Monday, July 5, 2004

Budget, Policy Reform and Growth

As most readers know, the budget consists of two parts: The revenue and expenditure accounts of the government (the ‘fisc’) and policy reform issues falling under the purview of the finance ministry. The latter includes tax reform and financial reform (capital market, banking, insurance, pensions). Since 1991 broader macro (growth and poverty reduction) policies have also featured in the budget speech. The shape of the budget will be determined by the economic and political back-drop.
With a new government, there is bound to be a change in socio-political emphasis, while the underlying themes will remain unchanged as they have since 1991. The Congress party manifesto, the CMP, the President’s address to Parliament and the PM’s speech have progressively sharpened the focus and the budget will give it concrete shape. We distil two messages from these signals: One that faster economic growth is essential for meeting the national objectives, but policy reforms must firmly focus on the growth of incomes of the bottom 50% of the population. There is therefore increased hope that the much talked about agriculture and allied policy reforms will be translated into concrete actions. Second, public services such as drinking water, sewage, sanitation, public health & basic education depend critically on governance factors and delivery mechanisms and these must be improved in tandem with increased allocation of funds. One hopes that the improvement in governance that Dr Singh brought about from 1991 to 1996 in the finance ministry, banks etc. would now be replicated through out the central government. This could have a measurable impact on the welfare of the poor.
On the economic front, growth has slowed during the last five years to 5.6% per annum from 6.7% per annum in the previous five years. This has both a trend component and a cyclical component. The underlying growth trend in the manufacturing, agriculture and mining sectors has been downward for the past 7 years. Consequently GDP growth has also been on a downtrend contrary to the conventional wisdom prevailing in 2003-4. There is an urgent need to reverse this trend if the CMP objective of sustained 7% to 8% growth and employment for all is to be realised. The cyclical component, driven in the last 3 years by rainfall variations, contributed to the poor performance. The 8% growth rate last year represented mostly a monsoon led recovery of agriculture from the very poor rainfall of 2002-3. There are clearer signs of a cyclical recovery in 2004. A recovery in domestic investment, which has been low in the past three years, is presaged by the sustained higher growth rate of capital goods production. The cyclical recovery in industry needs to be sustained and strengthened. Both these require reforms that will improve the environment for investment and the generation of productive jobs and stimulate higher productivity growth.
The forthcoming budget is likely to make a start in addressing these issues. In our view, the following reforms will fulfil the objectives and constraints discussed above:
1. Reduce the peak tariff rate to 15% and above peak rates to 60%. A department of revenue committee (Virmani, 2001) had recommended limiting above peak rates to twice (3 times for liquor) the ‘peak rate’. Alternatively, announce that the peak rate will go down to 10% by 2006-7 and a uniform 5% import duty will come into being by 2008-9 thus converting India’s tariff rates from the highest in the world to the lowest. An ICRIER study (WP 135) has estimated the positive impact on exports and productivity.
2. Make the CENVAT into a genuine central VAT by including services within its ambit, eliminating all exemptions besides food, medical, education and tiny industry (Rs 10-20 lac) and reducing the rate to 15%. This is a better alternative to the Service tax (WP 4/2002-PC, April 2002).
3. Simplify the personal income tax by eliminating all exemptions (80L, 88 etc), having one rate for the standard deduction and sharply raising the income levels at which the 20% and 30% rates become applicable. This should be tax neutral for the average tax payer, make tax filing/payment easier, reduce tax evasion and increase revenues over time.
4. Phase out SSI reservation over the next year or so.

Agriculture deserves special attention because (a) its growth rate has declined sharply to 2.1% per year during 1998-9 to 2003-4 compared to 3.6% per annum in the previous five years. (b) Repeated droughts in some rain fed areas have been particularly harsh on those dependent solely on agriculture. (c) A large proportion of the poor reside in rural areas. Reform of agriculture and the food economy requires action by Central and State governments. The following are under the purview of the Centre:

5. Introduce a food debit/credit card (smart card) that entitles the poor to obtain food rations from any registered shop at specified rates. This would have to be supplemented by food stamps in areas where credit card systems have not reached and by co-operative channels of distribution in remote areas where the PDS is non-existent (WP 5/2002PC, December 2001).
6. Repeal the Essential Commodity act and replace it with an act that can be used only in an emergency in a specified area for a limited duration.
7. Introduce a unified food act and a single food regulator to deal with all food regulations.
8. Comprehensive reform of the agriculture research system to make it more autonomous (free of red tape & bureaucratic interference) and accountable for research (peer review of defined output) and dissemination. Encourage private-public partnership in the interest of the farmer.
9. Remove ceiling restrictions on FDI (in telecom, banks, insurance, retail trade, real estate development) that is exclusively directed either at the agriculture sector or at rural inhabitants/areas.

On the expenditure side, budget allocations for agriculture, irrigation, water, health and education sectors and employment (guarantee scheme) are likely to increase. Governance and social service delivery system reform will probably take shape over the next 6-9 months.

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