that time of the year once more. P. Chidambaram will soon present
his third Budget as Finance Minister in the United Progressive
Alliance government. The big questions are: will it be another
dream Budget? Will he bow to the dicates of his Marxist allies?
Or will he walk the middle path between these two extremes? The
answers will be available on February 28. A Dream or Ideal Budget
will, obviously, be one that takes the reforms process forward,
and generates growth, without any baggage of Left influence; the
most Likely Budget will pamper the common man, keep his partners
happy and include a few incremental reformist measures; while
a Left-oriented Budget (God forbid) is too horrendous even to
The Ideal Budget
The direction of such a Budget is a no-brainer.
It should contain measures to push manufacturing sector growth,
currently hovering at around 7-8 per cent, up to 12 per cent,
thereby increasing the overall growth rate. "It will be difficult,
but not impossible, to achieve," says Rajiv Kumar, Chief
Economist, Confederation of Indian Industry (CII). Correcting
the inverted customs duty structure on a wide range of industrial
items-import duties on raw materials and inputs are higher than
those on finished goods, thus, discouraging value addition within
the country-will be a good first step towards this end.
| THE 5 PROBLEM AREAS
| AGRICULTURAL SLOWDOWN:
Agricultural growth has seesawed from -7 per cent in
2002-03 to 9.6 per cent the next, to 1.5 per cent in 2004-05.
It is unlikely to cross the 3 per cent mark this fiscal, pulling
back overall economic growth.
SLOW PACE OF REFORMS: There
has been no progress on disinvestments, labour reforms,
subsidy cuts and on easing caps on foreign investments in
certain sectors. Given the legislative arithmetic in the
Lok Sabha, this state of socialist bliss is likely to continue.
GROWING CURRENT ACCOUNT DEFICIT: The
current account deficit grew 54.3 per cent to $7.66 billion
(Rs 34,470 crore) for the quarter ended September 30, 2005.
This may lead to higher borrowing costs for consumers and
companies, slowing down economic activity.
TAXATION ISSUES: The Fringe
Benefit Tax is a step backward. Value Added Tax has been
introduced without phasing out the 4 per cent central sales
tax, adding to the burden of domestic producers. And higher
customs duties on intermediates than finished products penalise
THE OIL ECONOMY: The government
is wary of raising oil prices in a year when five states
will go to the polls. Result: rising subsidies, which are
farmed out to public sector oil companies. Indian Oil Corporation
incurred a loss last quarter while the profits of Bharat
Petroleum and Hindustan Petroleum fell 43 per cent and 33
per cent, respectively, in 2004-05. Clearly, such losses
are unsustainable in the long run. And that's over and above
the oil import bill that will touch Rs 1,72,326 crore this
The ideal Budget should also make it mandatory
for all states and Union Territories to uniformly implement Value
Added Tax (vat) and simultaneously do away with the 4 per cent
Central Sales Tax (CST). "It will be even better if the government
announces a single rate goods and services tax (GST) at an early
date to remove all disputes and anomalies in the central excise
and service tax structure," says D.K. Srivastava, Director,
Madras School of Economics. If implemented, these two measures
will rationalise the lop-sided indirect taxes structure in the
country and nudge the manufacturing sector into a higher growth
An ideal Budget will obviously have a high
feel good quotient. Abolishing the Fringe Benefit Tax (FBT) and
the Banking Cash Withdrawal Tax will generate disproportionate
amounts of it as will a reduction in the indirect tax rates (both
vat and excise duty). Introduced in the last (2005-06) Budget,
FBT shifted the tax burden on perquisites from employees to employers
and became a nightmare for the latter. The reason: many legitimate
expenses, such as business promotion activity and work-related
travel, have been classified as perquisites and are being taxed
at varying rates. Says Rahul Bajaj, Chairman, Bajaj Auto: "The
FBT is neither logical nor equitable and creates all kinds of
problems while filing income-tax returns. So, I would humbly urge
the Finance Minister to rethink the tax." India Inc. is even
willing to pay for this: industry leaders say they don't mind
paying an additional 2 per cent corporate tax-over and above the
current rate of 30 per cent-to compensate the government for any
losses. FBT apart, the direct tax structure in the country is
benign and needs only some minor adjustments to further improve
The other elements of the big picture: large
investments in infrastructure and agriculture, land reforms, and
the creation an all-India market. This last will mean doing away
with or amending laws such as the Essential Commodities Act 1955,
Standard of Weights and Measures Act 1976, and the like.
In services, the Finance Minister should
ensure that foreign companies with captive business process outsourcing
arms are neither taxed, nor made to file their returns here. "Otherwise,
the country stands to lose up to $1 billion (Rs 4,500 crore) in
revenues and a sizeable number of jobs. And worse, India may even
miss the target of $60 billion (Rs 2,70,000 crore) from it and
ITEs exports by 2010," says Sunil Mehta, Vice President,
|"The Budget needs
to increase the weighted deduction for research and development
for the pharmaceutical sector from 150 per cent to 200 per
But Chidambaram also needs to generate substantial
revenues to fund the government's massive social sector and infrastructure
schemes. The simplest way forward: reduce the number of tax-related
litigations, involving potential revenues of Rs 1 lakh crore,
which are currently pending in various courts. One solution could
be to set up special economic courts or special arbitration processes.
