A. Vasudevan

The Finance Minister will be considering suggestions by members of the industry, economists and commentators in laying down the broad framework of the Budget. Is he likely to broaden the tax base? And what about FBT? Will the proposed divestment of non-navratnas take off and how will public expenditure be contained? A. Vasudevan offers a few insights.

BY THE time this piece appears, the main frame of the Budget for 2006-07 would have been set, taking into account the suggestions of the industry, economists, and commentators as also the reactions of the Finance Minister to some of the suggestions.

None of this would, however, imply that policies and specific measures have been firmly determined. There could still be shifts as new market and economic information flows in and with political developments.

An impression, however, is being created that revenue deficit does not matter and social sector expenditures have been incurred efficiently. The overall fiscal deficit is reported to be on target.

Market borrowing programme is stated to be within bounds and not likely to arouse inflation expectations. It is also reported that infrastructure projects would soon take off so that the bottlenecks to growth can be largely taken care of.

The optimism about the fiscal health could be interpreted to imply that the low tax to GDP ratio provides an opportunity for the Government to improve the tax rate as well as the tax base.

The Finance Minister has, however, hinted that the tax rates would not change, an argument that implies that tax rate smoothing has already taken place. In other words, there has been consumption smoothing at the given levels of income — an argument that requires to be empirically tested.

The Finance Minister's intention to broaden the tax base especially in respect of services is laudable. But this often invites political resistance from the affected interests. If the Government succumbs to the pressures, there would be deficit widening, given the trend rise in expenditures.

Unfortunately, the Budget would be presented at a time when the oil price uncertainty is high. This phenomenon aggravates concerns about fiscal deficit-widening partly due to higher amount of oil subsidies and inflation expectations and about the likely increase in nominal expenditures without a corresponding increase in tax revenues.

The Finance Minister has no option but to bring into tax net as many service activities as possible. His preference to retain the fringe benefit tax (FBT) is politically correct. Notwithstanding the theoretical objections, FBT in the present context is defensible on equity grounds.

But the Finance Minister has to also examine as to why the FBT in the existing form has not curbed the propensity of managements, both in the public and private sectors, to give more and more of perquisites and fringe benefits to their employees and whether the ineffectiveness of FBT is only due to its complexity. He could perhaps go for a combined solution: Raise the corporate tax by 50 basis points and simplify the FBT, nay all taxes.

There is an increasing perception that the Government is doing little to curb the tendency of private and public sector managements to get rid of lower-end jobs in order to appear lean and to add a few more jobs at the middle- to higher-ends with large amount of perquisites in the name of improving professionalism and efficiency.

The excessive spending by the new professionals for attending events including music extravaganzas and on goods that are perceived to be luxury items has given rise to considerable unease particularly among the unemployed youth having non-professional educational qualifications that do not provide any succour to them.

To eliminate such a perception, the Finance Minister could consider doing two things. First, he should impose heavy imposts on lavish birthday parties, ostentatious marriages, large religious gatherings, music shows, political party meets and processions, night clubs, perfumes, large and luxury cars, and high-end music systems, to name a few. Next, as a Minister committed to the all inclusive agenda of the Government, he should raise the issue of the optimal lean structures of public sector entities and departments given the large young labour force in our country.

One gets the impression that the Indian managements are largely led by the literature on human resources development and labour economics on this issue emanating from the West where the ratio of unemployed labour force to population is much lower than is the case in India.

The Finance Minister's proposed divestment of non-navratnas could take off if some ingenuity is injected in the process. There is no reason why the navratnas cannot take over entirely or some parts of the business of the identifiable non-navratnas to reap economies of scale and scope. In the latter type of takeover, the residual business of non-navratnas would become available for privatisation. It is also worth examining whether some of the non-navratnas could be made viable by allowing them to enter into strategic alliances with related professional service providers.

Given the prospect of facing business cycles, the Finance Minister should try to compete with the market for resources through issuance of medium term bonds and 365-day bills that would be inflation-indexed with respect to both the principal and quarterly payments of interest. This type of indexation, already prevalent in the US, is gaining in popularity. It is also worth examining the tradability of such indexed bonds.

Containing the public expenditures is never easy. The Government, however, cannot avoid allocating larger proportions of expenditure for law and order, and fighting terrorism, as well as for meeting natural disasters, social sector including such diseases as AIDS/HIV and infrastructure needs.

But one has to ensure that there are no leakages in these types of expenditures.

The outcomes budget as an experiment towards accountability is a first step but it could be rendered more credible by having a system of `peer' auditing, peers being drawn from civil society organisations where they exist.

If necessary, peers could be created by having some senior and respectable members of society as trustees. The reports of the peers should be made public.

The monetary policy formulations have so far gone in tandem with the macro-economic needs. The policy measures that accompanied the third quarter review reflect the triumph of practical wisdom.

The markets and the media expected no increases in the rates but when the monetary authorities announced 25 basis point hikes in both the repo and reverse repo rates, they were said to have been surprised.

But apart from the uncertainties on account of oil prices and other external developments, when commodity and asset prices exhibit tendencies to move up despite a favourable growth outcome, it is necessary to signal a preference for rate increase more so when capital inflows provide liquidity.

However, since the hike is to act as only a signal, the authorities could well have moved up the rates modestly say by 15 or 20 basis points instead of 25 basis points sanctified by other central banks as a method of interest smoothing.

The announced hikes have left an impression that the central bank is moving towards inflation targeting, a luxury that the law as presently codified does not allow. The focus has to be as much on credit expansion for triggering activities as on price stability.

The central bank has to therefore allow sufficient elbow room for credit expansion by bringing down the cash reserve ratio (CRR) to the prudential level of 3 per cent as per law in a structured manner. Besides, from the growth point of view, it is best to measure the increase in credit flows in terms of non-food, non-priority sector credit rather than non-food credit.

(The author, former Executive Director of the Reserve Bank of India. He can be contacted at asurivasudevan@hotmail.com)

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