ECONOMIC HIGHLIGHTS

New Delhi, 2 March 2006

Budget 2006

Cashing on Booming Economy

By Dr. Vinod Mehta

The first budget of the UPA Government in 2004 had provided a big push to the rural sector.  This push continues into its third budget; large allocation has been made to the rural sector under the Bharat Nirman Yojna.  Some of its critics have questioned the ability to raise the resources required for Bharat Nirman Yojna, but the Finance Minister is banking on the booming economy, which will help generate resources it needs for the rural sector.  Apart from the rural sector it provides impetus to the infrastructure and social sectors.

In the Economic Survey he has already indicated that the growth rate will be around 8.1 per cent and hopes that he will be able not only to maintain it but will be able to raise it further.  The manufacturing sector is already booming for the last three years.  The Finance Minister feels that the time is appropriate to strengthen the manufacturing sector also.  Therefore, he has concentrated on growth rather than indulge in populist measures like giving the tax sops.  The ultimate aim is to take the growth rate to around 10 per cent  in the next two to three years as it will ensure more jobs as well as relatively higher living standards.

The Finance Minister has not touched personal and corporate tax rates and has also not tinkered with income slabs.  Last time when he had tinkered with the income slabs was during the last year’s budget.  The middle class was also not looking for any change this time in the tax structure and income slabs.  The Finance Minister has also not touched the savings parts of the individuals.  In the last year’s budget he had simplified the tax concessions on savings by allowing individuals to save up to Rs. one lakh in many of the approved savings instruments;  he also allowed an additional deduction of Rs.10,000 on medical insurance. 

The Finance Minister also kept the limit of Rs.10,000 on pension funds, which was included in the overall Rs.one lakh savings.  Also he has made two minor changes : i) the limit of investment in pension funds has been removed;  a person can now  invest all his savings in pension funds upto Rs. 1 lakh, ii) he has also allowed deduction of Rs.1 lakh if that money is kept in a bank fixed deposit for a period of five years or more. 

For the last one year media had been carrying stories that the savings under section 80C could be taxed at the time of withdrawal that is to say, for instance, the contribution made to Provident Fund will not be taxed but at the time of maturity it would be taxed.  This has been called EET that is to say Exempt Exempt Tax norm.   All this media hype, which had created a scare in the mind of average citizen, has been found to be damp squib.  There is no mention in the budgetary proposals of taxing the savings at the time of withdrawal.

The social sector funding which includes education and health care has been increased.  The old age pension to destitutes has been increased from Rs.75 to Rs.200 p.m.  Safe drinking water programme will get Rs.4,680 crore as against Rs.3,645 crore during this fiscal year.  Similarly, the National Health Mission allocation which includes eradication of polio by December 2007, has also been raised substantially.  The total budgetary support to the Bharat Nirman Programme is Rs.18,696 crores which represents a hike of 54 per cent over the 2006-06 allocation.  Budget allocation for the north eastern region has also been increased to over Rs.10000 crore.

As for farmers, they will be able to get loans at the rate of seven per cent interest, as against the present rate of nine per cent.   He has allocated Rs.1700 crore for this purpose. This amount will be credited to the bank accounts of farmers by March 31, 2006. The credited amount will be equal to two percentage points of the farmers interest liability on the principle amount up to Rs.1 lakh.  This is likely to provide a great relief to the farmers.   This, however, falls short of the four per cent interest rate recommended by a high level committee, headed by M. S. Swaminathan

The other emphasis of the Finance Minister has been to make India a manufacturing hub for small cars, garments, computer chips, chemicals and petro- chemicals, processed food, leather products and so on. The concession in excise duty and other sops will provide big boost to these sectors as well as generate more employment.  What this really means is that like China, India will make these products not only for the domestic market but also for export purposes and will be able to reap the benefits of large-scale manufacturing.  With these concessions in these industries more FDI may flow into these sectors.   It may be mentioned that India was able to attract FDI worth four billion US dollars this fiscal and with these sops more FDI is likely to flow into these sectors.

