What Mr Chidambaram Can Do

He should worry about the deficit, but try a new tack. This is because, as he has himself confessed, there is little he can do to control expenditure, 70 per cent of which is given to him as a fact of life. He should therefore concentrate on formalising an agreement with the RBI on putting an end to ad hoc treasury bills, and shift to a regular ways and means arrangement with the central bank. This will be beneficial in two ways. First, Mr Chidambaram will be able to turn around and tell those making unreasonable demands that, sorry, there is no money in the bank. For a start, this will stymie the utterly retrograde proposal to bring the oil pool account deficit into the Budget. Second, it will put a firm cap on monetisation of the deficit and take care of inflation. If a simultaneous decision is taken to restrict market borrowing to present levels so as not to pre-empt public savings any more than in the current year, the foundations of controlling the fiscal deficit will have been laid without having to

 

even put it as item number one on the agenda.

Even if the finance minister were to concede for the moment that precious little can be done on the expenditure front for political reasons, and the formalised limits on printing money and borrowing from the market will do the job just as well, and attention can be turned to raising more revenue.

Revenue without tears

This is best done the way both the finance minister and the deputy chairman of the Planning Commission have indicated, by expanding the revenue base through bringing within the tax net many more individuals who do not but ought to pay taxes. How to do this is no great secret; the Chelliah committee spelt out some methods, for instance. What it does need is focused attention, because the tax to GDP ratio has declined since 1991, and should be pushed back up if there is to be any hope of fiscal correction.

There is an even easier way to raise more revenues: lower customs duty. The last Budget was truly retrogressive in raising customs duty by 2 per cent across the board, thus conveying the wrong signal with regard to opening up the economy. Lower customs duties will reduce domestic costs and give a fillip to demand, thereby encouraging investment. India's customs duties remain among the highest in the world despite the cuts of the past six years; indeed the budgets of governments in most developed economies barely mention customs as a source of revenue. The levels of protection available to domestic producers have not really fallen since 1991, because the customs cuts have been compensated by the rupee's devaluation. And if needed this can be done again; there is good reason to believe that the rupee is now slightly overvalued. A cut of at least 10 percentage points in the peak customs duty is the minimum that needs doing, with comparable cuts down the line and a reduction in the number of duty slabs.

In fact, the finance minister should go ahead and impose customs duty on a range of consumer goods whose imports should be delicensed. This should not be impossible as the enabling action will have to be taken by the commerce minister who sees eye to eye with Mr Chidambaram in these matters. The impact of all this will be a sharp rise in customs revenue. Capacity utilisation in some consumer goods sectors might be partially affected by cheaper imports but this will be countered by industry's ability to source its inputs more cheaply and so produce and sell more. In the greater pressure of competition created by liberalised imports, the fitter Indian businesses will survive and the weaker ones go under. This should be acceptable as the declared policy of this government is to reward Indian winners.

Systemic changes

Revenue help can also come from another quarter: the likely decision to accept the finance commission's alternative scheme of tax sharing. Although it is unlikely that this will be possible in the coming Budget, the government must focus some attention on the services sector, which accounts for 40 per cent of GDP but yields a paltry Rs 500 crore in tax revenue. The central government has so far neglected taxing services because the proceeds of such taxes have to be passed on entirely to the states. With the expected consolidation of all tax revenues for devolution, the Centre will have an incentive to tax services also.

This really leaves two specific areas to be attended to, taxes for the corporate sector and promoting exports. Since the minimum alternate tax (MAT) has become a prestige issue of sorts for the finance minister he may not want to relent on it entirely. He has raised the option of addressing the issue of dual depreciation rates being charged for tax purposes and under company law, and since Mr Chidambaram oversees both, he could certainly look on this as an area for reform. But if there is to be a balance between revenue considerations and signalling through the Budget, the finance minister could consider the old issue of double taxation of dividends, which places equity capital at a disadvantage vis-a-vis debt (which is taxed only once). The short point is that some reform of corporate taxation should be achieved through this Budget. To make matters easier for companies, a unification of depreciation rules could be accompanied by raising the depreciation rates as well. This will be beneficial to those

companies which were not affected by MAT but which wish to invest extensively. And since the finance minister is not known to sit on prestige, he can make a concession on MAT by taking export revenue out of its purview.

Once all this is done, there will be no need to give more special incentives to the capital market to revive it. The key to improving market sentiment lies in improving earnings and initiating lower interest rates. The latter exercise has already started and the former should be ensured by the measures outlined above. None of the foregoing really affects the core political constituencies of the ruling parties. But such a package, even though it is a long way from what could be done by a stronger government, still has the potential to go a long way in undoing the damage done by the last Budget and paving the way for a resumption of high growth.