Following is the first of a pre-budget series by ICRA and The Financial Express. From tomorrow the focus will be on specific sectors beginning with information technology:The industrial growth that characterised the second half of FY 2000 seems to have tapered off in FY 2001. The Index of Industrial Production (IIP) for the period April-October 2000 was 5.8 per cent compared with 6.6 per cent for the corresponding period of the previous year. The capital goods sector displayed a significant decline reflecting the slowdown in investment activity in the economy. On the positive side of the economic performance in FY 2001 is the healthy growth in exports. Exports have grown by over 18 per cent in dollar terms during April-November 2000 compared with the corresponding period of the previous year.
The Union Budget for 2001-02, which will be presented against the backdrop of an industrial slowdown, excess capacity in key sectors, a precarious fiscal situation and a depreciating rupee, would have some tough issues to address. Fiscal challenge The Union Budget for 2000-01 had focused mainly on the revenue side (phase out of exemptions on export profits, increase in dividend tax, rationalisation of the excise duty structure, removal of interest tax etc.) On the expenditure side, while the budget had talked of the need for fiscal restraint, the budgeted increase in expenditure was 11 per cent over the revised estimate for FY 2000.
The Union Budget 2000-01 had projected the fiscal deficit to decline to 5.1 per cent in FY 2001 from the revised estimate of 5.6 per cent for 1999-2000. However, inability to curtail government expenditure and shortfalls in disinvestment receipts are likely to put continued pressure on the fiscal situation. The criticality of the situation is reflected in the fact that the government has limited leeway in controlling the expenditure on the three major heads-interest payments, defence and subsidies. Consequently, the revised estimates of expenditure exceed the budget estimates. For instance, the budget estimate for total expenditure in 1999-2000 was Rs 2,828 billion while the revised estimate was Rs 3,037 billion.
The key concern is that government borrowing is largely going into meeting revenue expenditure rather than income generating asset creation. Further, the return on public assets is way below the interest on debt raised to finance them. Thus, fiscal management would be a key issue for the forthcoming budget.
Some of the priorities that need to be addressed in the forthcoming budget are:
Broadening of tax base and improvement in compliance.
Reform of the subsidy structure in key sectors such as fertilisers, oil and food.
Imposition of fiscal discipline on state governments whose finances have reached crisis proportions.
Reduction of public ownership in non-core areas through disinvestment and privatisation.
Some recent hard decisions like the rise in kerosene and diesel prices, and the corporatisation of Uttar Pradesh State Electricity Board (UPSEB) and the Department of Telecom reflect a growing political will that could translate into a hard budget for 2001-02. But it must be remembered that similar expectations for the previous budget were belied.Revenue mobilisation The chart (Receipts: Budget Estimates 2000-01) presents the profile of the non-debt receipts of the government including revenue receipts (tax and non-tax) and non-debt capital receipts (disinvestment and loan repayment receipts).
The scope of bridging the financing gap through enhanced revenue mobilisation could be constrained in the medium term (despite the buoyancy in tax revenues in the first half of FY 2001) because of:
Slowdown in industrial production that has an immediate impact on excise duty collections. The adverse impact on corporate profitability of cost-push pressures (on account of rupee depreciation and high oil prices among others) and tardy demand offtake that prevents corporates from passing on cost increases to consumers. The overall thrust of India's economic policy in recent years has been towards freer trade and lower import duties. Further reduction in duties could offset the positive impact of rupee depreciation (which increases rupee value of imports) and higher oil prices on customs revenues.Significant growth in revenue mobilisation is likely to be a function of economic growth rather than tinkering with tax rates at the margins. Further, given the nature of government expenditure, especially considering the Gujarat earthquake in view, it would perhaps be naive to expect any drastic curtailment in the medium term. Thus, the key objective of the budget should be economic growth. Further, 2001-02 will be a significant year for Indian industry as all quantitative restrictions (QRs) shall be removed from April 2001. This reinforces the second important task that the budget shall have to achieve: that of enhancing India's global competitiveness.