Apart from rationalizing the excise duties and reducing the customs duties across the board, the Finance Minister has made changes in the service tax.  Services now contribute about 54 per cent of the GDP.  He would like to tap this source for increasing its revenues in the coming years.  In his first budget in 2004 he increased the service tax from eight per cent to ten per cent.   In his budgetary proposal for the next fiscal, he has not only raised the service tax from 10 per cent to 12 per cent but brought more services in the ambit of service tax. 

The new services that will now come under the service tax are internet telephony, travel by cruise ship and journey in business and club class of airlines, cable TV, advertisement in all media other than newspaper and magazine, commissions shared by merchants with acquiring bank and settling bank for credit cards, debit cards, consultancy in different areas, on banking transactions like issuing of bank drafts etc.  The service tax on services provided by public toilets like ‘Sulabh Shauchalyas’ could provide large amount of revenues considering India’s population, but it is hoped that in his eagerness to raise more resources, the Minister will never bring it under service tax net!

Taxes on certain processed foods like condensed milk, pasta etc. have also been exempted or reduced. Excise duty has been reduced on processed meat, fish and poultry, as well as ice-cream and pasta.  It is however difficult to appreciate that while duty has been reduced on instant food mixes like idlis and dosas but totally removed on pasta, an Italian dish.  It should have been the other way round.  Hopefully, however, it will lead to lower prices of processed food products and will provide boost to the processed food industry.  It would, however, have been much better if there was a packaged deal for the processed food industry where they could obtain latest machinery and technology to make products of international standards.

On the whole, the budgetary proposals for the next financial year per cent are good and will provide a further boost to the economy.  If the economy can sustain the 8.1 per cent growth rate and increase it in the next two years to nine per cent or so it will be a boon to the economy.  But the realization of this growth rate would be dependent upon the performance of the agricultural sector which in turn is dependent upon monsoon.  Does the Finance Minister have any control over the monsoon?---INFA

(Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 23 February 2006

Robbing Peter To Pay Paul

Rationalize Subsidies and Cut WASTE

By Dr. Vinod Mehta

Almost a decade ago it was decided to phase out subsidy on cooking gas.  Banking on this decision, a few private sector companies entered the cooking gas distribution business, thinking that there would be level playing field in a few years.  But the Government has not been able to phase out subsidy, and the few private companies that entered the gas distribution sector had to close down, as they could not compete with the subsidized gas distribution network of public sector undertakings.  Similarly, subsidy on Kerosene and diesel is affecting the price of petrol. 

All kinds of Central and State subsidies (open as well as hidden) are reported to account for 15 per cent of the GDP.  About 90 per cent of subsidies go for "non-merit goods and services" -- the non-merit goods and services as identified in one of the budgets include milk, power, transport, irrigation, education etc.

Take, for instance, the subsidy on fertilizer.  As per the available data the amount of subsidy being paid on fertilizers is very high.  This is expected to keep the price of fertilizer low for the farmers; but nearly 50 per cent of the fertilizer subsidy actually goes to the producers/suppliers rather than to the farmers.  In fact, subsidy paid out on food rarely percolates down to the consumer but gets absorbed in costs of handling and storing food grains.  Similarly, a significant portion of subsidies in higher education is appropriated by middle to high-income groups.

Unnecessary subsidies are leading to wastage of scarce resources.  For instance it has been mentioned that extremely low recovery rates in sectors like irrigation, water, electricity and diesel lead to their wasteful use as these have been withdrawn from some other sectors in which these could have been very useful.  Provision of free electricity to farmers is a big drain on resources.

Except for petrol all other petroleum products like diesel, domestic gas, wax, naphtha, etc. are being subsidized in a big way.  Of the total subsidies paid on the petroleum products nearly half of it goes to diesel, kerosene and domestic gas in that order.  As per the Rangarajan Committee Report on petroleum prices, the current -subsidy on cooking gas is still whopping Rs.171 per cylinder.

Similarly, the Railways are providing huge subsidy every year on movement of passengers and low cost goods.  The subsidy goes to ensure lower freight rate on essential items and second-class travel.  One could go on and on but it is sufficient to say that the nation cannot afford to go on paying subsidies on every conceivable  product  and service.   Subsidies beyond a certain level are  harmful to the economy in various ways. 

