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Up, up and across

Published in The Week, February, 21st, 1993

It's budget time again. The air is thick with expectations while the finance minister goes into a huddle with his officials. For, the 1993-94 budget is like none other - it offers a unique chance to move the ponderous economy away from the quagmire of Central planning on to the freeway of market-based growth. But will Manmohan Singh seize the initiative by announcing major policy shifts or will he opt for the time honored practice of merely tinkering with obsolete regulatory mechanisms?

Before we dwell upon the possible line Manmohan Singh can take, it may be worthwhile to look at some crucial factors that underlie the current travails of the economy .

First, the budget deficit is large in proportion to GDP. During 1985-90 the budget deficit has been an average of 2.2 per cent of GDP. With government expenditure being higher than expected, the gross fiscal deficit is currently hovering around 8 per cent of GDP.

The only way to reduce this deficit is to cut government expenditure, which accounts for over 80 per cent of the non-plan expenditure. Which translates into simple though potentially divisive logic; disband government agencies, cut ministries and departments, freeze new recruitment and provide more golden handshakes. But given the powerful nexus between politicians and the bureaucracy this unambiguous economic postulate is easier said than done.

More disturbing than the size of government expenditure is its lop-sided distribution. According to the World Development Report 1992, education, health and housing, social security and welfare merited only 2.5 per cent, 1.6 per cent and 6.9 per cent respectively of total government expenditure. Defense on the other hand, gobbled up 17 per cent. It is imperative therefore to refocus resources into the human development sector (education, health, housing) by pruning subsidies and public sector spending.

Secondly, our interest rates (18-22 per cent) are far too high to provide any real boost to industrial growth. Worldwide interest rates are moving in the 5-10 per cent range. Such a high cost of funds has a very negative impact on profitability and ultimately on investment.

Thirdly, our regime of administered prices does not reflect either productive efficiency or market conditions. The problem is further complicated by over regulations and high tariff rates - all of which conspire to reduce competition and thereby place further checks on productivity.

The need of the hour is to let the markets regulate demand, supply and prices by enhanced competition. The Chelliah Committee's plan to slash tariffs is therefore most welcome, especially the recommended ceiling of 30 per cent. The only discordant note relates to the time frame: the duty cuts are stretched until 1997-98. We just cannot afford such a long transition period. There is an urgent need to switch over to lower tariffs within 18 months.

The budget must therefore display certain fundamental policy shifts.

First, it can no longer confine itself to a mere 12 months. Rather, it must lay the groundwork for the evolution of the economy over the next 10 years. There can also be no regression to redistributive economics. In such a scenario, the primary focus will have to be on drastic cuts in government expenditure.

Secondly, budget allocations to public sector enterprises must stop. A comprehensive privatization program spread over 36 months has to be planned and implemented.

Thirdly, our tax rates have to be reduced to foster better compliance and provide higher incentives for productivity. The personal tax floor can be raised to Rs 50,000 per annum, while the corporate tax rate is cut to 40 per cent (with abolition of surcharge).

Fourthly, tariff rates may be fixed as per the Chelliah Committee report with effect from January 1, 1994. This will induce drastic changes in Indian industries. The import bill will balloon in the near-term (6-12 months) but over 12 to 18 months. Imports will slow down and be purely dictated by cost-benefit analyses by importers. Needless to say, competitiveness and productivity will be the basis for survival and growth.

Fifthly, the indirect tax regime will need to be thoroughly overhauled. Instead of adding to or deleting for excise duty we must switch to the VAT model. The double cascading effect of taxes on production has to be eliminated. This will swell revenue while minimizing the impact on prices.

Sixthly, important decisions relating to foreign investment have to be taken. In particular limitations on equity investment ownership and repatriation of profits and capital have to be removed. We also have to evaluate seriously, the prospects for rescheduling parts of our external debt. Considering the pressure on our forex reserves, we must also explore debt-equity swaps.

Seventhly, we must demonstrate our resolve to integrate the Indian economy with the world by shedding our inhibitions about unshackling the rupee. Partial convertibility only creates additional bureaucratic controls. It is far better to let the rupee find its true value and then let people freely convert back and forth in various currencies.

As an initial step full convertibility can be instituted on the trade account. The impact of such a policy coupled with lowered tariffs and excise duties would be to remove distortions from the market. Again, the short run will be painful: forex reserves will be depleted dangerously and the trade deficit will soar.

If we reduce interest rates simultaneously along with these policies, macroeconomic forces are bound to combine effectively over 12 to 18 months. Ultimately the value of the rupee will reflect the competitiveness of our economy and this indeed will be the true regulator of our fortunes.

Given these dramatic changes in our external trade and investment policies, FERA seems totally irrelevant. There is only one way to deal with this anachronism: abolish FERA and substitute it with a new minimalist, progressive law that has at its core the clear understanding that foreign investment and trade are vital lifelines for India's growth and prosperity.

None of these changes is going to be easy or painless. The large companies, in particular, are certain to be scorched by intense competition. We can no longer look to the government for everything. Success in integrating with the world economy will be achieved only if the Indian mindset is globalized!

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V.K.Madhav Mohan - The Leader : Mentoring Services, Mentoring Workshops, Mentoring products- Articles / Audio / Video/ Posters, Lectures