Fix The Fisc

After the firefighting, the consolidation. BT presents the speech that Union Finance Minister Yashwant Sinha should make when presenting Union Budget 2000.

I rise to present the Budget for 2000-01, the first Budget of the New Millennium. The year that has gone by has been a tumultuous one. A government fell, a war was fought, and India held its 13th General Election since Independence. Yet the economy has more than withstood these challenges. The inflation rate has dropped, the rupee has remained stable, and we have added more than $1 billion to our foreign exchange reserves.

Most important of all, growth is accelerating. Figures for the second quarter of 1999-2000 reveal a marked improvement. The rate of growth of Gross Domestic Product (GDP) has hit 6 per cent, up from 4.20 per cent in the corresponding quarter of the previous year. Much of this growth has been driven by a fast-spreading industrial recovery and the buoyant performance of the services sector. With most forecasts projecting a growth rate of 6 to 6.50 per cent in 1999-2000, India will be one of the fastest growing economies in the world.

The Revenue Strategy

Widen the tax base by including all services, such as software

Improve tax-compliance among professionals and non-salary-earners

Extend the 1-by-6 tax-filing system to farm income

Phase out all tax exemptions including those on exports

Rationalise and reduce the number of excise slabs to three

Set medium-term targets for cutting import tariffs

The expenditure Strategy

Allow the market to determine all interest rates

Replace input subsidies with capital subsidies

Replace the PDS with a system of food stamps for the poor

Make Plan allocations to the states conditional

Link allotment of Plan expenditure to reform of user-charges

Shut down redundant state departments and redeploy the staff

The privatization Strategy

Create a schedule for privatising select PSUs

Transfer these PSUs to the Disinvestment Ministry

Earmark 10 per cent of sale proceeds for employees

Set up a trust to manage the privatisation proceeds

Sell shares in profitable PSUs to the public

Wind up the Disinvestment Ministry after 5 years

However, this is not enough. We cannot afford to be complacent, because the economy is beset with serious structural problems. Most of these, I am sorry to say, begin and end with the government, more specifically the perilous state of public finance. Let me place before the members of this House the details of that worsening condition. Debt servicing obligations have risen throughout the last decade and today account for 135 per cent of current tax collections. We are now borrowing more because we need to repay more. Total public sector borrowings consume almost 40 per cent of domestic savings. Funds that should be available for investment are being used to pay the government's interest and wage bills.

The steady erosion in the net worth of the Government Of India has meant that the government can no longer fund essential expenditure. The Plan expenditure of the Centre and states-a rough proxy for public investment-has contracted from 11.30 per cent of GDP in 1990-91 to 9 per cent today. We spend more than 4 per cent of the GDP on debt servicing and less than 1 per cent on public health.

In the Budget for 1999-2000, we had committed to embark upon a medium term programme of revenue and fiscal deficit reduction. Unfortunately, despite our best efforts to contain expenditure, the shocks that were imposed on the system by the Kargil operation and by the General Elections will result in considerable fiscal slippage this year. In 1999-2000, the fiscal deficit will overshoot the budgeted target by Rs 27,459 crore, or by more than 1.50 per cent of GDP. If the fiscal deficits of the various state governments are added on, then we are running a gross fiscal deficit of more than 10 per cent of GDP. This is unacceptable. We must undertake far-reaching structural reforms of the public sector. Which is why this Millennium Budget will chart out a medium-term programme to tackle the growing fiscal challenge.

The fundamental fiscal problem is, of course, the growing interest bill. In 1999-2000, we paid out more than Rs 88,000 crore to meet our interest obligations. That burden is only likely to rise in the future. Not because we are spending more, but because the government is simply unable to earn enough to service its debt.

To break this vicious debt circle, I am proposing a reform strategy that will both raise the returns of government assets and reduce the interest costs of government debt. In essence, the reform strategy will involve a big push on three fronts: privatisation; rationalisation of user charges; and movement towards market determined interest rates.

