the board and the wide range of
reaction stems from the fact that there is still a lack of consensus
about whether the economy still needs stimulus, and whether that
need is worth the additional government borrowing, which risks
higher inflation and or interest rates. In some ways, these
divergent views reflect the wider uncertainty in the global economy
today, as the whole world grapples with the biggest economic
downturn since the Great Depression. Given these challenges and
constraints, Finance Minister Mukherjee has delivered an overall
no-frills, responsible budget that focuses on keeping economic
growth above 7% in the short-term by improving consumer purchasing
power, while building better infrastructure for medium-term growth.
The higher fiscal deficit is a concern and the government has

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currently punted to the scheduled October report of the Finance
Commission to develop a medium term deficit reduction plan.
However, a somewhat lower deficit is in the cards for next year
because the government salary increases would have been implemented,
which account for roughly one-fourth of the financing gap this year.
Further deficit reductions can come from more decontrol of refined
petroleum product retail prices and from restructuring the
fertilizer subsidy. These, like the other reforms that have been
suggested in the Economic Survey, require political consensus. And
a budget cannot deliver that.

BURLEIGH