In search of an ideal budget

The title surely sounds both presumptuous and pretentious. Presumptuous because in the title, one is perceived to be comprehending all the complexities of the socio-political system of the country and steering clear of the conflicting interest groups and pretentious because one is seen to be making a justifiable claim of knowing every solution to the knotty problems of fiscal management.

Despite the derisive grin that one is likely to attract, let us make an attempt at an ideal budgetary formulation.

Resolving conflicting interests

Having reconciled to this position, the next important issue is to determine the context and content of an ideal budget. Yes, it has to be ideal, but from whose point of view? For, there are literally hundreds of interest groups in our pluralist society.

Take only the industrial sector with which we are so much concerned. Here, the fragmentation of interests is as acute as in any other sector of the economy. We, thus, have the public versus private sector and large versus the medium and small sectors. Even within the small-scale sector, there is another tiny sector. Further, it can be classified into the final product manufacturing sector versus the raw or intermediate goods manufaturing sector and the domestic sector (swadeshi) versus MNCs operating in India, etc.

How is it possible to reconcile the interests of such divergent and conflicting groups?

Perhaps, the only way to satisfy all of them is to meet each one of their demands, irrespective of what happens to the government's fiscal responsibility.

By implication, the finance minister has to:

• reduce income and corporate taxes substantially
• rationalise and reduce excises
• expand plan and capital expenditure

Simultaneously, the FM has to provide incentives to save, invest and advise the Reserve Bank to initiate steps for reduction of lending rates. While there will be virtual unanimity on these policy initiatives from all sectors, there will be a conflict of interest on matters relating to rationalisation and reduction of customs tariff.

The conflict will remain because user industries, at present, find imports of a host of raw materials and intermediate products beneficial in view of the prevailing low global prices. So also the users of capital goods planning to set up new capacities in a variety of industries.

In contrast, manufacturers of such products have been complaining of intense competition and price disadvantage. Even manufacturers of many consumer products are complaining of dumping on an extensive scale. It is difficult to dismiss such contentions too easily. There is substantial truth in what is currently being experienced by divergent sections of Indian industry. This makes the task of any finance minister extremely envious. More so for the present incumbent. Why?

If one surveys the present economic scenario, one is delighted to see so many positive features -- peak levels of food stocks, healthy forex reserves, moderate core inflation, large surplus of industrial capacities waiting to be exploited fully, remarkable growth of exports, etc. At the same time, the performance indices of a large part of the industrial sector are disappointing.

For a fairly long time, the investment stimulus, in particular, has proved to be elusive due to which there is a sense of dismay and despondency in all the sectors. How will the FM strategise all the positives and engineer an industrial resurgence?

To begin with, it must be stressed that during the past few years, India has been wavering from its ordained path of growth. Therefore, the budget must reflect the noble intentions of the prime minister, who recently articulated the urgency of achieving nine per cent real gross domestic product (GDP) growth. Obviously, this is an enormous task for which a definitive road map must be formulated.

However, the immediate realistic objective would be to take the real GDP growth path, currently stuck at about 6 per cent, to the next higher stage of at least 7-7.5 per cent. Even for making this happen, Indian industry has to forge ahead at a 8 to 9 per cent rate on a sustained basis, granting that the services sector has now emerged as a principal engine of economic growth in India.

Priorities on corporate agenda
The corporate sector, engaged in manufacturing or any other business area, has the following three major issues on its immediate agenda of survival and growth:

• First, to prevent further erosion in shareholder values and  strive towards enhancing it as quickly as possible. The economic performance of a predominant section of the corporate sector, measured in terms of the now widely accepted technique of economic value added, has been a matter of serious concern.

  
  It has been perceived that on an average, three out of every five major corporations are value destroyers, yielding poor returns to their shareholders. None of the good corporate managements would like to be perceived so by their shareholders.

• Second, in the battle for survival in an intensely competitive and globalising environment, the concerned corporate sector has realised the imperatives of initiating and accelerating the process of business consolidation and restructuring. But the process is considerably hampered by the inadequacies of enabling legislative, judicial and administrative framework.

• Third, there is an urgency to secure external orientation to the business profile of their operations. This not only means export promotion as an integral part of the marketing strategies, but also new ways of looking at the external opportunities in the post-World Trade Organsiation (WTO) regime.

  
  This process needs to manifest increasingly in exploring global opportunities (both exports and imports), strategic alliances, technology transfers, out-sourcing and relocating operations abroad, etc.

Concentrate on key initiatives

There may be many other issues bothering the corporate sector. But in terms of the importance of strategic response to the new challenges of competition and globalisation, what has been stated above should obviously assume immediate precedence.