The 2 previous Budgets of the Atal Bihari Vajpayee Administration had reiterated the resolve of the government to reduce its stake in non-strategic Public Sector Enterprises (PSE) to 26 per cent. For my colleagues from the Left Parties, who are bound to allege that I am selling off the commanding heights of the economy to fund the fiscal deficit, I must explain why privatisation is essential for the survival of the public sector enterprise.

Today, there are 241 PSEs. If the oil sector PSEs are excluded from the reckoning because they earn monopoly rents, then the nation's public sector earns a return on capital employed of less than 3 per cent. But their cost of capital ranges anywhere from 12 to 16 per cent, which means we are eroding the capital base of these units at a rate of around 9 to 13 per cent a year. Worse, the intensifying fiscal crunch has cut the lifeline of budgetary support. Since the government can no longer pump in the resources for investment, the public sector cannot grow.

Privatisation is the only way to provide such autonomy. PSEs are by definition subject to Parliamentary scrutiny and ministerial supervision. And that means that the public sector will never function on purely commercial principles. Nowhere in the world have public enterprise reforms that stopped short of ownership transfer led to a sustained improvement in enterprise operations. In fact, if we do not initiate a large-scale process of ownership transfer now, we risk plumbing the commanding depths.

As the members of this august House already know, past efforts at disinvestment have generated little. This year too has been a failure. Against a budgeted target of Rs 10,000 crore, we have garnered only Rs 3,000 crore. Certainly, the fact that the government had to function with a caretaker tag for nearly 6 months did hinder progress; but procedural gridlock and a general lack of political will have stymied disinvestment efforts for nearly a decade.

In a clear statement of its political intent, this government has already created a Disinvestment Ministry. But, by itself, the creation of a Disinvestment Ministry will not be enough to cut through the bureaucratic red tape that has embroiled the disinvestment process. Therefore, I propose to transfer administrative control of the enterprises that are short-listed for disinvestment to the Disinvestment Ministry. Of course, the recommendations of the parent ministry will be taken into consideration, but responsibility for the disinvestment process will rest solely with my colleague, the Minister for Disinvestment.

That is an onerous responsibility but it will be a temporary one. The Disinvestment Ministry will be granted a 5-year term to execute the privatisation programme, after which it will be wound up. Its mandate, which will initially include all the PSEs referred to the Disinvestment Commission, will be expanded to include the entire public sector. The proceeds from privatisation will be managed by a trust set up by the ministry. Of these proceeds, 10 per cent will be earmarked for employees; the rest will be devoted to social sector spending.

The ministry will also determine the most appropriate mechanism for disinvestment-be it strategic sale, a Global Depository Receipt issue, or a retail issue to the general public. The only stipulation is that all profit-making public sector units be required to offer some percentage of their equity to the general public. In fact, I propose that such profitable public sector units file a shelf prospectus with the Securities and Exchange Board of India. Equity can then be sold to the general public in tranches. I am sure that this House will have no objection if I offered a discount on the family silver to the family itself.

The government has not been able to earn enough to cover its interest payments simply because it does not charge for the services it provides. The welter of explicit and implicit subsidies that state and central governments provide consumes over 15 per cent of GDP. Of these, over 60 per cent are non-merit subsidies, which means that it is possible to charge for these services. Yet recovery rates are no more than a shockingly low 3 per cent.

At this stage, I want to assure the House that it is not my intention to do away with subsidies. In a poor country like ours, subsidies are an integral part of the redistributive mechanism. However, badly designed and poorly targeted subsidy programmes do nothing to redistribute wealth. Worse, they lead to a deteriorating quality of service provision and, sometimes, no service at all.

We need a new social compact where the Indian population pays reasonable prices for reliable services. Of course, the state governments have to be equal partners in this compact. But I cannot ask my counterparts in the states to take hard decisions if I am not willing to do so. This year, therefore, I am announcing the restructuring of the explicit subsidies in the central government's budget.

