The Finance Minister and the Sensex

Looking at the modifications to the Budget proposals that Finance Minister Yashwant Sinha has refused to make and those he has made, it is clear that while he is pinching the paisa when it comes to safeguarding the interests of the poor, he is q uite happy appeasing the well-to-do by forgoing revenues from direct taxes.

C.P. CHANDRASEKHAR

FINANCE Minister Yashwant Sinha protests too much. "I am not the Finance Minister for the Bombay Stock Exchange," he is reported to have declared in his reply to the debate on the Finance Bill for 2000-01. That remark was just a bald response to accusati ons that economic policy in India, whether formulated by the Finance Ministry or the central bank, is increasingly shaped by the demands of Finance and the movements of the Sensex. Unfortunately, Yashwant Sinha's actions do not match his rhetoric.

Consider the modifications to the original Budget proposals he has turned down and those he has made. The Opposition and the Bharatiya Janata Party's allies have been demanding a reduction or withdrawal of a spate of increases in administered prices - of kerosene, liquefied petroleum gas (LPG), fertilizers and food materials issued through the public distribution system (PDS) - announced prior to and in the Budget. Their demands, especially in the case of food, have acquired significance in the wake of reports of pockets of severe drought in the country and predictions that after a gap of 12 years the country is likely to experience a bad monsoon in the year starting June. Put together, these actual and likely developments provide a case for preparatio ns for using the large foodstocks with the government for food-for-work programmes as well as for provision at subsidised prices for those who may be priced out of the open market by food price inflation in the coming months. Both of these would involve an increase in the explicit or implicit subsidy bill of the government. In such a situation the argument that food policy should be driven by the objective of sharply reducing food subsidies is not merely faulty in itself, as many have argued, but comple tely unwarranted from a welfare point of view. That the government too is unconvinced of its position should be clear from the decision to offer an additional allocation of 20 kg of foodgrain per capita to the drought-affected States, which would be sold at below poverty line (BPL) rates even to those above the poverty line. However, the demand to reduce the huge hike in the BPL rates has been ignored.

What is appalling, however, is that while Yashwant Sinha is counting the government's paise when it comes to safeguarding the interests of the millions who, even official statistics show, are either below or at the margin of subsistence, he has been quit e happy appeasing the well-to-do by forgoing revenues from direct taxes.

There are at least three modifications motivated by this concern of his. First, a lower surcharge on income tax in the case of those whose taxes are deducted at source, and higher exemption ceilings on interest on housing loans and investments in infrast ructure bonds for all income tax payers. Second, a graded tax holiday for export-oriented units, including those providing Information Technology-enabled services, provided at a time when even many within the government have been arguing for a tax on the huge export incomes earned by units supported in various forms with largesse from the state. Third, exemption from income taxes of stocks awarded to employees under the employees' stock option plans (ESOPs), on the grounds that the revenues generated fr om the sale of these stocks, as and when they are sold, would be subject to capital gains tax.

The concessions implied by the first two of these moves are obvious. The third needs closer examination. Stock options are virtually payments "in kind" to employees, with a double edge. These payments are income, even if they are incomes of a kind that a re by definition "saved" and "invested" in a specific form, and have, therefore, been considered to be subject to income tax. By virtue of being savings invested in financial assets, they can appreciate in value over the years, and if that increase in va lue is encashed through a sale of the asset, the additional earnings are subject to capital gains taxation as per the rules prevailing at the time.

It is no doubt true that ESOPs offered by companies are most often accompanied by regulations as to when the employee concerned can choose to sell them. And, in the interim the price of the stock can decline, so that the actual income derived by the indi vidual may be lower than that on which he/she paid income tax in the first instance. This is a risk any individual accepting stock options must take, since it is not the role of the government to encourage stock options as a mode of compensation.

However, stock options play a crucial role from the point of view of the companies offering them and the stock market. For companies, they provide a means of offering high and even astronomical salaries, without damaging their cash flow situations; and f or the markets, the practice ensures a growing number of participants, which over the years helps increase the volume of trading and extent of market capitalisation. By choosing to abjure treating stock options as a "perquisite" and exempting them from i ncome tax the Finance Minister has, in effect, provided a concession to firms and the markets at the expense of the state exchequer.

