More trouble ahead

Print edition : June 20, 1998

The Indian economy appears to be at its most vulnerable since the currency crisis of 1991, and everything about the unimaginative and lacklustre Budget seems to point to the possibility that another such crisis is in the making.

WITH the rupee touching new lows at the end of virtually every working day, the Indian economy appears to be at its most vulnerable since the balance of payments crisis of 1991.

Many factors have contributed to this state of affairs which, paradoxically, comes in the wake of what may be the longest run of consecutive good monsoons the country has witnessed. To start with, neo-liberal economic reform has contributed to a deceleration in GDP growth. It has displaced domestic production with imports through trade liberalisation. It has also adversely affected demand expansion and choked off capital formation in agriculture through a cutback in public capital expenditures.

Second, industrial growth has decelerated in recent times because the transient, post-reform industrial 'boom' generated by the pent-up demand for import-intensive durable goods exhausted itself during the three years ending 1995-96.

Finance Minister Yashwant Sinha with the Budget papers in Parliament on June 1. The Economic Survey and the Budget indicate that notwithstanding all talk of its swadeshi agenda, the BJP is fundamentally committed to liberalisation at the expense of all else.-SHANKER CHAKRAVARTY

Economic Survey swadeshi

Third, last year's disastrous "Dream Budget" of then Finance Minister P. Chidambaram has substantially eroded the Government's revenue generating capabilities and therefore its ability to prime the system even when running fiscal deficits that appear large relative to the targets set during the 1990s.

Fourth, the weak and aimless Budget of 1998-99 has done little to protect industry or revive slack demand, essentially because of the unwillingness of the Bharatiya Janata Party to reverse aspects of reform which have virtually tied the hands of the Government in recent years.

Finally, the uncertainty created in the capital markets by the sanctions in the wake of India's nuclear tests, and the failure of the Budget to respond to them, have converted the small "negative inflow" of investment by foreign institutional investors (FIIs) into a substantial outflow during the week ending June 5, reviving speculation regarding an East Asian-style meltdown in India's foreign exchange and capital markets.

At the post-Budget conference in New Delhi on June 2, Revenue Secretary N.K. Singh (left) and Finance Secretary Montek Singh Ahluwalia.-RAJEEV BHATT

There are a number of indicators which suggest that as a result of these trends India's economic fundamentals have become fragile. Agricultural production is estimated to have fallen by 3.7 per cent in 1997-98, while the growth of industrial production, though positive, decelerated from 12.1 per cent in 1995-96 to 7.1 per cent in 1996-97 and 4.5 per cent (provisional) in 1997-98. Further, after months of low inflation, the annualised growth of the consumer price index is moving close to double-digit levels. These incipient signs of stagflation are not accompanied by the promised signs of dynamism on the external front, which were to be delivered by the "efficiency-enhancing" effects of liberalisation. Exports in dollar terms grew by 5.3 per cent in 1996-97 and a dismal 2.6 per cent in 1997-98 as compared with rates of between 18.4 and 20.7 per cent a year between 1993-94 and 1995-96. Import growth also fell, but by a smaller extent, so that the trade deficit widened from $2.3 billion in 1994-95 to $5.7 billion in 1996-97 and $6.8 billion in 1997-98. However, with the effects of the sanctions on official inflows yet to be fully effective and FII outflows having been moderate in April and May, foreign exchange reserves still appear comfortable. Information relating to the first week of June suggests that even on this front the situation is worsening.

THESE features of the economy obviously called for some bold and imaginative initiatives from the BJP. What is surprising is the bland continuity that characterised the BJP-led Government's first Budget, which was also its first major statement of economic intent. The most striking element of continuity was the fact that Finance Minister Yashwant Sinha opted for a direct tax regime that keeps tax rates low and hopes to garner additional revenues through better tax administration and better compliance. He has not only abjured any increase in direct tax rates, but sought to make a show of providing additional concessions through a hike in the tax exemption limit (from Rs.40,000 to Rs.50,000) and an increase in the standard deduction for those with taxable incomes of less than Rs.1 lakh. This was indeed surprising given the collapse in revenue collections in 1997-98, when Chidambaram attempted to raise tax collections by slashing rates in order to encourage greater tax compliance. According to the revised figures presented in this year's Budget, the shortfall in revenue collection under different heads was huge.

Income tax receipts in 1997-98 are estimated at Rs.18,700 crores as compared with a budgeted Rs.21,700 crores, customs duties at Rs.41,000 crores as compared with the budgeted Rs.52,550 crores, and excise duties at Rs.47,700 crores compared with Rs.52,200 crores. The kind of misplaced optimism that resulted in these shortfalls pervades Budget 1998-99 as well. Despite an estimated revenue loss of Rs.950 crores on account of direct tax concessions, the Budget expects revenues from income taxes to rise from Rs.18,700 crores in 1997-98 (R.E.) to Rs.20,930 crores, or by 12 per cent, because of simplification of tax procedures and better scrutiny and administration.