Large public investments in infrastructure development will create
a virtuous circle and lead to a "crowding in" of private
sector investment. "An annual target for gross capital formation
in infrastructure should be announced by the government,"
says CII's Kumar.
And on the policy front, the Finance Minister
should encourage consolidation in the banking sector by amending
the Banking Regulation Act of 1949, introduce legislation to govern
the micro-finance sector, and raise the foreign direct investment
(FDI) ceiling in the insurance sector from 26 per cent to 49 per
cent, open up the retail sector and announce labour reforms.
The cumulative impact of all these measures
will almost certainly push the gross domestic product growth rate
to 9-10 per cent. Will it happen? Given the political compulsions
of the ruling coalition, it's highly unlikely.
The Likely Budget
The focus of the forthcoming Budget will
be "on the common man and the rural masses", the Finance
Minister has already announced. So, we can expect Chidambaram
to unveil measures to generate employment and announce higher
budgetary allocations for health, education, rural infrastructure
and irrigation. And sectors such as textiles, chemicals, handicrafts,
food processing, pharmaceutical and automobiles can expect tax
breaks because of their employment generation potential.
|"Given the state of
Indian infrastructure, the Budget needs to allocate an additional
Rs 10,000 crore per year for infrastructure development"
Managing Director, Videocon Industries
Since Prime Minister Manmohan Singh and Chidambaram
himself have promised to bring down customs duties to the levels
prevailing in the Association of South East Asian Nations, peak
import tariffs will come down from 15 per cent at present to 10-12
per cent. This apart, the Budget is unlikely to unveil radical
changes in the country's tax-both direct and indirect-structure
other than doing away with area and location-based tax incentives
(tax breaks for setting up industries in backward areas). "Since
there is little scope for tinkering with the tax rates, the thrust
will be on the tightening of the tax administration to prevent
leakages. The goal will be to make life easier for tax payers,"
says a senior finance ministry official. But evaders watch out.
The Finance Ministry, armed with countrywide data on big-ticket
purchases and other lifestyle expenditure, will intensify the
drive to catch the big fish, broadbase the tax base and increase
Some more pointers: the investment climate
will become more friendly, and Left or no Left, and the government
will disinvest minority stakes in non-Navratna public sector units.
And, this is iffy, Chidambaram may once again try to prune the
food and oil subsidy bills, and then roll this measure back as
a "concession" to Leftwing and populist sensibilities
in return for having his way on other issues.
But the real positives in this Budget will
be the expected announcement that the government has met the targets
set forth in the Fiscal Responsibility Act and the Budget Management
Act despite high oil prices, the tsunami, and political compulsions.
The negatives will be the unbridled rise in the current account
deficit and the absence of any tough reforms measures which are
necessary to take the economy up to the next level.
The Left-inspired Budget
The formula for this is simple and should
be familiar to anyone who's lived through India's disastrous tryst
with socialism: tax the rich further, levy higher taxes on consumer
goods and other targets of Marxist ire and squander precious revenues
on dubious pro-poor schemes which look good on paper but whose
economic value will remain unquantifiable. Says M.K. Pandhe, President
of the CPI(M)-affiliated Centre for Indian Trade Unions (CITU)
and a member of the party's politburo: "The government will
have to face the consequences if it does not desist from taxing
the poor and helping the rich and the corporate houses."
|"The Budget has to be
pro-growth and pro-investment. The Finance Minister wants
to refine the Fringe Benefit Tax; but I would humbly beg him
to scrap this obnoxious levy"
Chairman, Bajaj Auto
This means the pension sector will continue
to suffer; foreign investment in the insurance sector will remain
capped at 26 per cent, and the telecom sector at 74 per cent;
disinvestment will be a non-starter; and the small-scale sector
will continue to be protected from international competition by
high tariff walls.
The comrades feel the "rate of effective
taxation" in the country is rather low; so they want higher
corporate tax rates, higher income-tax rates for people at higher
income levels, and a 15 per cent short-term capital gains tax.
Nagesh Kumar, Director-General, Research and Information System
for Non-Aligned and other Developing Countries, partially agrees
with this idea. "There is a need to moderate the inflow of
foreign funds into the Indian stock markets to control the volatility;
hence, it won't be such a bad idea to levy some kind of an exit
tax when this money leaves the country," he says.
But higher taxes will almost certainly lead
to lower revenues and a deceleration of growth rates that economists
call the Laffer Curve Effect. And if the government accepts the
Sixth Pay Commission Report, the massive resultant outflow on
salaries will take the fiscal deficit into the stratosphere. The
combined result of these measures will puncture the current consumption-led
economic boom, lop off a few percentage points from the GDP and
other growth figures, fuel inflation, lead to a crash in the stock
markets (remember the first days of the UPA government when every
Left leader worth his salt shot his mouth off about economic policy?),
and take us back to the era of the Hindu rate of growth (an unfortunate
communalisation of a socialist construct). The poor, in whose
name the Left would want to visit this scenario upon us, will
be the worst losers, but inconvenient facts have rarely ever worried
the ideologically pure comrades. Fortunately, though, the Left
lacks the numbers to dictate such a Budget.
Then again, Chidambaram may well say "none
of the above" and surprise us with something totally different
and unexpected. Wait till February 28.