After a decade dominated by the neo-liberal philosophy of economic reforms, the headlong plunge towards "Reforms Phase II" presages a period of growing political contention, acrimony and weakening solidarity between the States and the Centre.
THE dire warnings started coming a whole month before the presentation of the Union Budget, providing a stark contrast to otherwise upbeat claims that the country was firmly embarked upon a second phase of economic reforms that would consolidate on the g ains of the first.
Finance Minister Yashwant Sinha sounded a note of buoyancy at the annual World Economic Forum meeting in Davos, Switzerland. There was no question now of either restraining or reversing the tide, he declared. And the Government would underline its irrevo cable commitment to the reform process by unfettering in the near future foreign investment in all but a handful of sectors.
Yashwant Sinha's announcement was not received very well in political circles, which thought it inappropriate for a Finance Minister to make a statement of this nature before a foreign audience when budgetary exercises are at an advanced stage. And short ly after arriving back in India and beginning to grapple with domestic economic realities, the Finance Minister seemed to revert to his usual sombre mood. The country had gone on for too long with easy options, he has repeatedly said in the past few week s. And these years of profligacy have taken a cumulative toll that the economy cannot bear any longer. There are now no options left but the hard ones, and the country would need to receive with appropriate impassivity and tolerance the bitter economic m edicines he is about to administer. Presumably speaking on behalf of the entire country, Yashwant Sinha said: "We are determined to bite the bullet. There are no soft options. What is left are only the hard options. Come February 29, we will spell them o ut."
In assuming that his determination will be shared across the political spectrum, the Minister may well have taken too much for granted. But the reasons for his gloom are evident. After a succession of seeming virtuoso performances by his two predecessors as Finance Minister, Yashwant Sinha's own two budgets have been rather pedestrian in terms of their conception and execution. The Union Budgets presented in 1998 and 1999 won adverse notice in comparison to P. Chidambaram's exercise of 1997, which had b een effusively described by partisans of liberalisation as the "budget of the century".
Chidambaram had seemingly signalled the end of "zero-sum" economics. His budgetary calculations boldly challenged the notion that to improve the government's fiscal position, it was necessary to make certain sections worse off through taxation. In his fi ve budgets starting 1991, Manmohan Singh seemed to flirt with this idea, though he could not quite bring himself to embrace the gospel of supply-side economics with the alacrity of his successor.
Manmohan Singh had good reason to hesitate. His five budgets had failed to substantiate the fundamental axiom of supply-side economics that rather than curtail revenue, cuts in tax rates engender enhanced receipts for the government through heightened ec onomic activity. And Chidambaram's own experience was to prove chastening.
Far from increasing, Central government revenues stagnated in nominal terms in 1997-98, indicating an absolute decline after adjusting for inflation. From a figure of 7.28 per cent of gross domestic product (GDP), the Centre's tax revenues fell to 6.91 p er cent. And the deficit on the current account of government (that is, the difference between total revenue and all current expenses) rose from 1.77 per cent of GDP to 2.52 per cent.
Substance had clearly been overwhelmed by artifice in the 1997-98 Budget, a crucial point of inflexion in the career of India's economic reforms. Put to the acid test, the fundamental axioms of the reforms process had come a cropper. Yashwant Sinha has s ince then been engaged in a dour exercise of staunching the flow of red ink that threatens to engulf government finances. Torn between an ideological commitment to the reforms and a pragmatic need to maintain solvency in government accounts, he has had f ew real options.
"Surcharge Sinha" was the unflattering epithet bestowed upon the Finance Minister after his 1999 Budget. The reasons were fairly clear. If Chidambaram represented the triumph of wishful thinking over substance, Yashwant Sinha in 1999 epitomised the virtu es of empty rhetoric. A large part of his budget speech had little to do with the actual details of fiscal policy. He made several verbal concessions to the need for a strong fiscal stimulus for the economy, but failed to back these up with any specific budgetary allocations. He emphasised more than once that he had no intention of departing from the trend of dwindling tax rates that his two predecessors in office had set. But apart from a rather indifferent effort to rationalise excise and customs duti es by reducing the number of applicable rates and reclassifying the various commodities, he sought to achieve very little.
Yashwant Sinha's key innovation was in levying a number of surcharges on excise and customs duties, effectively negating the loud assurances of stable tax rates that he had himself held out. Thus, after announcing all his measures of rationalising custom s duties, he slipped in a 10 per cent surcharge on all but a few commodities. And in another amazing pirouette, he first announced that the number of applicable excise rates would be reduced from 11 to three, and then imposed a number of surcharges that all but restored the number of rates to where it was earlier.
And with all these contortions, the results have been bleak. This admission was made by the Finance Minister in the course of a recent address to the All-India Conference of Corporate Managers and Tax Executives. The fiscal situation may compel the gover nment to reverse some of the tax exemptions and concessions in the coming Budget, he warned. Among other things, this meant that the surcharges introduced ostensibly as stop-gap measures would be maintained into the foreseeable future and perhaps integra ted into the basic tax rates.
If that was the forecast, another of Yashwant Sinha's statements cast a retrospective - and somewhat regretful - eye over the entire track record of economic reforms initiated in 1991. Had the ratio of tax revenues to GDP prevalent in 1989-90 been mainta ined, he claimed, the Government would not be confronting the kind of revenue and fiscal deficits that it was today being compelled to grapple with. In fact, the ratio today was so adverse that his overriding objective in formulating his taxation proposa ls was to ensure that there was no further deterioration.