Firstly, it leads to wasteful use of resources.   If a farmer is getting diesel or electricity at a very cheap rate he would not bother about economizing on the use of these two inputs.  Moreover, who knows that the electricity and diesel is also being used by farmers for non-agricultural purposes?  The wasteful use of electricity and diesel by the agricultural sector implies that some other important sector of the economy like industry is being denied the optimum use of these inputs. 

Secondly, subsidies lead to distortion of relative prices in the country and send wrong signals to business units.  For instance, the Railways are known to be the cheapest mode of transport as far as bulk commodities are concerned.  But by subsidizing diesel we are artificially propping up the  motor transport sector and at the same time forcing the railways also to keep their freight rates relatively lower from those of the motor transport etc.  None of these two sub-sectors have any incentives to economize on the use of diesel, coal and electricity or to improve their efficiency by reducing their operational expenses. 

Thirdly, subsidies beyond a certain level also imply that either the country resorts to deficit financing or imposes higher taxes on the people.  Subsidies are not produced out of thin air; somebody has to pay for it. Subsidies are essentially, what economists call transfer of incomes.  Subsidies are in fact, a modern version of the old saying:  "Robbing Peter to pay Paul".  Therefore, at one level the choice boils down to either having more subsidies and more taxes or fewer subsidies and fewer taxes. 

Fourthly, the subsidies are also inimical to the export sector.  They make the cost of export lower to the foreign buyers; to that extent the domestic population is aiding the consumption of foreign buyers.  One cannot afford to support export sector on the basis of subsidized inputs for all times to come.  Subsidies only reflect the uncompetitiveness of the domestic production and hence there is no incentive for the exporters to improve their efficiency by reducing production costs. 

Therefore, what the country needs is to have a dispassionate  look at all kinds of subsidies and decide as to which subsidies need to be continued, which subsidies need to be reduced and which subsidies need to be discarded.  This cannot be a one-time affair but a continuous process in the sense that the effects of subsidies need to be reviewed every three to four years to see if they are fulfilling their role and a decision taken as to whether it needs to be continued, reduced or discarded. 

Apart from downsizing, the Government can also save funds by introducing a kind of contractual employment at a higher level where the services of specialists are needed for a specific purpose and for a specific period.  For instance, it may be less expensive to employ a doctor or a health specialist or two to prepare the health policy than to allow a non-specialist bureaucrat to develop a health policy with the help of a specialists committee.  This will also help save lots of money which currently goes into meeting the expenditure related to the organization of committee meetings which includes cost of air travel, daily maintenance, honorarium or sitting fee and so on.

At the moment a large part of administrative expenditure goes into maintenance of law and order especially in disturbed areas as in Northeast, J & K etc.  If these problems could be settled politically, a lot of money, which is being today spent on military and para-military forces in these areas, could be saved.          

It is high time that along with pruning subsidies, the Centre comes out with appropriate policies and takes appropriate steps to reduce the size of bulging bureaucracy, cut down expenditure on stationery, telephones, electricity etc., cut down expenditure on maintenance of law and order and thus reduce the cost of administration and divert the funds so saved to more purposeful activities like education, health, housing, food etc. 

The reduction of subsidies is a politically sensitive issue as many interest groups would not6 like them to be curtailed, but at least the Finance Minster can initiate the process of streamlining the subsidies and curbing the wasteful expenditure in the budgetary proposals.---INFA

(Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 16 February 2006

Interest Rate Economy

Don’t Punish People Who Save

By Dr. Vinod Mehta

The slashing of interest rates on various saving instruments initiated in 2000 by the, then, Government continues till date.  The interest rate on savings bank deposit has been slashed from 4.5 per cent to 3.5 per cent.  The interest rate on public provident fund (PPF) as well as on GPF has been progressively reduced from 12 per cent to 8 per cent.  The interest rates on bank fixed deposits as well as on Government bonds have almost been halved in the past five years.  The latest in the series is the abolition of bonus on Post Office monthly income deposits.

The industry has been hailing these steps for the simple reason that the Government has been accepting their demands relating to the reduction in interest rates as they have all along been arguing that the cost of borrowing is higher in India.  Similarly, it also meets the Government’s desire to reduce its debt burden.                                                           

In other words, the Government has accepted, on the one hand the long standing argument of the industry that the high interest rates are coming in the way of industrial expansion and, on the other hand, its own desire to reduce debt burden.   It has also been argued that the reduction in interest rates will spur the economic activity and reduce Government deficit.  Whether it will actually lead to such results one has to wait and watch.

