In search of stimulus

As Finance Minister Yashwant Sinha readies Budget 2002, the weakening fundamentals of the financial system provide a standing reproach to the ongoing course of economic reforms.

WHETHER Union Finance Minister Yashwant Sinha permits himself to be bound by memories of the past is not clear. But as he enters the period of relative seclusion that is customary in the weeks before the Union Budget, he cannot fail to harbour rather bitter memories of last year. For the first time in four essays, he had then managed to obtain the unequivocal endorsement of business and industry and to dispel the impression that he was only plodding along in a groove that had been sunk by his two immediate predecessors. There was a great deal of talk of "second-generation reforms" that would go beyond tinkering with budgetary figures and rework the fundamentals of the economy. But with all the ambitious extra-budgetary measures that he promised last year - including in areas that the Union Cabinet was yet to reach agreement -Yashwant Sinha has managed to do little since.

A 'growth oriented' budget is what the Finance Minister was exhorted to produce last year. And that, indeed, is what he was adjudged to have done for two days - certainly the briefest honeymoon in the markets ever enjoyed by a Finance Minister. As he now prepares for the effort at retrieval, he is confronted with the unpleasant realities. Industry is in a slough of gloom, perhaps its worst slowdown in a decade. And over a period that broadly coincides with his tenure, overall economic growth performance has perhaps been the worst since the late-1970s.

For reasons that have never been very clear, the stock markets have in recent times begun to be acknowledged as a barometer of wider economic health. But the malaise that seemed to afflict the markets in the immediate aftermath of last year's Budget has since become generalised.

Yashwant Sinha has often given expression to his intention to boost government spending in a bid to impart a stimulus to the economy, unmindful of the consequences for the fiscal deficit. In this respect, he has shown a willingness to go beyond the orthodoxy of the last decade of reforms, which seemed to put fiscal deficit as the singular variable to target. Where he has been found wanting is in summoning the means to back up his verbal concession that there could be objectives that could take precedence over the fiscal deficit.

In February 2001, the Union government had sought to prepare a favourable environment for the Budget by announcing the privatisation of Bharat Aluminium Co (Balco) in a strategic sale that fetched it just over Rs. 550 crores (Frontline, April 27. 2001). This kicked up a controversy because of the opaque manner in which it was pursued. But the government's intention was clear. After years of ambitious targets and modest achievements from disinvestment of public sector equity, 2001-02 was expected to mark a quantum leap. Signalling this new resolve, the disinvestment target for the year was fixed at Rs. 12,000 crores - representing, in the acerbic assessment of many Opposition politicians, a controversy every fortnight.

The following months of rather desultory performance seemed to indicate that the government, even if it was prepared for an unending cycle of controversy, really had few options on the disinvestment front. Valuation procedures remained contentious, and with share values being subdued and overall economic conditions gloomy, few prospective strategic partners seemed inclined to sink the large sums of money required to take substantial stakes in the public sector giants up for sale.

ON February 5, the logjam seemed to clear with dramatic effect, when Disinvestment Minister Arun Shourie announced the sale of the international telecommunications giant Videsh Sanchar Nigam Ltd. (VSNL), and the country's largest stand-alone retail distributor of petroleum products, Indo-Burma Petroleum (IBP Ltd). With the outright sale of a number of hotel properties also being announced, February 5 came to represent a windfall day, with over Rs. 2,500 crores accruing to government coffers.

Yet the reservations were quick to surface. First it was observed that the buyer of IBP was none other than another public sector petroleum company, Indian Oil Corporation Ltd (IOC). With a bid that was almost twice as high as the next competing bid, it seemed that IOC had merely been coaxed into offering an alternative route to transfer large sums from its cash surplus to the government. And with IOC now being proscribed from bidding for the next two petroleum sector disinvestments - in Bharat Petroleum and Hindustan Petroleum - it is questionable how fruitful these would be.