Growth impetus
The Union Budget needs to provide a growth impetus through policies designed to attract foreign direct investment (FDI), encourage exports and enhance the infrastructure in the country. Following the economic reforms programme that began in 1991, there was a quantum jump in the level of FDI in India. However, the level of FDI flowing into India ($2.2 billion in FY 2000) is far below that of China and India's requirements, especially in core infrastructure sectors.
The critical constraint to growth in India is the lack of adequate infrastructure: both in qualitative and quantitative terms. Specifically, India's requirements are in the following areas: power, roads, telecom, municipal services and construction. The two major constraints to infrastructure development in the country are the lack of clarity on policy issues and the lack of adequate funding (the latter in part deriving from the former). The Union Budget needs to address these issues in order to promote infrastructure projects.
Policy issues: Policy issues continue to undermine the completion of several infrastructure projects. For instance, the addition of power generation capacity continues to be hindered by unresolved policy issues and structural impediments like the low earning capacity of state electricity boards (SEBs). The SEBs are the principal distributors of power in the country and since they are going to purchase the power produced by the generating companies, their creditworthiness is essential. The lack of an adequate payment security mechanism and the controversy regarding the allocation of the escrowable capacity of the SEBs has become a subject of litigation. In case of roads, despite fiscal incentives, private sector participation has remained below expected levels on account of the long-gestation, land acquisition problems and difficulties in toll collection. The Indian construction industry remains plagued by the absence of regulatory framework, lack of proper financing mechanisms and low mechanisationlevels leading to time and cost overruns in project execution.
Funding: One impediment to infrastructure lending in the country is the high interest rate structure. The rate of return on infrastructure projects is relatively modest and the high cost of funding for financing agencies undermines the viability of infrastructure lending. An important reason for the high interest rate structure in the Indian economy is the large quantum of market borrowing by the government.
The return provided by the government on its `risk-free' debt has the effect of crowding out private investment and raising the cost of capital to the private sector. This is evidenced by the declining credit-deposit ratio of the Indian banking sector, which has invested in government securities far in excess of SLR requirements. As mentioned previously, the Union Budget for 2000-01 could not adequately address the concerns on fiscal imbalances. While the changes in the bank rate and CRR impact the interest rates, the fundamental cause for increasing interest rates is the burgeoning fiscal deficit. While the curtailment of fiscal profligacy is a laudable aim, there are practical difficulties in doing so. A mere realistic option for the budget would be to lower the cost of projects through tax incentives, concessional duties and finance.
Enhancing global competitivenessSince the economic liberalisation programme began in 1991, the average level of customs duty have progressively declined and QRs have been removed in a phased manner. Even in areas where foreign trade is yet to be liberalised (i.e. QRs are still present) foreign investment has been liberalised, for instance in automobiles. Currently QRs remain on five important sectors: urea, petroleum products, consumer goods (including automobiles, consumer electronics, liquor and cigarettes), textiles and agriculture.
In the case of petroleum-related products and urea, the issue of removal of QRs would be complicated by the need for deregulating the domestic market. The sector that has been most affected by the forces of liberalisation has been the small and medium enterprises. With the removal of QRs, the utility of the system of small-scale industry reservation becomes doubtful as the imports of the `reserved' products become free. The Union Budget 2001-02 needs to initiate the process of redefining the role of the state from a provider of subsidies to a provider of social and physical infrastructure.
Clearly the government does not have the resources to perform both the roles. Specifically, the issues that need to be addressed for enhancing India's global competitiveness are:
Expansion and upgradation of the road and telecom infrastructure necessary for the efficient transportation of goods and information, respectively.
Restructuring of the power sector to reduce the high power costs in India is also crucial
Financial sector reforms and prudent fiscal management to lower interest rates.Copyright © 2001 Indian Express Newspapers (Bombay) Ltd.