However, going by past experience, it is highly unlikely that it will really lead to any significant expansion in the economic activity.  Whatever buoyancy is being seen in the economy is due to factors other than reduction in interest rates.  On the face of it the argument that the economic activity is not expanding because of the high interest rates is doubtful.  Interest payment is only one component of the total cost of production.  The cost of other factors of production like labour and materials  is much higher. 

But these countries never argued that the wages and cost of materials be brought down to make their product competitive.  Therefore, to argue that interest rates in India are higher than interest rates in other countries and for that reason our production costs are relatively high do not carry much weight as the relatively cheap labour and cheap raw material offset the disadvantage of high interest rates. India as the cheap interest rates  offset the disadvantage of expensive labour and raw material in the developed countries. 

The real reason for asking downward revision of interest rates is that the Indian industry, even after 15 years of economic reforms, has not yet been able to gear itself to make efficient use of all the resources, as the foreign industry has.  They are not yet aware of the need to use economically the available resources including the borrowed funds.  In fact, a large number of our companies are in the habit of diverting the borrowed funds into unrelated channels or activities and because of their ability to window dress their balance sheet, this diversion of funds are rarely detected.  For instance, the money borrowed from banks to meet the short term working capital needs are many a times used to make speculative purchases at the bourses. 

Therefore, it is difficult to say that the increased availability of funds at reduced interest rates will give a big push to the industrial activity in the country.  It is likely that a large part of borrowed money will either be diverted to other unrelated activities to make short-term speculative gains or it will be used to retire the high cost debts raised earlier; it will seldom be used for expansion activity. 

In fact, the downward pressure on interest rates is also due to the convergence of interests of the Government and industrialists.  It is common knowledge that the Government is the largest borrower of funds in the country.  PPF, GPF and EPF as well as terms deposits with post office funds which are savings for an average citizen are in fact public borrowing by the Government; the funds collected through GPF, PPF, EPF and post office deposits go directly to the Government account. Apart from these direct borrowings, the Government also borrows from commercial banks through the medium of short-term and long-term bonds etc. to meet its current expenditure.

These borrowings and interest payments over the years have accumulated so much that the government is almost caught in a debt trap wherein it has been borrowing to repay its earlier loans.  Therefore, the government has also been very keen to reduce the interest rates as it will reduce the cost of public borrowing to the government.  One percentage point reduction in interest rates on PPF, GPF etc. and new bonds will result in savings of thousands of crores rupees on Government borrowing.  This one reason was sure enough to bring down the interest rates continuously.  

As in any game there are always some winners and some losers.  In this game of interest rate cut the winners are the industrialists and the Government, while losers are the average citizens who save money for their future needs and for their old age.  The reduction in interest rate while reducing the cost of borrowing to the industries and government will in effect reduce the earnings on savings of the general public.  The sufferers are pensioners, the old people, the widows and others who are solely dependent upon interest earnings of their savings.  The younger people may also feel that their savings are not growing as fast they should.  It is likely that the aggregate domestic savings over a period of time may also go down as some people may not find it attractive to save in the banks.

In India, provident fund and term deposits in banks are the major forms of savings as both the capital market and mutual fund sector are not highly developed.  In developed countries people invest their savings either in equities, in mutual funds or in pension funds which give them a relatively very high rate of return, much higher than the interest rates on term deposit in the banks.   In India both the primary and secondary capital markets are highly manipulated by speculators and therefore the equity market has not been able to become an alternative to savings in the banks for a large number of people.  

Similarly, the mutual funds sector is again highly dependent upon the volatile capital market and therefore cannot assure a steady and growing rate of return on investments in mutual funds.  Had there been a transparent equity and mutual fund market, people could have diverted their funds from banks to these institutions.  Since these sectors are highly manipulated, the Indian saver is condemned to keep his surplus money in banks (or invest it in gold and real estates) which offer a relatively low rate of return. 