These factors together with the "Samadhan" scheme, which is an amnesty scheme for those who indulged in unwarranted tax avoidance rather than tax evasion, are expected to ensure large collections of corporation taxes and excise duties. The latter scheme offers the benefits of waiver of interest and penalty and immunity from prosecution upon payment, at current rates, of arrears of direct tax under dispute and a further 'abatement' of 50 per cent of the duty in the case of excise duties. Its effects on tax payment, among other factors, is expected to ensure that, although there are no changes in corporation tax rates, collections which were projected to rise by 13 per cent before the implementation of budgetary measures are estimated to rise by 24 per cent (from Rs.21,360 crores to Rs.26,550 crores) consequent to their implementation.

Chief Economic Adviser Shanker N. Acharya.-RAJEEV BHATT

WHILE this fundamental element of continuity limits the Government's room for manoeuvre, economic circumstances and its claim to "distinctiveness", on the one hand, and the remnants of the impact of the Pay Commission's recommendations, on the other, have forced the BJP-led Government to push up current expenditures marginally from 12.87 per cent of GDP in 1997-98 to 12.93 per cent (even prior to the rollback of the urea subsidy), despite the fact that GDP growth in 1998-99 is projected at 14.83 per cent as compared with 10.3 per cent in 1997-98. Thus even to keep the revenue deficit from rising above the level it touched in 1997-98 - close to 3 per cent - the Finance Minister has had to look for other sources of revenue. Given the Government's unwillingness to raise direct taxes, it has had to adopt a fiscal stance which is regressive. Most, if not all, of the increase in tax revenues would finally come from indirect taxes, which are inflationary and the burden of which are known to fall more heavily on the poor and the middle classes. Further, despite the swadeshi rhetoric, a larger share of revenues mobilised through indirect taxes is to come from excise duty increases rather than from customs revenues.

Thus, while additional revenues garnered from customs revenues is placed at Rs.3,304 crores, that from excise duties is placed at Rs.5,009 crores. This large increase in revenues from excise duties comes not merely from the controversial levy on motor spirit but also from other duties such as the 8 per cent excise duty on packaged and "branded" food products (such as tea, spices, "edible preparations", and so on). The term 'branded' by no means refers to only premium products consumed by the better-off, since a branded product is defined as any item provided in a packet with any name or signature on it. The inflationary consequences of taxes of the latter kind are obvious.

Finally, even the non-Modvatable hike in additional customs duty by 8 per cent imposed as a countervailing measure to sales tax, whose actual incidence would have been closer to 12-16 per cent, was not a protectionist measure. The duty only increased the prices of imported inputs but did not raise the price of imported final goods, since the latter are subject to sales tax when sold domestically. Thus units using imported inputs to produce final goods as in the capital goods sector would have been faced with a reduction in the effective rate of protection they enjoy vis-a-vis foreign suppliers. The real impact of the duty would have been an increase in costs and prices and not a significant increase in protection, as implied by the claim that the measure gives a swadeshi tinge to the Budget. Indian industry, led by a pro-Government faction, initially hailed the Budget, but soon realised the implications of the import duty. The opposition to the duty from big business has, at the time of writing, resulted in a halving of the rate of duty, which further completely undermines the budgetary calculations.

But efforts of this kind to hike indirect taxes on some commodities, even if supported by optimistic assumptions of buoyancy, are not expected to make much of a difference to total revenues. As a result, notwithstanding the Finance Minister's claims of increases in expenditure in specific sectors, total expenditure (revenue and capital) relative to GDP is expected to fall marginally from 16.62 per cent in 1997-98 to 16.49 per cent in 1998-99. That is, the promise made by Prime Minister A.B. Vajpayee to the Confederation of India Industry that the Government would step up investment in order to revive the economy has not been redeemed. The effort to spur growth has been confined to measures to encourage private investment in areas such as housing by improving the availability of credit for housing purposes and by proposing the repeal of the Urban Land Ceiling Act.

There is no reason to believe that this marginal dose of deregulation would unleash private "animal spirits" when the large-scale liberalisation of the last few years has failed to do so. If yet the Budget relies on such measures, it must either be because the Government is naive in the extreme or because these measures are merely the fig leaves being used to cover up the fact that the Budget, which threatens to stoke inflation, offers little by way of growth stimulus. Instead, it poses the danger of stagflation.

The only possible evidence of neo-Keynesian pump-priming that votaries of the Government can point to is the fiscal deficit, which however is a reflection not of a significant step-up in capital expenditures but of a loss of revenues. What was required to "kick-start" the economy was a reversal of the fiscal stance of recent years in the form of:

1. an increase in direct taxes that helped sustain capital expenditures which could spur demand, ease supply constraints and trigger a revival in private investment; and

2. a significant increase in customs duties, which would have also helped garner additional revenues, and simultaneously helped revive sections of industry adversely affected by the unwarrantedly rapid import liberalisation of recent years.