Over the next 3 to 5 years, the food subsidy will be replaced by a system of food stamps. The coupons will be issued every quarter to qualifying beneficiaries to supplement their purchases from the free market. The sellers would be reimbursed by the government for the coupons. At one stroke, we would do away with procurement and storage costs, and leakages would be minimised. To improve targeting, the distribution of food stamps would be linked to participation in rural employment schemes.

I also propose to phase out the subsidy on fertilisers over the next 3 years. Let me explain how such a withdrawal would actually benefit the farmer. Studies show that over half the fertiliser subsidy accrues to fertiliser companies. It cannot be the objective of policy to subsidise inefficient companies.

Nor is it the objective of policy to discourage investment. But the subsidies on agricultural inputs like fertiliser, water, and power do precisely that. Since the farmer can earn adequate returns with nominal investments, there is no incentive to invest in the capital assets needed to break free of a low-level equilibrium.

Thus, I propose to use the money that is saved from the withdrawal of fertiliser subsidies to set up a fund for agricultural development. This will provide subsidies for capital investments like tubewells. And, apart from boosting agricultural output, such a scheme can also be politically rewarding.

State governments across the country are also initiating the rationalisation of user charges. To encourage such reforms, I propose to link a rising proportion of plan allocations to the rationalisation of user charges.

The cost of capital in India is simply too high. Real interest rates in India range between 7 and 11 per cent; in the rest of the developing world, it is around 3 to 4 per cent. High real rates constrict investment and raise debt-servicing costs. Our interest rates are out of alignment with those in the rest of the world, because interest rates on a large chunk of savings are not market-determined. The rates on small savings schemes, postal deposits, and provident funds are still set by administrative fiat.

In January, the government had reduced such interest rates by 100 basis points. To hasten the transition to fully market determined interest rates, I propose to transfer the responsibility for setting small savings and provident fund interest rates to the Reserve Bank of India.

I am aware that small savings constitute a form of social security. But we cannot jeopardise investment and growth prospects simply because we as a nation have failed to provide a social security system to our citizens. The Dave Committee has suggested a complete overhaul of our pension funds. I am happy to announce that we accept its recommendations. We will be implementing its recommendations within the next year so that we can provide savers with viable investment alternatives.

In a federal system, reform of the small savings rates will hinge upon the consent of the states, as the bulk of such collections are transferred to the state governments. To allay the anxieties of state governments, I propose to transfer all such collections to state governments, as opposed to the current proportion of 80 per cent. Also, state governments should understand that the lower the deposit rate is on small savings, the lower will be the lending rate that the Centre charges for the transfer of such funds to the states.

Although the savings achieved by trimming the administrative expenses of the Government of India will be limited, administrative reforms will only enhance the credibility and the efficiency of the government. Our patterns of governance are leftovers from an earlier, more regulated era. That leads to duplication, waste, and painfully slow decision-making. In a liberalised economy, what is the need for a Development Commissioner of Steel?

In my last budget, I had resolved to introduce zero-based budgeting. By looking at each item of expenditure afresh, we will be able to identify a whole slew of redundant posts and departments. These departments will be shut down, and the personnel will be redeployed in more productive functions. Such redeployment will effectively translate into a recruitment freeze, enabling us to pare down the numbers on Central government rolls.

Sir, I now present my tax proposals. By now, it is fairly evident that the rationalisation of income and corporation tax rates has improved compliance. There are now 20 million income-tax assessees as compared to 12 million in 1997. Therefore, I do not propose to alter these rates, other than to withdraw the 10 per cent surcharge I imposed last year.

However, improved compliance has not translated into buoyant revenues. For the last 5 years, the ratio of direct-tax revenues to GDP has remained stuck at around 3 per cent. In fact, revenue receipts fell short of the target in 1999-2000 largely because of a shortfall in direct tax collections. If tax collections remain sluggish in the face of an industrial recovery and rising personal incomes, then we have to accept the fact that our tax system has failed. It has failed to capture the benefits of economic growth largely because enforcement remains poor and because the tax base has not expanded.