The record here is again fairly clear. In 1989-90, the Centre's gross tax revenues as a percentage of GDP stood at 9 per cent. In a decade dominated by the neo-liberal philosophy of economic reforms, the revenue situation has deteriorated alarmingly, wit h no mitigating gains on the expenditure side. No more effective comment is necessary on the founding premises of the first phase of reforms.
Crucial bridging manoeuvres devised to lessen the severity of the revenue shortfall have proven dismal failures. Disinvestment of public sector equity was budgeted this year to net an unprecedented Rs.10,000 crores for the government. The inflow so far i s only Rs.1,000 crores - almost entirely from the sale of shares in Gas Authority of India Limited and a limited volume of retail sales in Videsh Sanchar Nigam Limited. To these must be added the Rs.105 crores that were received from the sale of the gove rnment's stake in Modern Food Industries Limited to the private sector giant, Hindustan Lever Limited.
Even if the government were to put into effect its controversial plans to privatise rapidly some of the most high-profile public sector corporations - such as Indian Airlines - there is little likelihood that the yawning revenue shortfall will be anywher e near bridged. Estimates made for the first three quarters of 1999-2000 show that both direct and indirect tax receipts are running well below target. For instance, a revenue increase of over 18 per cent has been assumed in budgetary calculations on the direct taxes front. The figures available till December 1999 show a shortfall of over 5 percentage points.
IT is important in this context to identify the precise sources of inspiration for the freshly minted phrase of "Reforms Phase II". In the light of the experience over the last decade, the phrase is little else than a transparent admission that the entir e course of reforms has run into a cul de sac. To avoid the consequences of this chastening realisation, the government will have to move recklessly into a phase of economic policy that does away with all residual controls on foreign capital. Conf ronted with a virtual investment famine in vital infrastructure sectors, it would have to open these up for private investment - from both overseas and domestic sources - with all the attendant risks of severe imbalances emerging between regions and sect ors.
The last week of January brought two major changes in the policy governing the inflow of foreign capital. First, the government removed all restrictions on Indian companies seeking to issue American Depository Receipts (ADRs) and Global Depository Receip ts (GDRs), whether through private placement or otherwise. These are financial instruments that have of late been in favour with some of the more profitable Indian firms seeking to broaden their capital base. In the aggregate, though, the impact has been marginal. To permit an even larger number of companies to issue global equity without prior scrutiny may in this sense be no more than a symbolic gesture.
The second measure taken could lead to a degree of buoyancy in the stock markets - on February 11, a bull frenzy pushed the Bombay Stock Exchange Sensitive Index past the 6000-point barrier - though again the long-term implications remain unclear. On Jan uary 25, the government gave its assent to the proposal by the Securities and Exchange Board of India (SEBI) to permit overseas corporate entities and individuals with a high net worth to invest directly in the Indian capital markets. The aggregate 24 pe r cent ceiling on equity would remain in effect though.
Despite their seeming isolation from a broad enunciation of policy or principle, these two moves provide crucial indications of the philosophy underlying Phase II of the reforms. More than ever before, foreign capital and the stock markets are going to b e the dominant motifs in policy formulation. And if the evidence of Phase I is anything to go by, the implications for the languishing infrastructure sectors are likely to be dismal.
THE story of the Indian economy today is one of a low equilibrium trap. A relative dimunition of revenue collections, mounting expenditure commitments and an obsessive concern with trimming the fiscal deficit, even at the risk of making deep cuts in vita l capital investment, have plunged the economy into a state of chronic recession. Isolated instances of growth in certain sectors - notably information technology - do not alter the picture of an economy devoid of growth momentum on account of an investm ent famine. The flagging momentum is most evident in the infrastructure sectors, which private investment generally remains wary about entering.
The World Bank has identified the gradual supplanting of public investment by the private sector as the key structural transformation that the Indian economy has undergone in the 1990s. By this criterion, the turning point was 1995-96, when for the first time gross fixed capital formation in the private sector exceeded that in the public sector. Evidently, though, the spread of investment has remained skewed towards sectors without any great growth or public welfare implications. The most recent summary assessment of India's performance by the World Bank observes that despite the progress on the policy front, "the injection of private capital in key infrastructure subsectors has been slower than anticipated, and so have results. Few investments have be en brought to closure under the new national policies."
The antidote in the World Bank framework would lie in empowering "regulatory authorities" in all these sectors to promote efficient private sector participation. This is a blueprint that has been partly implemented in vital sectors such as telecommunicat ions, electricity and insurance, with ambiguous results so far. But few people seem to doubt that the long-term consequences would include a sharp increase in the price at which these services are provided. Just as reforms Phase I caused a radical shift in price parities between sectors, differentially affecting primary products, including foodgrain, Phase II could put basic services well beyond the reach of the lower income groups.
Increasingly it is clear that the fiscal crisis at the central level has percolated down and aggravated matters in the States. Grants to States and Union Territories from Central revenues have declined sharply in relative terms since the reforms process began. This has forced many States to cut back sharply on vital expenditure commitments, including in the sectors of health, education and social welfare.
Where phrase-mongering flourishes, there is reason to believe that ideas of any worth have been all but extinguished. The headlong plunge towards "Reforms Phase II" presages a period of growing political contention, acrimony and weakening solidarity betw een the States and the Centre. And since the government and the main Opposition have discovered an identity of interests in hastening the country along this path, the challenge would have to come from elsewhere.
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