Review of the Economy
Review of the Economy on the Eve of Budget 2006-07
Challenges Before the Finance Minister
Dr. Tejinder Singh Rawal
Chartered Accountant
tsrawal@tsrawal.com
Come February 28, and the Finance Minister, P Chidambaram, who has been named the finance minister of the year 2005 for Asia by 'Banker' magazine for pushing reforms and reining in fiscal deficit, will be presenting another reform Budget for the year 2006-07. The Finance Minister’s job is not an easy one, and balancing the desire to be progressive with the pressure from the coalition partners of the Government is a tight rope walk for him.
The Budget is not merely a statement of projected income and expenditure of the Government. It explains the direction the Finance Minister wishes the economy to take during the coming year, and explains the deviation in the policy in comparison to the existing policies. Second, policies on various expenditure items also come under the scanner. The Finance Minister will, no doubt, be expected to spell out details of his divestment proposals, or at least such of them as remain after the gruelling negotiations with the Left.
Alarming Fiscal Deficit: While the engines of the economy are working a full speed, and the economy is accelerating at an impressive pace, fiscal deficit at 8.3 percent of gross domestic product is alarming. Let us understand the implication of fiscal deficit. There is a limited pool of savings available in the country for the Centre, the states and the private enterprise to borrow from. In order to meet the deficit the Govt has to access this pool. As long as there is a comfortable liquidity situation in the country, there is no problem, but when the liquidity deteriorates, borrowing by the Government has an effect of increasing the interest rates, which might throw out of gear the efforts of the Government to keep inflation under control.
One may argue that there is nothing wrong in the borrowings by the Government, if there is nothing wrong in private enterprises borrowing money from the market. This situation would have been comfortable if the Government borrowings had resulted in the creation of new capital investments, thus providing an impetus to growth. However, when the borrowings are used to finance the revenue spending, it defies all norms of financial prudence. Already 22 paisa of every rupee the Government earns towards meeting interest obligation of the debts contracted by the Government.
Implement FRBM Act: The Finance Minister has decided to keep in abeyance the implementation of the Fiscal Responsibilities and Budget Management Act 2003 (FRBM Act), which Act was conceived with a view to eliminating the revenue deficit. FRBM Act had provided for the gradual reduction in deficit to zero by 2007-08, the Finance Minister had deferred this date to 2008-09, so that, he argued, it is conterminous with the term of the present Government. The Finance Minister now knows that meeting this target is not possible. He confesses of having “pressed the pause button to the FRBM Act”. What is apprehended is that it might turn out to be the ‘stop’ button instead of the ‘pause button’
While effective steps have been taken to attack the problem of deficit by increasing revenue, more efforts are required on the expenditure side. Government needs to address issues of downsizing itself, tighter control on Governmental spending, and reduced allocation to certain sectors. For example, the budgeted expenditure on defence last year was a whopping Rs. 83,000 Crores, out of which Rs.34,000 were budgeted to go towards capital expenditure. Defence consumes as much as 14 paisa of every rupee earned by the Government. It certainly makes a case of improving relationship with our neighbour, rather than spending more of defence budget, since defence allocation has been eating into the resources of our as well as our neighbouring country’s not-so-healthy economy.
If the commitment the Government has made under FRBM Act is to be honoured, the Revenue Deficit will have to be reduced by Rs.90000 in three years, which is a Herculean task. It means a reduction of Rs. 30000 every year: this is something unheard of in Indian economy: only twice in last 20 years has the deficit fallen in comparison to the previous figures in absolute terms, on both occasions the reduction was less than Rs. 1000 crores.
The Left Factor: The greatest stumbling block in India’s progress has been the stand its Leftist coalition partners have been taking on various items of the reform agenda. Last year they made it difficult for the Prime Minister to go full stream with his reform process, disinvestment of many profitable PSU’s had to be kept in abeyance, the decision to allow FDI in important sectors had to be postponed.
Subsidies account for nearly nine per cent of government spending. It is an open secret that the subsidy ,more often than not , does not reach the people it is intended for, with the result that while it is big burden to the exchequer, it does not benefit the target clientele: something the country can ill afford, with a huge fiscal deficit. Successive governments have talked about scaling down subsidies but have always shied away from implementing it, lest they lose populist support. There is no escaping the fact that the exchequer has to pay for every concession, every subsidy the Budget offers.
The Finance Minister's success as a Budget-maker will be tested by his resoluteness in resisting the temptation to offer too many freebies. Mr. Chidambaram has a difficult task on his hands, given the demands of infrastructure and the compulsions of coalition politics, in framing a Budget that will please most, if not all, and help take the nation forward on a path of sustained economic growth with stability.
