Stroking Sentiment

(Times of India, 26 January 2001)

In most countries, government budgets are of interest mainly to businesses

and businessmen. But ever since the 'development effort' began in earnest

in India in 1957, and with it steep increase in all kinds of taxes, the citizen has

taken a rather dim view of the budget. The only interlude was during

1991-97, when Dr Manmohan Singh began a process of cutting tax rates. But

ever since Mr Yashwant Sinha has taken over, the budget has

once again become something to dread.

This year is unlikely to be very different from the last two, which saw

consistent increases in taxes.

Indeed, tax increases are more likely this year as Mr. Sinha has to meet the norms set by the

proposed Fiscal Responsibility Act (FRA). The Act imposes limits on the amount

of government borrowing. The process of reducing deficits may well

start with the forthcoming budget. By March 2006 the revenue deficit needs

to be eliminated wholly and the fiscal deficit needs to be brought down to

2 percent of GDP. The latter is now at about 5.5 per cent of GDP and two-thirds of it consists of the revenue deficit.

So, Mr Sinha's main problem is the revenue

deficit, namely, the gap between current revenue and expenditure. The latter

consists of interest payments, subsidies, defence and government

administration. Of these interest payments account for nearly half and are

committed payments on past borrowings. So they will not be easy to cut.

One way out might be to reduce the interest rate on small savings or the

Public Provident Fund, even though that might be politically unpopular --

all the more so with so many assembly elections falling due this year.

Last year, the interest rate on PPF was brought down by one percent. This reduced the government's interest burden to some extent.

Given the lack of an old age support system for

non-salaried employees, this rate is very sensitive. Yet, since there are

few vocal groups amongst them to pressurise the government, there may be a

move to reduce interest rates on small savings.

While arguing his case for the FRA the finance minister has said that fiscal deficits

are bad for inter-generational equity because they make future generations

pay for the excesses of this one. He is absolutely right. But he needs to

ask himself whether inter-generational equity is enhanced if existing

productive units like railways, power stations, roads, schools, hospitals

etc are run into the ground because political compulsions will not allow

the charging of economic prices.

The cost of provision of services minus the amount collected through user

charges is the true measure of the excesses of the current generation and

it is the real burden which is being passed on to future generations.

It is consumers not paying even the average cost of

provision of services that constitutes a burden on future generations. What

sense does it make, for instance, that while power costs Rs 2.70 to

generate on average, the average price is only Rs 2.03?

As the Dabhol crisis unfolded, the possibility that the guarantees of the

state or central governments may be invoked has became quite real. In case

the MSEB had failed to pay Enron, the payment would have had to come from

the state, and failing that, the central government. Such means (by which

the government pledges future resources through guarantees) are not part of

the budget statement but should be. After all, they form an important part

of the 'excesses of the current generation'.

Indeed, the impending elections mean that Mr Sinha will find it hard

to raise user charges and reduce subsidies. (The railway minister,

Mamata Banerji has already indicated as much for railway fares).

Thus the onus of containing the deficit may fall on taxes because of political pressures both for not cutting expenditure and not raising user charges. Taxes may rise

also because Mr Sinha is under pressure from domestic industry to

do something in the matter of customs duties (even though this

could make him unpopular with traders who benefit from selling imported

goods). Though raising tariffs will fetch the government some much-needed revenue, it would be the wrong thing to do. It would provide protection to domestic industry which is

demonstrably inefficient by world standards.

Where direct taxes are concerned, in all likelihood, his gaze will settle

on services whose share now accounts for close to half of India's GDP. Even if services are taxed at a rate of 1 percent, large revenues can be generated. But as taxing all services will not be feasible the question is which services he will tax, how much, and

in what way.

While other taxes may not be raised, and there may be some rationalisation of indirect taxes, where will the much needed boost to the economy come from?

In the immediate context what the budget needs to do is to revive

investment, which has been flagging for almost five years now. Despite

attempts by himself and his predecessor, the investment ratio has

been disappointing. The budget for 2001-02 will be judged mainly by its

success or failure in this regard.

Last year witnessed a continuous decline in business sentiment (NCAER's Business Confidence Index has been falling since June 2000). This was attributed largely to the lack of good news on the economic front. An increase in investment requires an improvement in business sentiment.

Mr Sinha's main task is to achieve such a change of mood.

The various Chambers of Commerce have put forth scores of proposals to

revive investment. Some of these, such as a reduction in the surcharge on corporate income tax, are designed to reduce the burden of tax or to increase the level of profit at the firm or

industry level. Instead of rejecting these proposals outright, because they may upset the budget's balance, Mr. Sinha may do well to consider those that will improve sentiment and could therefore increase investment. Higher investment will translate into higher GDP and employment. Instead, he worries too much about housekeeping.

In other words, Mr Sinha needs to be the bearer of good news. One way to do

so is to give the economy -- rather than the polity -- what it wants. That

is genuine reform and good macroeconomic management which, for once, puts economic populism on the back seat. And this is Mr Sinha's real problem: no one is confident that he will do

the needful.

Which, in fact, provides him with an opportunity. Even if he does very

little, it will go a long way.

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The author is a senior economist at NCAER. The views expressed in this article are her own.