Much of this battle has no doubt to be fought by the corporate management itself. But without the supporting environment, the task is almost impossible to be accomplished. It is the fundamental task of fiscal governance - as it is even in the most developed countries of the world -  to protect and promote the interest of the domestic industry. This is particularly true in India, where the domestic industry has been built over decades in a totally different, inward-looking, highly regulated industrial environment.

It is in this context, and speaking strictly from the view point of domestic industry, that one would like the ideal budget to reflect the following five key initiatives.

• First, the cost structure of Indian industry has been impaired by a variety of factors in which the contribution of the domestic tax system and its incidence has been very deleterious. As an integral part of the newly-introduced Fiscal Responsibility Bill, it must be ensured that we provide a long-term stable tax regime. Therefore, frequent tinkering with the rate structure and various provisions relating to incentives and concessions must be eschewed.

  The forthcoming budget must clearly lay down the income and corporate tax structure having validity at least for the next three years, if not more. Thus, exigencies like natural calamities or even 'external shocks' like oil price hikes need to be met from the normal budgetary provisions or special contingency fund to be built over a period by diverting at least one per cent of total receipts exclusively for this purpose.

  The corporate sector must be relieved of the uncertainties of frequent tax changes. It is in this context that we want to suggest the withdrawal of the existing surcharge on both income and corporate taxes.

• Second, and the far more important aspect of the conducive tax policy is to mitigate the high cumulative incidence of indirect taxes on the Indian manufacturing sector, namely the burden of central excise (now called Cenvat) and states sales tax system, promised to be reformed in the next couple of years as states VAT. 

  On an average, the combined incidence of indirect taxes on industrial products would work out to at least 15 per cent. The extent of this burden on many products, particularly the high-value consumer products and consumer durables, would be as high as 25 to 40 per cent. At this level, Indian products are destined to be out-priced not only in comparison with imported foreign goods, but also in terms of the purchasing ability of Indian consumers.

  The truncated affordability of industrial products has limited the growth of our domestic markets and denied Indian producers the opportunity to exploit the economies of scale in a new market situation. Hence, the ideal budget must promise to reform and rationalise indirect taxes with a clear mandate to bring them to global standards in the next three years.

  There is no justification to move towards the customs tariff levels followed by the Association of South East Asian Nations (ASEAN) unless this basic condition precedent is ensured for Indian industry. To secure the commitment of the state governments in this endeavour, it may become necessary to give them comfort by proposing to incorporate some special grants-in-aid to cover the likely temporary dislocation in their revenues.

• Third, the FM cannot ignore the imperatives of vibrant capital markets. The investment sentiments have been severely damaged by the increase in the dividend tax from 10 per cent to 20 per cent in the last budget. The economic logic of this measure is extremely weak. The combination of the present corporate tax and dividend tax is excessive and severely constrains the capacity of the corporate sector either to distribute dividends or to retain profits for its operational needs.

  Further, there is a basic flaw in terms of promoting the ‘feel good’ factors with which the FM is so rightly concerned. Surely, therefore, it will be an act of economic sagacity, if the forthcoming budget makes a strategic retreat to the previous level of dividend tax.

• Fourth, to enable Indian industry to accelerate its exports, the budget must clearly set out the bold framework of export promotional efforts. With the proposal of phasing out the tax benefits on export profits (Section 80 HHC) already in place, an alternative scheme that is compatible with the regulations of the World Trade Organisation, needs to be urgently incorporated. Why should India shy away from its basic priority of helping forex earners, when most of the other countries are said to be providing incentives for promoting their own national objectives.
  
• Last, the budget must contain initiatives to remove various hurdles in the legislative, administrative and judicial process in tackling expeditiously the situations of liquidation and insolvencies. Much has already been said and written about the infirmities of the present environment in dealing with the growing problems of industrial sickness and restructuring.

  Ensuring flexibility of labour and property markets must certainly become a part of this process. Just as entry into various businesses has now become easy, the exit process - with all the necessary safeguards,  including the protection of basic essential interest of the labour -  should also be made easy.

Conclusion

In conclusion, on the basis of the logic of external value creation, the corporate sector, especially the manufacturing sector, would like the budget to give a bold and innovative lead.

Of course, it is also imperative to soften the real interest rate structure to global standards. But one appreciates the fact that unless the fiscal and the over-all macro-economic balances are corrected on a sustained basis, there is no prospect of an enduring reduction in interest rates.

The experience of the early part of the current financial year bears adequate testimony of the proposition that tinkering with the interest rates on considerations of short-term expediency cannot deliver the goods.

We believe in the intrinsic merit of the accelerated growth process to facilitate the ultimate goal of fiscal responsibility as well as global standards of interest rates. Hence, first things first.

We hope the FM is listening.

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(* Mr. S. S. Bhandare is a consultant with the department of economics and statistics of Tata Services Limited. This article has been reproduced with permission from www.tata.com, the official website of the Tata Group.)