Particularly depressing is the scenario on petroleum prices, with his own ministerial colleague sticking to his stand that the rise in international prices should not be passed on to the public. This has serious repercussions in form of lower dividend payments by oil companies and thus affects the revenue deficit directly. While rise in petroleum prices affects everyone badly, and the opposition comes from all quarters, the Government shall have to learn to pass on the additional cost to the people. Actually, the inability to do so stems from the past blunders of the Government. In the past the Government did not let the citizens enjoy the benefits of reduced prices when there was a drop in international prices. Obviously, now they don’t have the nerve to displease the voter by loading him with additional cost burden. An unsustainable Budget is no good, however many sops it offers. There is no escape from the economic lesson that the exchequer has to pay for every concession, every subsidy that the Budget offers.
One bone of contention between the Finance Minister and the Left partners is the issue of disinvestment of the PSU’s.. While some progress has been made in getting the concurrence of Left partners in regard to profit-making navaratnas, there are still great many hurdles which the Government will have to clear using the process of political bargaining.
Learn from the neighbour: The Finance Minister needs to convey to his coalition partners the lessons of the Chinese experience with the divestment of stakes in Chinese State-owned banks in recent months. Massive divestment has taken place in China through the giant-sized initial public offerings in respect of its State-owned banks. China, which still wears the garb of a communist nation is now more laissez faire than many of the supposedly market driven economies. India needs to learn the lessons of free enterprise from its Communist neighbour!
Nurture the IT superpower: We need to remember the fact that India' is becoming one of the most important players of the world in the IT sector and it is the fastest growing foreign exchange earner for the country. Several US and European companies have located their back office operations in Bangalore, Chennai, and Pune. Abundant supply of labour, low wages, cheap satellite communications and the internet have been instrumental in the decision of foreign firms to establish their back office operations in India. Such operations create job opportunities in Indian cities and help lower costs for the foreign companies. These range from billing to payroll handling, from credit appraisal to airline reservations, and from inventory management to answering customer complaints. Data transcription and transmission for hospitals in the US and telemarketing for US firms is also being undertaken by Indian companies based in various Indian metropolitan cities.
The Government will have to do more for this industry, by creating the required infrastructure in the country. The government needs to support basic science and R&D in this sector to some extent because India has world-class engineers and scientists that have already brought it ahead in an important way and could keep it in the very forefront of this new technology. We had missed the bus of industrialisation in the sixties and seventies when the Western world which wholeheartedly climbed the bandwagon of industrial revolution. India had been able to make up for that by being a front runner in the IT race, it becomes imperative for the government to provide the right environment for the sector to flourish.
Labour Laws: Labour law reforms are critical as India has signed several free trade agreements with neighbouring countries. India has never succeeded in becoming the manufacturing hub for the world despite it being a low cost producer, because of archaic labour laws. But reform of rigid labour laws, which make it hard for firms to sack workers, is unlikely, given the expected fierce opposition from Communists and trade unions. Without labour reforms, competitiveness of the small and medium enterprises will be hurt, which in turn could impact export and industrial growth. It is time political parities think in terms of economics and not politics, if India is to usher into the league of developed nations.
Tax reforms: The regime of Manmohan-Chidambaram has been that of tax reforms. Tax collection has been higher than ever before, system more transparent and administration more conducive. However, in his over-enthusiasm, the Finance Minister seems to have treaded into controversial territories. One such example is the Fringe Benefit Tax (FBT). No other tax provision in recent times has caused so much dissatisfaction in recent times as FBT. FBT as implemented is indirectly a tax on expenditure. Moreover, the administration mechanism of the tax is complicated and confusing. The Constitutional validity of the law is being challenged at various Courts. The Finance Minister will have to completely re-write the law if he wishes it so serve as a logical instrument of tax revenue.
The Stock Market: The stock market has been on fire for quite some time, with indices scaling unprecedented heights. This is thanks to the inflow of huge foreign money on the strength of a buoyant economy. FII money will stay in only if the reform process continues, more FDI opportunities open up, and the GDP not only continues to grow, but grows at a pace faster than other emerging markets. This will also depend on the extend to which India is able to integrate itself with the global economy.
The $700 bn Indian economy, Asia`s third-largest, is expected to grow 7.0-7.5 per cent in the fiscal year ending March 31 but India needs to grow at sustained double-digit levels to reduce mass poverty. China`s economy has grown at about nine per cent a year for the past decade while India`s economy has averaged about six per cent. Tough reforms aimed at downsizing the Government, reducing the cost of governance, streamlining the bureaucracy, curtailing the financial deficit, coupled with labour reforms will be needed to give India the much needed growth rate of 10 per cent by the end of the decade.