The more chastening reality is that the proceeds from disinvestment will fall considerably short of target and then would still be inadequate to meet an unforeseen budgetary obligation in the next financial year. After many months of deliberate vagueness, the Unit Trust of India towards the end of December announced that the net asset value (NAV) of its once-popular US 64 scheme stood at Rs. 5.94 a unit. For a long while since the UTI admitted that it had contrived a massive deficit in its holdings owing to a sequence of injudicious stock investments, unit-holders had been placated with the assurance that the NAV would not fall below Rs. 8. They are now being held at bay with the assurance that the government will redeem holdings of up to 5,000 units at the rate of Rs.10.50. There are estimates that this bailout of UTI will impose a cost of Rs.7,000 crores on the government. How far Budget 2002 will provide for this operation is yet unclear. But the Finance Minister will not be able to evade at least a part of the burden.

This task is rendered more urgent by the strong whiff of malfeasance that surrounds the UTI. It has now been revealed that UTI borrowed Rs.6,500 crores early last year to fund a number of redemptions of its stricken US 64 scheme. Large corporate houses with substantial holdings in the scheme managed to cut their losses by redeeming these at Rs. 14. The UTI met these costs at least partly through the mammoth borrowing that it had contracted at an interest rate of 14 per cent.

UTI is, however, only the most visible symptom of the deep-seated crisis in the financial sector. For long buoyed by boom conditions in the stock market - which were themselves premised upon an artificially rosy prognosis of the course of economic reforms - the financial system today is creaking under the burden of a number of reckless exposures in sectors that are vulnerable on account of recessionary conditions. The number of public sector banks that are deemed financially weak is seven, as against three just three years back. The weakening fundamentals of the financial system are a standing reproach to the ongoing course of economic reforms. Not attending to this immediately could induce the large-scale desertion of the only constituency for economic reforms that the Finance Minister has.

If these expenditure commitments are called for merely to stabilise an economy that tends to teeter towards crisis, a number of others seem imperative to propel it on to a viable growth path. Massive investments in infrastructure and agriculture, for instance, seem indicated. Industry associations, alarmed by the precipitate decline in rural purchasing power, have called for a doubling of investment in irrigation and a substantial increase in outlays on rural employment and poverty alleviation programmes.

IT was once considered a feasible proposition to meet some of these additional obligations at least by downsizing government. Trimming payrolls and eliminating much of the workforce deemed surplus, it was held - despite visible evidence of gross under-provision of public services - could free much-needed resources for vital investments. In line with this belief the government on February 5 announced a voluntary retirement scheme for surplus staff. With seemingly generous provisions, the scheme is expected to cut payrolls by 50,000 in the next financial year and by up to 1.1 million over a period.

Even if the optimistic forecasts are met, the government would have to surmount a hump in the next few years when retirement benefits would have to be paid to surplus staff. Although the detailed projections have not been made, it is more than plausible that the savings in the initial years will be more than eroded by costs. There would, in other words, be no immediate stimulus for productive investment.

Other expenditure commitments - such as interest payments which account for 30 per cent of total expenditure and defence which amounts to 17 per cent, afford little flexibility for reduction - though for different reasons. Although subsidies have afforded a soft target over the last 10 years, no absolute reduction has been secured, though its share in the total may have shrunk at some political cost. A further effort to cut subsidies may be presaged by the recent decontrol of sugar and foodgrains. But pushing through the actual changes on the ground will involve serious political risks.

This leaves the option of raising revenues through taxation as the only feasible course that the Finance Minister can pursue. And he enters the fray with a rather shoddy track record. Over the decade of reforms, the Central government's tax revenues have shrunk as a proportion of GDP from well over 11 per cent to under 9 per cent. Within this adverse trend, there has been a sliver of a healthy movement with the share of direct taxes in total revenue growing at the expense of indirect taxes. But the administrative effort to improve tax compliance and widen the net has been conspicuously lacking, which only feeds the impression that between reiterations of the necessity of attending to this task in successive budgets, the Finance Ministry remains largely idle. And there is little prospect that Budget 2002 will induce any changes in that fairly robust summation of Yashwant Sinha's tenure in the Ministry - undistinguished in terms of ideas and lethargic in terms of action.