Monday, February 25, 2008

What the Indian FM should do

Abolish income tax and look at other ways to ensure that India does not slip into an economic crisis
Subramanian Swamy

Congress party leaders have let the cat out of the bag and publicly deflated finance minister (FM) P. Chidambaram in a most embarrassing way. According to a well-placed media leak, a conclave of 38 party leaders told the FM that this year they would like to have a Budget “that caters to the aam aadmi”. Thus, they told him, inflation and farmers’ woes must be combated head-on and relief given concretely. No more esoteric dream budget rhetoric, they told him.

(Jayachandran/Mint)The implication of this directive is that the last four budgets Chidambaram presented did not cater to the aam aadmi, and that today inflation is rampant and farmers are in distress. Thus the globetrotting FM was rudely brought down on desi soil and given a reality check by the party itself.

Despite high GDP growth, the internal organs of the Indian economy are not healthy today. This is alarming. Any fast growing economy can collapse suddenly, as the 1997 experience of the East Asian economies showed.

These are the principal ills in the economy right now.
1. Jobless, low-productivity growth. High growth rates are not generating enough jobs, which have been growing at 2.25% a year since 1999-2000. However, to progressively reduce the unemployment backlog, absorb excess farm labour into industry and provide for the new entrants in the labour market, jobs must grow at about 3.5% a year. At the same time, the economy must raise productivity of labour and capital through induced innovations and new management practices, so that higher and higher investment rates would not be needed to sustain growth. Hence, in the Budget there must be adequate provision for encouragement of labour-using instead of labour-substituting technology. There should also be provisions to promote innovation through radical tax breaks. This means the education sector has to be nurtured in the Budget.

2. Lack of agricultural reforms. The growth rate in agriculture should be at least 4% annually to ensure that 8-10% GDP growth is sustainable. But since 1997, agriculture has shown a trend rate of 2.5%, with wide fluctuations year to year, due to lack of reforms, declining public investment, and poor, even pre-modern, infrastructure. Rather than resorting to the silly ad hoc measures to uplift rural people that we have seen in past budgets, we must empower farmers to export through imaginative schemes rather than provide more subsidies and higher purchase prices.
3. Fiscal deficit. Governments are impounding public sector bank funds (nearly 48%) to finance the budget deficit, thereby starving the public sector (especially manufacturing) of resources. Chidambaram has a propensity to play to the gallery of unions of organized labour by wrecking fiscal balances through the appointment of pay commissions (for example, in 1997 and 2006) and then creating a huge capital account budget surplus to finance the huge revenue account budget deficit. This is anti-development. No wonder inflation is rampant today, fuelled by rising money ­supply from revenue ­expenditure.

4. Debt trap. The debt accumulated by the Centre and states is so large (86% of GDP) that the annual servicing outlay now exceeds the fresh loans taken. This is unsustainable and can explode into a crisis. Moreover, if we correct Chidambaram’s budgets to date for the Enron-type classification of contingent liabilities, then, as the International Monetary Fund (IMF) recently found, the fiscal deficit as a ratio of GDP has actually been rising, and not falling as the FM claims.

5. Budget allocations are straitjacketed. Due to the folly of all finance ministers since 1996, nearly 98% of the receipts in the revenue budget are committed to heads that cannot be politically pruned. That is, items such as defence, subsidies, interest payments, counter-guarantees, pensions, police and grants to states are those committed allocations that weak governments cannot reduce. These commitments leave only 2% of total revenue receipts for other sectors. Hence, the governments are dependent on loans for funding other heads of expenditure, which, however, due to the debt trap, is also an evaporating option for funds.

So, the question will be: How will the Budget address these five major ills without aggravating the economic situation? By 2101, ­India will at this rate face a major fiscal crisis of the kind we have not seen before.

First, the middle class has to be motivated to save more, go in for financial products such as insurance and equity, and buy consumer durables on credit. For this, we must abolish income tax, which is largely at the root of India’s black money. The resources lost for the government can be more than recouped through increased quantum of excise revenue due to higher growth rate arising from higher investment.

Second, Indian industry must be encouraged to out-compete Chinese labour-intensive manufacturing. For this, India must invite foreign direct investment and otherwise invest in food processing, textiles, retail trade, infrastructure and R&D. We need a nationally focused skill augmenting education system.

Third, treat agriculture as industry and extend all the fiscal concessions to industry to it. Land should be leased and consolidated where farmer cooperatives want to enter grain, vegetable, fruit, milk and flower exports. Local feeder airports should be constructed for speedy freight transport and e-commerce introduced.

Fourth, to discourage the government from poaching on bank finances for revenue expenditure, public sector banks must be privatized. The government can compete with others for these funds through the market, or by equity floating of public sector enterprises.
Subramanian Swamy is a former Union minister of commerce. Comments are welcome at ­
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1 comment:

Carly said...

Interesting to know.