That Yashwant Sinha is prone to sacrificing revenue to appease the stock markets has been demonstrated repeatedly. The most glaring instance was when he reined in the tax authorities from ensuring tax payments by a group of foreign institutional investor s (FIIs) who were allegedly misusing the double taxation treaty between India and Mauritius. Responding to market rumours that a slide in the Sensex was generated by the notices served on these FIIs, the Minister stepped in to allay "market fears" that t hese FIIs would be scrutinised and made to pay the sums demanded, if necessary. Keeping the Sensex buoyant is obviously more crucial to Yashwant Sinha than enforcing the laws of the land and trying to reverse the post-liberalisation decline in the tax-GD P ratio at the Centre.

Besides these, the Finance Minister has provided a number of less obvious concessions, such as a higher weighted deduction (of 150 as opposed to 125 per cent) for Research and Development (R&D) expenses incurred in knowledge-based industries. Experience shows that such concessions are exploited by passing them off as R&D expenditure outlays on activities that would not meet any acceptable definition of research. This transforms into a concession a measure introduced as a means of promotion. Add to this the fact that every possible existing or new firm is adding on a 'tech', a 'dot' or a 'com' to its name in order to be identified as belonging to the knowledge-based sectors, and that such firms were the ones driving the speculative stock boom, which now appears headed for collapse, these concessions too are at one remove aimed at propping up the financial markets and providing incentives to finance capital. And with these manoeuvres coming in the wake of a steep slide in the Sensex, they are widely see n as having been formulated to cool market nerves.

THE government's focus on the markets does not stop here. In recent years, monetary policy has also served to prop up the market, a tendency which has been strengthened by the latest credit policy announced at the end of April. There are three ways in wh ich implicit support for the market has been provided. First, the Reserve Bank of India (RBI) has over the years increased the flexibility of the banking system to enter new areas and undertake investments of a kind that help capital market growth. The l atest such "innovation" is the permission granted to banks to enter the insurance sector, despite their not-too-satisfactory performance in areas such as mutual funds and housing finance, which they had been permitted to diversify into in recent years.

Second, through repeated reductions in the Cash Reserve Ratio (CRR) required of banks, amounting to an overall 7 percentage points, liquidity in the system has been considerably enhanced, allowing market players easy access to funds, not just for warrant ed but also speculative investments. The recent credit policy has gone considerably further in enhancing liquidity available to the market players. In his statement making the announcement, RBI Governor Bimal Jalan promised to "maintain easy credit and ( institute) a cut in CRR if required and if the inflation rate is down." Obviously, Jalan is concerned only about the likely inflation in the prices of commodities, and is not too concerned about the huge inflation in the prices of financial assets that h ad occurred before the recent downturn in the stock markets began. In fact, the direction of monetary policy is such that it appears geared to supporting high asset prices. As one observer has put it: "The proposed Liquidity Adjustment Facility (LAF) to provide crunch funds for market players (and sometimes to drain the rushes), the reduction in the minimum daily requirement of CRR balances by banks from 85 per cent to 65 per cent, a special facility for securities settlement quite similar to an intra-d ay credit facility, a Debt Securities Clearing Corporation and the rest are all meant to keep the financial market amenable to the RBI's intentions."

Finally, over the reform years, especially in the recent past, interest paid on deposits with the banking system has been substantially reduced. The maximum rate of interest has fallen by as much as 3 percentage points. And to keep pace with this, the go vernment has recently launched an effort to reduce interest rates on small saving schemes. This fall in interest rates serves to push small savers into mutual funds and debt and equity instruments, which offer or are expected to offer higher rates of ret urn, helping to sustain demand in the market. The tax incentives being provided on investments in specific financial assets such as infrastructure bonds only further this tendency.

In sum, the combination of fiscal and monetary policies that are being put in place appear to have been formulated with one eye on the market. And inasmuch as the market has been passing through a speculative phase resulting in unsustainable price-earnin gs ratios, this effort to prop up the market amounts to support for speculative practices. The problem is that speculative activity tends to drive the market both ways, with the smaller investors rushing in when the market is buoyant and exiting, having burnt their fingers badly when the market is in free fall. This exaggerates the movements of an index, which have been given undue significance as a pointer to the health of the economy under the current regime. Not surprisingly, the Finance Minister is not too comfortable with the wild swings in the index. He expressed his resentment when he declared in his reply to the budget debate: "The manner in which stock markets are behaving leaves much to be desired. It is very silly behaviour." What he left un said is that he himself has been silly enough to place all his bets on those very same markets.