The most important question, however, is that why should Reserve Bank of India dictate the savings bank rate to the banking industry in this era of liberalization.  Like any other central bank it should only fix the bank rate and free all other interest rates including the savings bank rate to be determined by the demand and supply of funds.  By imposing savings bank interest rates it is forcing the banks to adopt a similar pattern of interest rate structure.  The move apparently is to protect the interests of the weaker banks.  If the Reserve Bank of India were to free the savings bank rate of interest, there would be many efficient banks which would be willing to give a higher rate of interest than the one fixed by the RBI.  Similarly, the efficiently run banks would also be in a position to offer higher rates of interest on term deposits also.

Therefore, when we are talking of financial sector reform, it is high time that the Reserve Bank of India limits itself  to fixing the bank rate as well as the CRR and let market forces of demand and supply for funds determine the interest rates on various instruments savings including the savings bank deposit rate.  If the demand and supply conditions require the savings bank interest rates be below 4% or be above 4% then let it be so. 

Let the saving public decide in whatever form it would like to keep its savings depending upon the rate of interest being offered by various banks on various kinds of savings instruments.  At the same time the rate of interest on provident funds including Post Office deposits should not be reduced below eight per cent so long as the pension funds as also mutual funds are not placed on strong footing.  Reduce your debt burden, help reduce production costs but do not punish the savers especially the pensioners, old people, widows etc.  –INFA

 (Copyright, India News and Feature Alliance)

ECONOMIC HIGHLIGHTS

New Delhi, 10 February 2006

Vision 2020

INDIA A DEVELOPED NATION

By Dr. Vinod Mehta

The Sensex has crossed the ten thousand mark; the average growth rate for the first two quarters is above eight per cent.  It looks forward to participating in G-8 meetings. Most people now feel that India should shed the tag of developing country and be classified as an ‘emerging’ economy before being called a developed economy.

Some people may think of it as a cynical idea; even after 50 years of Independence we have not been able to ensure safe drinking water to every person or achieve 100% literacy, so why talk about India as developed nation? Well, this is a brute fact and should be recognized so and efforts doubled to solve these issues on an urgent basis.

However, it is the vision which is very important. Nehru had a vision of India as a developed country over a period of time. This vision led him to set up institutions like IITs, IIMs, CSIR, ISRO, Atomic Energy Commission. DRDO, Agricultural Universities, AIIMS and even research in the field of social sciences and humanities have made them known. People had at that time also laughed at him but today after 50 years, the achievements by Indian scientists, engineers, doctors, managers, social scientists are known the world over. We are at a stage now where we can talk about and think about   achieving the status of  a developed country in the coming years.

The eyes of many countries are focused on India. Each of its development or achievement is being scanned by these countries. There are some powers which would not like India to become a developed nation and so are engaged in pinpricking. The treatment meted out to our software engineers in Malaysia, Indonesia and Netherlands a few years ago, was a pointer in that direction. Even some of our drug companies had to face and are still facing legal battles against their newer drugs in some of the developed countries.

The ban on the transfer of certain kinds of technologies is also a pointer in the direction of slowing down India’s entry into the league of developed nations. Therefore, keeping in mind that other countries would like to stall or delay our march towards a developed nation, we must have a clearly defined path to achieve the goal of becoming a developed nation.

Having said that, let us now try to build on our strengths. As we know, the process of economic reforms is on for the past 15 years. During this period many new first-time entrepreneurs have emerged in the country such as Infosys, Wipro and many others. The process of economic reforms needs to be speeded up further so that we are able to complete this process in the next five years. If the economy is competitive in the international market it will automatically become strong over a period of time. Without a strong economy and a strong financial system we will not be able to keep abreast with the developed nations.

The results of economic reforms are now for everyone to see; Indian firms are becoming lean and cost effective now. After the reforms in the industrial sector we should now complete the economic reforms in the financial sector also. Steps have already been taken like the establishment of private sector banks, private insurance companies, setting up of Pension Funds, relaxation in foreign currency regulations and so on. But we must speed up the reforms in this sector and get rid of NPAs at the earliest.

Finally, we also need to have a world class infrastructure ready in the next 15 years. We need to set up world class communication system, transport system including good road, rail and air network.  All these are minimum requirements for the emergence of a developed nation which India aspires to be. ---INFA

 (Copyright, India News and Feature Alliance)