The Hindu : A selfish and shortsighted public reaction

Online edition of India's National Newspaper
Tuesday, Mar 12, 2002

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A selfish and shortsighted public reaction

By Prem Shankar Jha

Yashwant Sinha's budget for 2002-03 is the most unpopular that he has ever presented. Industrialists are disappointed that he did not remove the minimum alternative tax, but lowered the peak rates of customs duty at a time when the country is facing an avalanche of cheap consumer goods imports. Fixed income groups are up in arms over the reintroduction of the dividends tax and removal of concessions on income from various types of socially desirable investment. Farmers, or to be more precise their lobbyists in Parliament, are sore over a small reduction in the subsidy on urea. Other self appointed protectors of the poor are angry because Mr. Sinha has marginally raised the price of cooking gas, and kerosene to reduce the whopping subsidy on these items.

These reactions are selfish and shortsighted. They are selfish because they look only at the expenditure side of household incomes and not the income side. Take cooking gas: a typical middle to upper working class family of five uses at most two cylinders of gas a month and will therefore have to spend Rs. 80 extra a month. But nine out of ten of these families also own either a scooter, a motorcycle or a car, which runs on gasoline. Between early February and the budget day, the price of gasoline has come down on an average by Rs. 2.50 a litre. The family has to use only one litre of gasoline a day, to save the additional cost of the cooking gas. Most families use more than that. Truck and bus owners have been similarly benefited by the decline in diesel prices.

By the same token urea prices have remained unchanged for at least four years, but the minimum support price for foodgrains has been raised by 7 to 17 per cent a year for the last decade if not longer. Does anyone seriously believe that only incomes should rise and not costs of production? Yet this is what the farm lobby and its champions in parliament and the State legislatures have forced the nation to accept for most of the 1990s.

What is missing in these reactions is an awareness of the consequences of not reducing the fiscal deficit for their own and their children's' future, a few short years in the future. Let me put this cost bluntly. If the fiscal deficit is not contained soon, then in at most two years the Indian State will find itself in an internal debt trap from which it will be able to extricate itself only by deliberately triggering hyperinflation and reducing the real value of the national debt drastically. Long before that happens foreign short term lenders to India, whose money now makes up 95 per cent of our so-called reserves will start to leave the country. The country will then be plunged into a second foreign exchange crisis of the type it faced in 1991. This time the IMF will be merciless, and the terms of a bailout may well include the dismantling of nuclear weapons and arbitration on Kashmir.

The statistics are damning: The combined debt of the Central and State governments has climbed to 85 per cent of the GDP, of which the State governments have accumulated fully one third, largely be simply ignoring the Constitution of India. The Central Government is on the teetering edge of a debt trap. Its interest payments now swallow 51 per cent of the total revenue.

Another 21 per cent goes in salaries and pensions and 26 per cent on defence. These three irreducible items, over which the government has no control, account for 98 per cent of all revenues. This means that all, literally all of its budgetary support to its own and the State government plans, to Centrally sponsored schemes, and to specific state schemes such as rural electrification comes from borrowed money.

Most of this is revenue expenditure, that is, money being used to maintain capital assets and not add to them. It therefore counts as consumption and not investment. It cannot be reduced either without allowing the capital assets built up in past decades to turn into derelict ruins. With the combined fiscal deficit of the Centre and the States running at nearly 11 per cent _ more than twice the growth of GDP, the ratio of national debt and debt servicing to GDP is bound to keep rising.

Mr. Sinha has been aware, virtually as he took up the finance portfolio, that there are only two ways of avoiding a debt trap. The first is to reduce the fiscal deficit drastically within a year or two, divert the savings into investment, thus kickstart an industrial recovery and rely on the rise in tax revenues to bring down the 98 per cent ratio of fixed expenditures to a more manageable figure.

The second is to reign in the growth of the fiscal deficit as a proportion of the GDP, by curbing the growth of government expenditure to the extent possible and increasing tax revenues in a manner that does the least damage to future production, and relying on a good harvest and an increase in public investment, to push up demand and spark an industrial recovery.

Last year and the year before, he attempted to take the first route: he announced the cessation of unlimited procurement, ended subsidised food sales to above poverty line recipients in ration shops, and announced that petroleum product prices would be completely regulated by March 31. His efforts were beaten back by the determined resistance of bankrupt State governments and their representatives in the NDA coalition at the Centre, who are simply too broke and too populist in their temperament to brook the slightest change in the present scheme of unlimited subsidies.

This year Mr. Sinha was left with no option but to try the other route. He has budgeted for an increase in tax collection of Rs. 10,500 crores and plans to keep the rise in expenditure within 12 per cent of last year's figure. He is also budgeting for a spontaneous increase in revenues of 12 per cent, to be generated by a 7 to 8 per cent rate of growth in Industry. He is pinning his hopes of an industrial recovery on the good performance of agriculture and on a one fifth to one-third increase in public investment in the infrastructure.

Mr. Sinha's strategy may be foredoomed. First, the Centre is only responsible for half of the country's fiscal deficit. The States are responsible for the other half and are not proving conspicuously successful in containing their burgeoning expenditures. They have already swallowed their employees' provident funds, and are regularly consuming the small savings into which poor people put their faith. The memoranda of understanding with which Mr. Sinha has tried to bind them down to greater fiscal responsibility, have so far had little impact on their expenditures. So the few decimal points of reduction in the fiscal deficit that Mr. Sinha will achieve with the above strategy is almost certainly be swallowed up by their rising deficits.

Soon, a finance minister of India is going to find out that he is left with only the first option, and has to choose between economic catastrophe and a guillotine reduction of the fiscal deficit. But even if four fifths of the present subsidies (which are responsible for the deficit) are misdirected, the fact remains that cutting them will be a painful exercise. If the richest and most secure people in the country, who have the most to gain from drastic economic reform, are unwilling to set an example by accepting marginal cuts in their ever rising incomes, then how can they expect the poor and the middle classes, who benefit most from subsidies today, to accept much larger cuts in the near future?

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