Challenges Before the Finance Minister
Dr. Tejinder Singh Rawal
Chartered Accountant
tsrawal@tsrawal.com
Come February 28, and the Finance Minister, P Chidambaram, who has been named the finance minister of the year 2005 for Asia by 'Banker' magazine for pushing reforms and reining in fiscal deficit, will be presenting another reform Budget for the year 2006-07. The Finance Minister’s job is not an easy one, and balancing the desire to be progressive with the pressure from the coalition partners of the Government is a tight rope walk for him.
The Budget is not merely a statement of projected income and expenditure of the Government. It explains the direction the Finance Minister wishes the economy to take during the coming year, and explains the deviation in the policy in comparison to the existing policies. Second, policies on various expenditure items also come under the scanner. The Finance Minister will, no doubt, be expected to spell out details of his divestment proposals, or at least such of them as remain after the gruelling negotiations with the Left.
Alarming Fiscal Deficit: While the engines of the economy are working a full speed, and the economy is accelerating at an impressive pace, fiscal deficit at 8.3 percent of gross domestic product is alarming. Let us understand the implication of fiscal deficit. There is a limited pool of savings available in the country for the Centre, the states and the private enterprise to borrow from. In order to meet the deficit the Govt has to access this pool. As long as there is a comfortable liquidity situation in the country, there is no problem, but when the liquidity deteriorates, borrowing by the Government has an effect of increasing the interest rates, which might throw out of gear the efforts of the Government to keep inflation under control.
One may argue that there is nothing wrong in the borrowings by the Government, if there is nothing wrong in private enterprises borrowing money from the market. This situation would have been comfortable if the Government borrowings had resulted in the creation of new capital investments, thus providing an impetus to growth. However, when the borrowings are used to finance the revenue spending, it defies all norms of financial prudence. Already 22 paisa of every rupee the Government earns towards meeting interest obligation of the debts contracted by the Government.
Implement FRBM Act: The Finance Minister has decided to keep in abeyance the implementation of the Fiscal Responsibilities and Budget Management Act 2003 (FRBM Act), which Act was conceived with a view to eliminating the revenue deficit. FRBM Act had provided for the gradual reduction in deficit to zero by 2007-08, the Finance Minister had deferred this date to 2008-09, so that, he argued, it is conterminous with the term of the present Government. The Finance Minister now knows that meeting this target is not possible. He confesses of having “pressed the pause button to the FRBM Act”. What is apprehended is that it might turn out to be the ‘stop’ button instead of the ‘pause button’
While effective steps have been taken to attack the problem of deficit by increasing revenue, more efforts are required on the expenditure side. Government needs to address issues of downsizing itself, tighter control on Governmental spending, and reduced allocation to certain sectors. For example, the budgeted expenditure on defence last year was a whopping Rs. 83,000 Crores, out of which Rs.34,000 were budgeted to go towards capital expenditure. Defence consumes as much as 14 paisa of every rupee earned by the Government. It certainly makes a case of improving relationship with our neighbour, rather than spending more of defence budget, since defence allocation has been eating into the resources of our as well as our neighbouring country’s not-so-healthy economy.
If the commitment the Government has made under FRBM Act is to be honoured, the Revenue Deficit will have to be reduced by Rs.90000 in three years, which is a Herculean task. It means a reduction of Rs. 30000 every year: this is something unheard of in Indian economy: only twice in last 20 years has the deficit fallen in comparison to the previous figures in absolute terms, on both occasions the reduction was less than Rs. 1000 crores.
The Left Factor: The greatest stumbling block in India’s progress has been the stand its Leftist coalition partners have been taking on various items of the reform agenda. Last year they made it difficult for the Prime Minister to go full stream with his reform process, disinvestment of many profitable PSU’s had to be kept in abeyance, the decision to allow FDI in important sectors had to be postponed.
Subsidies account for nearly nine per cent of government spending. It is an open secret that the subsidy ,more often than not , does not reach the people it is intended for, with the result that while it is big burden to the exchequer, it does not benefit the target clientele: something the country can ill afford, with a huge fiscal deficit. Successive governments have talked about scaling down subsidies but have always shied away from implementing it, lest they lose populist support. There is no escaping the fact that the exchequer has to pay for every concession, every subsidy the Budget offers.
The Finance Minister's success as a Budget-maker will be tested by his resoluteness in resisting the temptation to offer too many freebies. Mr. Chidambaram has a difficult task on his hands, given the demands of infrastructure and the compulsions of coalition politics, in framing a Budget that will please most, if not all, and help take the nation forward on a path of sustained economic growth with stability.
