Exaggerated Fears, Exaggerated Hopes

When the UPA government came to power about 40 days ago, there were exaggerated fears about the negative role of the left and of some of the coalition allies with respect to the reform process. These stemmed partly from selective reading of the Common Minimum Programme and but were enhanced by statements made by members of some of these parties. It was asserted by many observers that the reforms undertaken by the previous NDA government would be reversed and the overall pace of reform would slacken with negative consequences on economic growth. After the PM and FM took charge and a new Deputy Chairmen of the Planning commission was appointed these fears gave way to exaggerated hopes of a “dream budget.’ Both these have been laid to rest by the budget.
Two of the reforms about which there was great doubt were Foreign Direct investment and dis-investment. This happened despite the fact that there was no clear statement against FDI and a number of statements about stimulating investment and supporting growth. Similarly while the CMP clearly ruled out privatization of profit making units, this was not ruled out for loss making ones. Dis-investment in all PSUs was also an open question. The cabinet decision on setting up public-private partnership in Delhi and Mumbai airports with 49% FDI and 26% government ownership was a pre-cursor. The budget takes the investment message forward unambiguously by proposing to raise the FDI limit to 49% in Airlines (from 40%) and Insurance (from 26%) and to 74% in Telecom.
Given the example of West Bengal fears on the dis-investment side were also clearly exaggerated. The finance minister in his budget speech has taken a leaf out of the book already written by this Left front government by announcing the setting up of a Board for Restructuring of Public Sector Enterprises (PSEs). As stated by the FM this Board will evaluate the PSEs and make recommendations accordingly. This could involve closure, sale or disinvestment. The plans of one profit making PSE to raise funds through sale of the shares to the public has also been supported in the budget and credit taken for Rs 4000 crore of dis-investment receipts.
A third are of even greater concern was the fiscal balance. Frightening estimates of the cost of the CMP were published some by reputed research institutions. The question was repeatedly asked how the tax revenues to fund these programs would be raised and would this not involve a large increase in the tax rates. Stock market intermediaries and fiscal conservatives unambiguously outlined their concerns about the fisc. The first indication that these concerns were exaggerated came when the FFRBM along with the rules for its implementation were notified a week before the budget. This indicated how seriously the government took the responsibilities embodied in the FRBM. These concerns have been considerably dampened by the careful and cautious way in which the CMP promises on social sectors, employment and rural/ agriculture have been spelt out. A clear road map has been given for rural and agricultural reform, with the Planning commissions forthcoming mid-term review charged with spelling out concrete changes and re-allocation of resources that are necessary for an implementation of this strategy. A number of well targeted social schemes have also been picked up for greater emphasis and future expansion, to promote the social objectives of the government. At the same time the budget by containing the fiscal deficit proportion and reducing the revenue deficit at the same time has confirmed this responsible approach.
Other reform actions for improving competitiveness and growth prospects are SSI de-reservation and the start of merger/integration of service tax with CENVAT. The de-reservation of 85 SSI items clearly signals the governments understanding that such economic reforms that promote employment growth will go forward.. Any number of committees have argued for complete abolition of SSI reservation. More recently the labour intensive exports and employment generated in China in the sectors in which SSI reservation exists in India, and has limited exploitation of economies of scale, has added to the urgency of de-reservation.
The move to give a set-off to service tax payers across goods and services and vice versa is an important new reform. It is the first significant step in the direction of integration of goods and services in the Central Value added tax (CENVAT).
As with virtually every budget, there are also some anti-reform steps and a few that are ambiguous. The former includes the abandonment of CENVAT for the textiles sector. This will limit exploitation of the great opportunities that are opening up with the expire of the Multi-fibre agreement next year. The abolition of the long term capital gains tax the reduction of short term capital gains tax to 20% and its replacement by a turnover tax for securities does not appeal to fiscal purist like me who worked on tax evasion issues well before they became popular. The same reservations apply to the new method of reducing tax rates up to Rs. 1 lakh through a rebate. In my experience such theoretically unsound ideas always lead to problems in the long run even though they may be successful in the short term.