G. Chandrashekhar

Given the competitive environment in which businesses function, even a small concession can disturb the balance in favour of players in certain regions, and by implication hurt the interest of others.

Mumbai , Sept. 5

THE Tamil Nadu Chief Minister, Ms J. Jayalalithaa's recent objection to grant of fiscal concessions for attracting investment in States such as Himachal Pradesh and Uttaranchal might have evoked mixed reaction from different quarters.

Apart from business economics, the political implications of the objection are not lost on people. But there is considerable merit in her argument that concessions create avoidable distortion.

While there can be no two opinions on the need to pursue policies that would result in all-round economic development with minimal disparity between regions, grant of tax and other exemptions is sure to skew the marketplace and tilt the existing playing field in favour of the tax beneficiaries.

It is common knowledge that investments generally flow to regions that promise safe and steady returns. Given the competitive environment in which businesses function, even a small concession can disturb the balance in favour of players in certain regions, and by implication hurt the interest of others.

It is therefore necessary that tax and similar concessions decided by the Centre are based on objective criteria. These criteria have to be unambiguous and spelt out in advance. Any relaxation should be backed by strong persuasive need.

While on excise duty concessions to underdeveloped regions, a classic case that comes readily to mind is the excise duty exemption granted by the Centre to manufacturing units in the Kutch region of Gujarat as part of relief package following the massive earthquake the region faced in January 2001.

Exemption from excise duty for Kutch-based units was announced some time in June 2001. At that point of time, manufacture of refined oils and vanaspati was not subject to any excise duty. No investment into the region's oilseeds-based sector flowed for over a year-and-a-half. No new refineries or vanaspati factories were set up for nearly 20 months. On March 28, 2003, the Union Budget imposed excise duty on manufacture of refined oils and vanaspati.

Action started from that time. In a short span of time, large players including multinational corporations in the edible oil business set up huge refining capacities in Kutch, merely to take advantage of the duty concessions. In about a year's time, about a dozen companies added 30 lakh tonnes of refining capacity, even when the rest of the country carried large idle capacity.

The commercial viability of all the new units depended almost entirely on imported raw material.

There was little justification for concentrating large refining capacity in one region when the consumer market spread across the length and breadth of the country. Given the highly competitive trade environment in edible oil, the exempted units enjoyed windfall gains as they enjoyed not only scale economies but also tax breaks.

Through their aggressive pricing policies, they hurt the older and smaller refineries. Indeed, there was nothing to suggest that the excise duty concession was passed on to consumers; while on the other hand units that bore the brunt of the tax burden were faced with the prospect of closure or sickness.

Worse, employment generation - one of the key considerations in attracting investment in any region - was rather limited in Kutch as most manufacturing units were highly automated. The new refineries in Kutch came up not because there was dearth of capacity in the region, but primarily to take advantage of the tax concession. In retrospect, as ill-luck would have it, in the last Budget the Government abolished excise duty on manufacture of refined oils and vanaspati, a move that levelled the playing ground once again. The corporates that invested in Kutch, based solely on the hope that the tax differential between them and others will continue for five years and deliver to them windfall profits have now been left high and dry. The commercial risk they took misfired. It is unclear if shareholders of these companies were hurt.

Because huge investments have been made and factories have to run, these units continue to import crude oils for refining, whether the market needs it or not. This is one of the reasons why India's edible oil imports are expected to rise by over 10 per cent during oil year ended October 2005 to over 50 lakh tonnes, despite the government claiming large production of oilseeds.

In sum, tax concessions for specific reasons have to be on merits. Region-specific tax breaks distort the business environment. Policymakers have to think-through the implications of such largesse granted selectively not only on the region selected but also outside the region.

© Copyright 2000 - 2009 The Hindu Business Line