Particularly depressing is the scenario on petroleum prices, with his own ministerial colleague sticking to his stand that the rise in international prices should not be passed on to the public. This has serious repercussions in form of lower dividend payments by oil companies and thus affects the revenue deficit directly. While rise in petroleum prices affects everyone badly, and the opposition comes from all quarters, the Government shall have to learn to pass on the additional cost to the people. Actually, the inability to do so stems from the past blunders of the Government. In the past the Government did not let the citizens enjoy the benefits of reduced prices when there was a drop in international prices. Obviously, now they don’t have the nerve to displease the voter by loading him with additional cost burden. An unsustainable Budget is no good, however many sops it offers. There is no escape from the economic lesson that the exchequer has to pay for every concession, every subsidy that the Budget offers.
One bone of contention between the Finance Minister and the Left partners is the issue of disinvestment of the PSU’s.. While some progress has been made in getting the concurrence of Left partners in regard to profit-making navaratnas, there are still great many hurdles which the Government will have to clear using the process of political bargaining.
Learn from the neighbour: The Finance Minister needs to convey to his coalition partners the lessons of the Chinese experience with the divestment of stakes in Chinese State-owned banks in recent months. Massive divestment has taken place in China through the giant-sized initial public offerings in respect of its State-owned banks. China, which still wears the garb of a communist nation is now more laissez faire than many of the supposedly market driven economies. India needs to learn the lessons of free enterprise from its Communist neighbour!
Nurture the IT superpower: We need to remember the fact that India' is becoming one of the most important players of the world in the IT sector and it is the fastest growing foreign exchange earner for the country. Several US and European companies have located their back office operations in Bangalore, Chennai, and Pune. Abundant supply of labour, low wages, cheap satellite communications and the internet have been instrumental in the decision of foreign firms to establish their back office operations in India. Such operations create job opportunities in Indian cities and help lower costs for the foreign companies. These range from billing to payroll handling, from credit appraisal to airline reservations, and from inventory management to answering customer complaints. Data transcription and transmission for hospitals in the US and telemarketing for US firms is also being undertaken by Indian companies based in various Indian metropolitan cities.
The Government will have to do more for this industry, by creating the required infrastructure in the country. The government needs to support basic science and R&D in this sector to some extent because India has world-class engineers and scientists that have already brought it ahead in an important way and could keep it in the very forefront of this new technology. We had missed the bus of industrialisation in the sixties and seventies when the Western world which wholeheartedly climbed the bandwagon of industrial revolution. India had been able to make up for that by being a front runner in the IT race, it becomes imperative for the government to provide the right environment for the sector to flourish.
Labour Laws: Labour law reforms are critical as India has signed several free trade agreements with neighbouring countries. India has never succeeded in becoming the manufacturing hub for the world despite it being a low cost producer, because of archaic labour laws. But reform of rigid labour laws, which make it hard for firms to sack workers, is unlikely, given the expected fierce opposition from Communists and trade unions. Without labour reforms, competitiveness of the small and medium enterprises will be hurt, which in turn could impact export and industrial growth. It is time political parities think in terms of economics and not politics, if India is to usher into the league of developed nations.
Tax reforms: The regime of Manmohan-Chidambaram has been that of tax reforms. Tax collection has been higher than ever before, system more transparent and administration more conducive. However, in his over-enthusiasm, the Finance Minister seems to have treaded into controversial territories. One such example is the Fringe Benefit Tax (FBT). No other tax provision in recent times has caused so much dissatisfaction in recent times as FBT. FBT as implemented is indirectly a tax on expenditure. Moreover, the administration mechanism of the tax is complicated and confusing. The Constitutional validity of the law is being challenged at various Courts. The Finance Minister will have to completely re-write the law if he wishes it so serve as a logical instrument of tax revenue.
The Stock Market: The stock market has been on fire for quite some time, with indices scaling unprecedented heights. This is thanks to the inflow of huge foreign money on the strength of a buoyant economy. FII money will stay in only if the reform process continues, more FDI opportunities open up, and the GDP not only continues to grow, but grows at a pace faster than other emerging markets. This will also depend on the extend to which India is able to integrate itself with the global economy.
The $700 bn Indian economy, Asia`s third-largest, is expected to grow 7.0-7.5 per cent in the fiscal year ending March 31 but India needs to grow at sustained double-digit levels to reduce mass poverty. China`s economy has grown at about nine per cent a year for the past decade while India`s economy has averaged about six per cent. Tough reforms aimed at downsizing the Government, reducing the cost of governance, streamlining the bureaucracy, curtailing the financial deficit, coupled with labour reforms will be needed to give India the much needed growth rate of 10 per cent by the end of the decade.
posted by Dr. Tejinder Singh Rawal at 10:24 pm
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