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Will it be a realistic document?

If the Government has to get a grip on public finances and even partially fulfil its responsibility to the poorest sections of the population, tough measures need to be taken, says Abhijit Roy.

"Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.''

Charles Dickens,

David Copperfield

THE NEW Finance Minister is about to present his first budget. As a build-up towards this budget, the Kelkar Committee recommendations and the proposed introduction of a comprehensive value added tax (VAT) have generated lively debate. To make the task of the Finance Minister more difficult, a number of important State elections are coming up. Further, a prolonged U.S.-Iraq conflict may result in budgetary estimates going awry.

Which are the areas in the budget the citizen concerned should be interested in? The budgetary exercise is being made in the backdrop of two important positives — the large foodgrain reserves and the burgeoning foreign exchange reserves.

The foodgrain reserves should be mainly used to implement a comprehensive food-for-work plan that will enable our poorest citizens to have two square meals a day as well as build necessary infrastructure, especially in drought effected areas.

As we have enough foreign exchange reserves, exporting foodgrains at subsidised rates in not the ideal solution.

For the first time since independence, we have substantial foreign exchange reserves of over $70 billion, and the amounts keep growing.

The Reserve Bank of India has been trying to find ways of stemming the growth in reserves by encouraging spending by the rich — allowing higher spending limits during visits abroad, investment abroad (directly or through mutual funds), and the like as well as encouraging Indian companies to invest abroad. However, the effective way to reduce the growth of foreign exchange reserves is to encourage imports.

On account of WTO pressure, most non-tariff controls on imports have been removed. Hence, in the new import regime, the importance of customs duty has become paramount.

Lobbyists are hard at work trying to ensure continued protection of domestic goods. Assuming imports at Rs. 48 a dollar plus average import duty at 30 per cent plus transportation costs for shipment from overseas, the landed cost of most imported goods rise to around Rs. 65 to Rs. 70 per dollar. This does not take into account countervailing duties, as domestic goods have to pay excise. Domestically produced goods should not require this amount of protection on an average to remain competitive.

However, even with reduction of import duty, import of capital goods may not rise if the investment climate does not improve.

For example, why should investment in power generation take place if offtake risks are not taken care of? The budget will provide an indication whether the Government is prepared to reduce the customs duty to Southeast Asia levels over the next few years.

However, lowering customs duty rates would impact revenue collections. The total tax to GDP ratio in India is around 15 per cent.

With Government expenditure exceeding income, the total fiscal deficit of the Centre and States is around 10 per cent of GDP. The faster we realise that the Emperor (the Government) does not have any clothes, the better for all of us. Unfortunately, the contents of the proposed Fiscal Responsibility Bill have already been diluted.

If the fiscal deficit of the Centre is to be brought down from 5 per cent to say 3 per cent over the next couple of years, the Government would have to depend upon both revenue generation and cuts in expenditure. Cuts in expenditure are already impacting the production of public goods.

However, reduction in expenditure are possible in areas such as subsidies, government downsizing and defence, but they are difficult politically. For example, newspapers have been full of reports that India is planning to make huge defence purchases.

Given the fact that India and Pakistan are under substantial international pressure not to be adventurous, will huge additional defence expenditure really improve our security?

On the revenue side, the corporate sector and individual income tax payers have to realise that choices have to be made. If the corporate tax were to be lowered from the present 35 per cent, then exemptions would have to be foregone. Similarly, if subsidies, sundry benefits such as housing loan tax deductions and Section 88 benefits have to continue, then there cannot be a substantial hike in the `no tax' slab. Another politically sensitive option is to hike disinvestments in public sector enterprises.

The Approach Paper to the Tenth Plan (2002-07) has suggested that a gross domestic savings rate of 29.8 per cent and a current account deficit of 2.8 per cent would be required to achieve an investment rate of 32.6 per cent, which given an Incremental Capital Output Ratio (ICOR) of 4, would result in a growth rate of 8 per cent during the Tenth Plan period.

Given the fact that the ICOR may have crept up to 5 during the Ninth Plan, achieving an 8 per cent growth rate appears well nigh impossible. In fact, achieving even a reasonable 6 per cent growth rate during the Tenth Plan would only be possible if government revenue expenditure is curtailed and foreign investments encouraged.

Given this background and the fact that the Foreign Investment Promotion Board (FIPB) is now under the Finance Minister, the Finance Ministry should play a proactive role in implementing the recommendations of the <243>N. K. Singh Committee on FDI. In fact, we should encourage foreign investments not only in infrastructure but also in other sectors such as financial services, real estate and retail distribution.

The Finance Minister also has to take a decision on pension reforms. The increase in life expectancy is resulting in a rapid rise of the number of elderly people. Out of a labourforce of 400 million, only about 28 million are employed in the organised sector. Even in the organised sector (including Government and public sector), the `defined benefit' model for the payment of pensions has become outmoded. A `defined contribution' model needs be implemented at an early date. However, the growth in the pensions market can be fuelled by tax benefits. Given the state of government finances, this is another conundrum for the Finance Minister to solve.

To conclude, if the Government has to get a grip on public finances and even partially fulfil its responsibility to the poorest sections of the population, tough measures need to be taken. If Government cannot control widespread tax evasion, then Government expenditure, including investment in the much needed infrastructure services, would have to be curtailed.

During 1996-97 and 2001-02, the combined fiscal deficit of the Centre and States as a per cent of GDP has risen from 6.4 per cent to 9.9 per cent. Government debt has crossed 70 per cent of GDP and if the present trend continues, a disaster is round the corner. The political and administrative structure and citizens have to realise that the Government cannot spend its way out of trouble.

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