Stringent inflation targeting in the past few years has led to a tight monetary policy (see Dearer Capital), which has its own implications in a weakening global economy. Surging foreign capital inflows have led to rapid rupee rise last year. Managing these flows while retaining export competitiveness remains a serious issue. Though a Tobin tax is being contemplated on foreign investment, it is extremely unlikely to be introduced. The burgeoning foreign exchange reserves may, however, lead to both further liberalisation of overseas investments and the use of forex for infrastructure projects. Announcements on measures to improve the liquidity in the debt markets seem likely with a view to boost infrastructure investments.
Growth & competitiveness The immediate task then for the FM is to preserve the growth momentum in the economy. BJP’s Sinha says: “The virtuous cycle of low interest rates, low inflation, high consumer demand and high infrastructure spend is now threatened. There is a definite slowing down in the economy.” While housing may have become the first casualty, manufacturing, too, is slowing down. The sectors that have been most affected are the ones where growth is backed by consumer credit—two wheelers and consumer durables. R. Seshasayee, MD, Ashok Leyland, concurs. “There is no question that there is a slowdown in manufacturing. However, it is not a secular problem and one believes it will be sorted out soon,” he says. “The cost of components or raw materials is on the higher side in India. Manufacturing becomes further unviable with the addition of inverted duties and high infrastructural cost,” says Moon B. Shin, MD, LG Electronics India, adding that compensation to manufacturers on basic infrastructure requirements such as electricity, water, steel for construction and operation of a plant will help. As a result, the EAC has suggested selective tax cuts to boost consumer goods, whose output has been declining over the latter half of 2007. The Finance Minister himself has indicated relief to sectors stressed by the rupee appreciation and a boost to labour-intensive manufacturing segments. Sixth pay commission: A fiscal bomb At present, the Sixth Pay Commission (SPC) is the single largest risk that could derail fiscal consolidation and, hence, is a huge overhang on the forthcoming Budget. The panel, headed by Justice B.N. Srikrishna, was set up a decade after the previous commission, and is expected to submit its report by April 5, 2008. Though meant to formulate guidelines for salary revisions of central government employees, the recommendations of such Pay Commissions are almost always adopted by the state governments, as well. The Fifth Pay Commission, implemented in 1997, resulted in a payout of Rs 53,000 crore and impaired the public finances for many years to come. The brunt of the hit was taken by the states. Between 1997-98 and 1999-2000, the primary deficit of the states went up from 1 per cent to 2.6 per cent of state domestic product and the fiscal deficit from 3.2 per cent to 5.1 per cent. As a proportion of their revenue receipts, their revenue deficit went up from 9.6 per cent to 26 per cent. Of course, the Fifth Pay Commission had recommended cuts in the government workforce and the number of pay scales along with the abolition of vacant posts. The productivity recommendations were not followed due to their unpopularity and, hence, the ballooning deficit, which took 7-8 years to become manageable. Policy watchers believe that the SPC will have a similar impact. Others such as former finance minister, Yashwant Sinha are more critical. “The Fifth Pay Commission had nuked the Indian economy and now we are waiting for another nuclear assault,” he says. |
Software services exporters, though, may be disappointed. “The IT industry is expecting the government to implement the recommendations of the Kelkar Committee on linking the phase-out of the tax holiday with the signing of the totalisation agreement with the US,” says Kris Gopalakrishnan, CEO, Infosys Technologies. Declining tolerance for such exemptions, however, may result in such tax benefits not being extended beyond 2009. Then, the anomaly between software companies operating in SEZs and IT parks and those operating in non-SEZ regions will need to be rectified. Investments hold Notwithstanding sectoral slackening, the rotation of demand in the economy is keeping up the momentum. This demand is manifesting itself in a massive investment boom, which has still not responded to higher interest rates. Says ICICI Bank’s Joint MD, Chanda Kochhar: “There is a very visible investment pipeline of around $700 billion (Rs 28 lakh crore) by Indian companies over the next three-and-a-half years. We need to make sure that this is sustained.” The UPA government, despite its weak political hand, has successfully persuaded the private sector to prepare for 9 per cent growth, believes Suman K. Bery, Director General, National Council for Applied Economic Research (NCAER). “This investment boom is substantially stimulated by a belief that 9 per cent growth is here to stay. And one should not forget how recent that conviction is,” he says. The FM’s task this Budget will be to strengthen the belief even more. Taxation as a tool to improve competitiveness may require some skilful handling. As the Goods and Services Tax (GST) is around the corner, the expectations relate to the alignment of the existing rates to the expected GST rate. A clear roadmap on evolution to GST is expected this year. To retain competitiveness, business chambers have sought a slower reduction in customs duty to ASEAN levels, especially since the rupee appreciated almost 12 per cent last year. Petroleum Minister Murli Deora is not alone in pitching for a lower tax incidence on petroleum products for reducing the impact on the economy. “The Finance Minister should lower the tax burden on our petroleum products. That will allow us to absorb the higher oil prices without affecting the consumers,” says Rajiv Kumar, Director, ICRIER. It seems unviable at present, but the recent fuel price hike may well become a negotiating tool for such restructuring. No easy options It is now clear that the easy reform options have been exhausted. For the economy to cruise at higher growth rates, a fresh impetus is needed. “On the policy front, we need to reform a whole host of labour laws to allow large firms in the labour-intensive sectors (apparel, footwear, toys, consumer goods and other light manufacturing) to emerge,” says Columbia University’s Panagariya. NCAER’s Bery feels a new policy mix—more stringent fiscal policies and an easier monetary policy—is in order given the strength of the economy now. True, but probably a new government will be better suited to tackle such new tasks. In the meantime, as hard-nosed jostling for sops continues in the days leading up to the Budget, it is clear that there will be some trade-offs. Not very regressive, though, one hopes. As Amit Mitra, Secretary General, FICCI says: “Certainly, if the Finance Minister wants to offer a dream Budget, it has to be a dream for everybody.”
Additional reporting by Rishi Joshi and Shamni Pande
of Business
Today
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"Total reduction of excise duties by 2% will give a welcome boost to the manufacturing sector. Also, the exemption of specified parts of set-top boxes from customs duties is commendable".
