India: Budget Knocks

By R S Nambi & R Nirmala

"Death and taxes are certainty in life. To rise to glory, the toil has to be harder."

As one looks through the economic kaleidoscope of India, one would notice that India is not a poor country and has been made poor, not wanting in resources but not put to proper use and unlike other developing countries, has rich managerial talents to manage these resources. With $72 billion forex reserves and the GDP growth rate of more than 5%, which is the envy of many, the economy is planning to leapfrog into 8% bracket of growth rate in the near future. Mind you, this is despite global recession, post-kargil management of economy, continuing cross-border terrorism which requires heavy defence expenditure and droughts gripping most states during the year. The exports have also picked up of late, the tax revenues are near the budgetary levels and the manufacturing sector is looking up with confidence. The tertiary sector is ever willing to contribute its mite to the overall growth rate of the economy. On the flip side of the coin, the country is faced with the growing menace of fiscal deficit and the ever-expanding subsidies. The authors analyse the various options available to the Finance Minister (FM) to rise above the expectations and make a professional job out of the forthcoming budget.

One of the problems faced in the recent past is the sluggishness of the investments both in the Government sector and the private sector. The psychology is also in the negative. Therefore it is upto the FM to motivate all the players in the country as well as outside to promote investments. The demographic analysis of the country reveals a burgeoning middle class who are dependent on fixed income and are active players in the capital market. It is only hoped that the FM would consider the long standing plea of doing away with the taxation of dividends both in the hands of the payers and the recipients and treating dividend payments as tax deductible expenditure in corporate taxation. Enough precautions may be taken through appropriate tax measures in respect of forex outgoes in this regard so that the resources are recycled only within the country for further national development. The FM and his team may also provide necessary reliefs and incentives for the NRIs to bring in their investments into India and participate actively in the economic development of this country. It is heartening to note that the disinvestment plans are on course and if only these funds are recycled properly in productive channels, the benefit of these resources can be enjoyed by the people at large. One of the suggestions in this regard is to retire the high cost debt and improve the allocation to various sectors such as health, education, infrastructure, etc. Further there should not be any discrimination in the matter of fiscal reliefs between NRI investments and foreign direct and institutions investments. One of the motivations could be the indexation of the devaluation of the Rupee for the foreign investor in allowing repatriation. In our view, these measures would boost the morale of the investors and the investment climate would pick up in the short term. As a rippling effect, the mutual funds industry would also start looking up.

We have a lot to learn from China and Korea in terms of policy on FDI. If the recommendations of N K Singh committee were implemented properly, it would encourage FDI not only in infrastructure sector but also in financial services, real estate and retail distribution.

The introduction of VAT across the country is likely to promote tax neutral regime and this in turn would induce investments in a particular area. The efficiency and the speed with which the new system is implemented would become the centrifugal force for attracting investments.

Any critic of the Indian economy is genuinely concerned about the fiscal deficit number. If the fiscal deficit were well under control, the country rating would also go up from the credit agencies. The fiscal deficit would have an inter-generation impact and the rate of interest at which the deficit was serviced should be much lower than the rate of growth. Thanks to the ability 0of the authorities to manipulate the interest rate, they could effectively hide the inter-generation impact. The lack of development on the infrastructure front is also having a consequential impact on the fiscal deficit number. The proper disinvestments programmes of both state and central PSUs can go a long way in containing the fiscal deficit. If we cannot achieve success in this arena, the virtue of having a high savings rate cannot be enjoyed.

A decision on pension reforms is also called for. The increase in life expectancy resulting in a rapid rise in the number of elderly people is mind-boggling. Out of a labour force of 400 millions, only 28 millions are employed with the organized sector and the concept of "defined benefit model" for the payment of pensions has become outmoded. The existing scheme has to be replaced by "defined contribution model" at an early date. However the growth the in Pensions market can be fuelled by tax benefits and professional management of the pension funds like what is obtaining in the advanced countries, can be considered.

The agriculture and the construction industry are the backbone of the Indian economy in the sense that these industries occupy the first and the second position in the economy. As has been pointed out by the Kelkar Task Force (KTF), the earlier the FM proposes agricultural income tax; it is better for the economy. As has been pointed out by eminent scholars, it would be financially prudent to subsidise the cost of capital inputs into the industry to make it more cost competitive and to enable the players to catch up with the contemporary technology in terms of pre and post harvesting techniques.

The FM should also lower the duty rates on construction equipments so that the industry would be able to acquire the latest technology and thereby improve productivity. A rationalisation of tariffs at regional level by comparing the rates prevailing with that in the neighbouring countries would promote cross-border investments.

An analysis of the account profile of the Government reveals a sorry spectacle of 82% of the revenue receipts being accounted by defence expenditure, interest costs and subsidies. For fear of political fallout, each of these has become a holy cow. Hence an attempt to improve Government finances has to come necessarily from increasing revenues through new tax measures. The subsidies account for close to 14% of the GDP i.e. more than the fiscal deficit of the Centre and the states combined. The non-merit subsidies such as higher education, sports, village and small industries, food, fertilizers, etc account for more than 75% of the total central budgetary subsidies or in simpler terms almost all the Centre’s borrowings for the year. It is much the same in the states as well. The net result is that for both the centre and the states combined, the overwhelming bulk of total borrowing was exhausted by non-merit subsidies leaving very little for investment. At the state’s level, the comparisons make the schemes laughable. Logically, one would expect non-merit subsidies to be lower in richer states where people are more in a position to pay compared to poor states. The research shows exactly the opposite. The per capita subsidy in Bihar is Rs.15, in Maharashtra Rs.261 and in Gujarat Rs.357.

Based on a recent study, the Indian middle class will remain amongst the more heavily taxed in the world. Based on a regional comparison of income and tax levels across the countries, it would be worthwhile for the basic income level to be increased to Rs.1 lakh as was proposed by KTF and introduce only two more slabs namely Rs.1 to Rs.4 lakhs and above Rs.4 lakhs. This would make the system more tax compliant at lower slabs and participative at higher slabs. The other simplification measures on direct taxation suggested by KTF are good economics and therefore merit consideration. In addition the harmonization of the personal tax rates can also be achieved and this would provide mobility of talents across the region.

It would be better to provide for a leaner and a meaner economy and introduce a budget with key emphasis on fiscal deficit and measures that would stimulate investments. The choice of making himself a professional or a politician lies with the FM and the coming 28^th would reveal it all.

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The authors, partners with M/s. RSN & Associates, Chartered Accountants, Chennai, can be reached at tejasve@md2.vsnl.net.in. The firm is on the panel of World Bank Group and ADB.