The four fold promise

Indian Express, 27 February 2010

Finance Minister Pranab Mukherjee delivered more in Budget 2010 than was expected. It was a challenging job to roll back the stimulus in small and calibrated manner, as well as lower the fiscal deficit significantly. But, the FM delivered more than this tight-rope balancing act. He laid out a big picture of fiscal consolidation by reducing government debt, as recommended by the Thirteenth Finance Commission. He promised that the Direct Tax Code and the Goods and Services Tax will be implemented from April 1, 2011. These would be vital ingredients in allowing the government to meet its fiscal consolidation targets.

However, some of these announcements were expected, and perhaps not fulfilling these expectations would have created a negative sentiment. What came as a pleasant surprise were some new initiatives in the budget speech.

First, the FM announced the setting up of an apex-level Financial Stability and Development Council to strengthen, institutionalise and maintain financial stability. The need for such a body has been acutely felt after the global financial crisis. In the nascent field of financial stability there is an understanding that taking steps to address issues of risks to the financial system as a whole can require giving directions to all regulators. On his own a regulator, such the equity markets regulator, or the banking regulator, may not be able to see risks building up and may not tighten norms when required. This means a body over and above the existing regulators is required. Also, in the Indian context, this may involve taking decisions about unregulated entities, as it did in the case of the investment banks in the US. Today we may not know where trouble may arise but if it does, these trouble spots should not fall between the cracks in regulation.

Further, the public anger seen in the US and UK public on the use of tax payer money to help out big banks has shown how politically sensitive this issue can become. Tomorrow, if in India, tax payer money has to be used for bailing out a private financial institution that can create a risk to the system as a whole, the government could find it self facing all kinds of allegations. It is thus a sensible and forward looking idea to protect itself in such a situation by creating an institutional framework though which the FM does not put himself into the unenviable position of Hank Paulson or Alistair Darling. When faced with the decision to bail out a private financial institution, and be blamed for the decision, or to the let it fail and be responsible for a crisis, the government should be able to take bold decisions.

The Financial Stability and Development Council has to be over and above all regulators, who may have failed in their jobs. In the UK this job has been located in the Bank of England which is not a financial regulator, and in the US in a Council of Regulators. In India, the proposed Financial Stability and Development Council is along similar lines.

Second, the Finance Minister has taken into account the needs of India as a fast modernising and globalising economy. The laws that govern the financial sector are outdated, and after many ammenments over the years, they are now non-transparent and often ambigous. The existing structure of financial regulation has worked to a large extent by banning one financial product or the other. As the Economic Survey points out, India needs to move away from a model of an intrusive government to one of an enabling government which works through creating policies which are incentive compatible. This sentiment was supported by the FM in the early part of his budget speech when he says, "An enabling government...creates an enabling ethos so that individual enterprise and creativity can flourish." If this idea is taken forward it will require a whole new way of thinking about financial regulation. The FM has proposed setting up of a Financial Sector Legislative Reforms Commission to rewrite and clean up financial sector laws to bring them in line with the requirements of the sector.

The third pleasant surprise in the budget is the announced intention of the banking regulator, the Reserve Bank of India, to give new private bank licenses. This decision is welcome especially because after the global crisis many commentators seemed to forget that India was still to satisfy basic needs for financial services of its people, that half the population of the country still did not have access to banks. Instead, the crisis had become a reason to argue that India had done right not to allow more private banks to operate. The FM's speech has brought a sense of balance back into the discourse by indicating that India will make progress on providing financial services to its population. This is in line with the proposals for financial inclusion recommended by the Raghuram Rajan committee report.

The fourth forward looking decision in the budget is the creation of a Technology Advisory Group for Unique Projects which proposes to look at various technological and systemic issues for newly created projects that have a strong IT requirement. These include the Tax Information Network, New Pension Scheme, National Treasury Management Agency, Expenditure Information Network and the Goods and Services Tax. These projects require rising above the normal governement style of functioning i.e. within the given structure and existing department. They will need to be treated as projects that require a new way of thinking and the creation of the Technical Advisory group indicates that the government is aware of this challenge and will devote resources to meet it.

The disappointment in the budget speech was in the missing vision of a system devoid of "industrial policy", with the government knowing what is best for industry and promoting some sectors or products versus others through the use of tax exemptions, lower rates or subsidies. The last part of the budget speech was reminiscent of the old India of the 1970s with the FM proposing a reduction in duty on items such as rhodium, magnetrons and toy balloons. Once the Direct Tax Code and GST kick in these relics of the past will hopefully disappear forever.

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