To improve tax administration, I am setting stretch targets for the Central Board of Direct Taxes (CBDT). Computerisation of all records will have to be completed within the next 2 years. To expedite the process of computerisation, I am announcing a Rs 500 rebate for all tax-payers who file their return over the Internet.

Exclusions and exemptions have ensured that our tax base remains narrow. Agriculture and a wide range of services are not taxed, ensuring that nearly 75 per cent of the economy remains outside the tax net. I realise that taxing agricultural income would involve practical and logistical difficulties, as we have no reliable data on such income. To pave the way for the eventual levy of an agricultural income tax, I propose to extend the six-attribute tax-filing route for income tax to include agricultural income.

Services are easier to tax. I, therefore, propose to levy a flat tax of 5 per cent on all services, including software. The tax will rely on presumptive norms, rather than on voluntary declaration. For those who are concerned that a software tax will constrain the expansion of the knowledge economy, let me stress that this is an extremely low rate of taxation for a sector that is projected to export services worth $50 billion by 2008. To remove all anomalies, I also propose to withdraw the income tax exemption on export income over the next 3 years. My colleague, the Union Minister for Commerce will be providing details of the rationalisation of export subsidy schemes in the forthcoming Export-Import Policy.

In my last Budget, I had rationalised excise tax rates with the objective of moving towards a Value Added Tax (vat). As promised, I now propose to bring the number of excise slabs down from 5 to 3: a central rate of 16 per cent, a merit rate of 8 per cent and a demerit rate of 24 per cent. The movement towards vat will now hinge on greater uniformity amongst states' sales tax rates. In a historic decision in November, 1999, the states agreed to common minimum floor rates. To progress further, we now need to agree on common maximum ceiling rates.

On Customs duties, the time has come to quantify our intentions so that industry will be able to plan its investments. Earlier, the Chelliah Committee had provided signposts; but since 1997, there have been none. I propose to reduce the average tariff-which is currently around 30 per cent-to 15 per cent by 2003. This schedule translates into a reduction of 5 per cent a year. The special additional duty, which was intended to compensate industry for non-rebateable local taxes, will also be withdrawn in phases, but the timetable will hinge on the progress towards vat. Also, the reduction will be accompanied by rate rationalisation so that there is no negative protection. Inputs cannot be taxed at a higher rate than the final product.

For those who are worried that lower Customs duties will lead to an unlevel playing field for Indian industry, I want to emphasise that these fears are overblown. A study by the National Council of Applied Economic Research reveals that Indian industry is price-competitive in most segments. Four decades of isolation from the world economy has taught us that high tariff walls do not improve quality.

Our World Trade Organisation (WTO) commitments require us to push forward the schedule for removing all quantitative restrictions (QRs) to 2001. After consultations with the Commerce Minister, I am recommending that all such items be subject to tariff rates that are no higher than the peak rate of duty. Of course, these tariff rates will be brought down, keeping in mind the overall objective of the rate rationalisation and reduction.

The removal of QRs also makes dereservation an imperative. The 800-and-odd items that were reserved for small-scale production will now be competing with large-scale imports from abroad. And reservation prevents them from investing in the scale and technology that is necessary to take on those imports. I urge the members of this House to rapidly evolve a consensus on dereservation. The future of our small-scale sector is at stake.

I am confident that this process of fiscal consolidation and tax rationalisation that I have set in motion will reduce the fiscal deficit to 2 per cent by 2003. The House would have noted that this Budget has focused exclusively on fiscal reforms. I have done so because I believe that we have to first tackle a deepening fiscal crisis before we can begin to embark upon second-generation reforms. As Union Finance Minister, my primary responsibility is the state of the exchequer.

Of course, there is no danger of an immediate fiscal blowout, but the continuation of current trends will eventually lead to a crisis that will rock the foundations of our economy. The members of this House thus have a clear choice before them. We can continue to muddle along by tinkering with a few reforms every year, and wait to have a crisis thrust upon us. Or we can act now and push India decisively onto a higher growth and employment trajectory.