This would, of course, mean reversing the direction of economic policy pursued since 1991. The reason why the Budget delivers little is because of the unwillingness of the BJP Government to deviate from International Monetary Fund-style internal and external liberalisation.

THE stagflationary character of the Budget does not imply that it has offered little to Indian big business. In fact, besides the diluted tax amnesty scheme, "Samadhan", which condones tax avoidance and allows settlement at lower tax rates, there is a range of measures that favour both foreign capital and domestic big business. The first of these is the decision to go ahead with the controversial opening up of the insurance sector to domestic firms, without defining whether minority participation of foreign firms in an enterprise is to be allowed. With international insurance companies having tied up arrangements with some domestic partners, it is likely that this policy would permit the backdoor entry of foreign firms into the insurance sector. In the din over urea and petrol prices, the full import of this measure may remain undebated in Parliament and outside.

The second major policy pronouncement relates to privatisation. Besides divesting itself of 51 per cent of the equity in Indian Airlines, the only commercially successful domestic airline, the Government also plans to divest 74 per cent of equity in profitable public sector enterprises like the Indian Oil Corporation, Gas Authority of India Ltd, Videsh Sanchar Nigam Ltd, and Container Corporation (CONCOR). It is to be expected that, given the current state of the markets, equity in these corporations would be handed over at rock-bottom prices to domestic and international buyers so that the budgeted Rs.5,000 crores can be mobilised in the form of privatisation proceeds during this financial year. Since there is no reason why the private sector would pay the Government anything more than the capitalised values of future expected returns from public sector assets, sale of prime public assets amounts to using the resource crunch as a poor excuse to make a resource transfer to the private sector.

A similar tendency to subsidise the private sector implicitly through the sale of public assets cheap is reflected in the retrenchment-cum-sale scheme for loss-making public sector units (PSUs). Under the scheme, the Government would "separate" workers in loss-making PSUs from the assets of those entities with a "golden handshake" package and then sell the assets (including, ostensibly, land) at the "best economic price" to recoup the restructuring expenditure. Here again the motive appears to be to hand over prime land cheap to private interests.

THIS BJP version of "crony capitalism", which favours not just domestic but also foreign capitalists, is the real thrust of the BJP's economic agenda. Even before the BJP's nuclear adventurism, which invited sanctions without winning India any political mileage whatsoever, the economic challenges facing the Government were immense. The nuclear tests and the sanctions that followed have worsened the situation by increasing uncertainty in capital markets that are attuned to governments relentlessly pursuing reform. The Budget and other instances (such as the resolution of the dispute with the Suzuki Motor Corporation over control of Maruti Udyog Ltd) suggest that the Government is choosing to combine nuclear adventurism with wide-ranging economic concessions to international investors. Unfortunately for the BJP, however much developed country governments may want to underplay India's nuclear tests, there are laws, right or wrong, which must take their course. It is unlikely that the pro-reform noises and the promise of opening up sectors like coal and insurance will help dampen the uncertainty that characterises the capital and foreign exchange markets in the wake of sanctions triggered by the nuclear test. Inasmuch as an incompetent and farcical budget would further undermine confidence in economic management, the threat of a crisis in the capital and foreign exchange markets is real. This appears to be the inevitable consequence of the heady mix of jingoistic nationalism and compromise with foreign capital that the BJP is brewing.

There is, of course, the other side to the story: nuclear "diplomacy" and prefabricated temples, which occupy headline space, allow the BJP-led coalition Government to divert national attention away from the challenges posed by slow economic growth, persisting deprivation and growing external vulnerability, which its own "hidden" economic agenda is unconcerned about. The Economic Survey and the Budget, which together embody the economic perspective of the Government, indicate that as its term in office lengthens, the BJP is being forced to reveal that all talk of its swadeshi agenda notwithstanding, it is a party which is fundamentally committed to liberalisation at the expense of all else.

The BJP, however, must pay the penalty of late entry. When the Congress(I) publicly embraced a neo-liberal strategy, it had two advantages: first, it could use the balance of payments crisis (which its own policies had created) to argue that there was no alternative to opening up the economy; second, it could claim that the buoyancy in industry generated by the release of pent-up demand for import-intensive durable goods was in fact the result of the private initiative unleashed by its supply-side policies. With foreign exchange reserves still at comfortable levels and industry crying hoarse about a demand recession, such claims would be dismissed in the current context.

Only a currency crisis that involves the IMF and international finance in discussions about India's 'national' economic policy can make liberalisation the 'only' alternative once again. Seeing the unimaginative and lacklustre Budget presented by a government which had the support of circumstances and its own manifesto to turn its back on IMF-style reform, there may be some who sense a conspiracy brewing in the Finance Ministry virtually to engineer a currency crisis. It must be remembered that in 1990-91 it was the Ministry of Finance which first declared that the balance of payments situation left the country with little option but to turn to the IMF, and it was this that resulted in a run on India's foreign currency reserves.

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