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Redefine budget preparation with five issues in mind !

JANUARY 28, 2008

By Naresh Minocha, Our Consulting Editor

CAN the Finance Minister P. Chidambaram muster professional will to take the country out of the rut of annual budget exercise? Can he dare to do that in what looks like the last full budget prior to the Lok Sabha polls due in 2009?

We raise five challenging issues with larger national perspective for Mr. Chidambaram to consider in preparing the budget for 2008-09. Before discussing the issues, it would be appropriate to review the pre-budget scenario.

The casino players operating as investors have tried to grab the pre-budget eyeballs by crying hoarse over the loss of their paper wealth in sync with global chill that last week swept the stock markets in several countries.

The loss, call it technical correction if you wish, is justified. Justified because the gains were much more rapid and of much longer frequency than the loss over a couple of days.  Several initial public offers have been over-priced in the recent months. Many shares have been trading much above their intrinsic worth. The markets would in case find their own levels just as the water does. 
Mr. Chidambaram ought not to consider any tax sops, interest rate changes or any other initiative to prop up day-trading, derivatives trading, etc. He should instead act on his loud thought of moderating money inflows from abroad to prevent re-emergence of stock market bubble.

And while moderating inflows of hot and speculative money, he should also allow central public sector enterprises (CPSEs) to avail of foreign currency convertible bonds and well as other avenues for tapping foreign capital markets that are currently open to only private sector.

As cheap finance is perhaps the most crucial factor in market-driven economy, there is no case for tying the hands of CPSEs while asking them to face competition from private sector counterparts as well as imports.

The run-up to the budget has also been marked by cacophony of demands from ever-hungry export lobby. The Finance Minister has thrice doled out financial packages for exporters to cushion the impact of appreciating rupee against dollar in current fiscal. And textiles sector is specific beneficiary of each package.

He had also handpicked a few other sectors for treatment, leaving out less vociferous ones as well as thousands of self-employed exporters, including consultants and journalist who offer their services to foreign entities.

The risks and rewards of foreign currency fluctuations constitute a normal variable of liberalized, globalizing economy. The companies must take risks and windfalls in stride. In any case, there is no need for devaluation or depreciation as hardening rupee benefits industries and companies that have high import intensity.

Yet another relatively new factor in pre-budget scene is the lobbying for project subsidies from different industries as well as their administrative ministries both under the highly-misleading name of public private partnership (PPP) as well as under other mechanisms.

Both the Centre and States have opened a new avenue for dole-outing cash grant as well as interest subsidies to new and expansion projects on case-to-case basis, thereby making the system more prone to corruption, lobbying and fiscal indiscipline.

These dole-outs are being handed over, unveiled or in the works. The major beneficiaries of these include textiles, leather, semiconductor, sugar, roads, airports and other infrastructure projects.  

They can collectively leave a big hole in the central and state exchequers, if not stopped immediately. The project-related grants and interest subsidies already run into several thousands of crore of rupees.

Experience shows that once the Government introduces a time-barred scheme for one sector, it invariably gets enlarged in scope and tenure.

This is best illustrated by textiles sector for which Technology Upgradation Fund Scheme (TUFS) was introduced for 5 years ending 31 March 2004. It was later extended up to 31 March 2007 as well as enlarged in scope, attracting total investment of Rs 86,000 crore.

In November, the scheme was further liberalized and enlarged to cover technical textiles and was extended till 31 March 2012 to attract investment of Rs 150,600 crore.

The Government has already agreed to include units producing synthetic fibre and yarn in this scheme though detailed notification is yet to be issued.  

TUFS offers lollipops such as 5% interest subsidy on loans, cover up to 5% on foreign exchange fluctuations and 10-25% capital subsidy on purchase of specified machinery.

Since the notification on technical textiles on 7 December, 10 companies have already secured registration from the Government to become eligible to avail of benefits.

Similarly, the Government has committed to offer 20-25% of project cost as grant to companies that set up semiconductor projects under special incentive package notified in March 2007. A news report says that this package has already attracted offers to invest Rs 40,000 crore.

The Government has also announced its decision to set up Petrochemical Technology Upgradation Fund (PTUF) on the lines of textiles TUFS to facilitate modernization and expansion of plastic products industry.

The dole-out story is equally sugary for sugar sector. The sugar industry package announced in October 2007 provides for interest subsidy for all mills, moratorium of loans outstanding against cooperative mills and re-structuring and re-scheduling of certain other loans.

The infrastructure projects under PPP format are doled out cash either as equity or grant or as both and interest subsidy or interest-free loan. The beneficiaries include private sector promoters or joint ventures for Delhi, Mumbai, Bangalore and Hyderabad airports.

Such projects are separately eligible for cash dole-outs from the States, in addition to central and state tax benefits.

The project sponsors have started advertising the Central subsidy in the tender notices too to attract more bidders and to impart some transparency to this case-by-case favours. Chandigarh Administration, for instance, has cited Rs 100-crore subsidy from the Centre in its notice soliciting offers for setting up a agricultural terminal market.

Mr. Chidambaram should stop giving cash subsidies over and above the innumerable tax incentives to the industries. If he is convinced that certain projects are unviable or have long-gestation period, he can consider increasing the tenure of tax incentives or can offer them more tax incentives.

The cash grant of 10-30%, coupled with interest subsidies, constitutes a direct dent on the Centre’s kitty. These dole-outs, along with tax benefits, serve as power incentive for firms to make projects appear as highly unviable. This rust-plating is similar to gold-plating that companies do with their plants under administrative price mechanism to reap windfall.

The cash subsidies in fact should be reserved for persons living below the poverty line or the public that is victim of natural calamities such as earthquake.

The promoters of perceived unviable projects must first put in their own money to implement projects without any time and cost overruns and then reap tax benefits for long turn. In this way, the Finance Ministry can avoid cash outgo and thus ward off potential strain on fiscal deficit.

The Finance Ministry can also give longest-term tax incentives to banks and other investors that chip in money in such projects as loans, quasi-equity and equity.
Barring these two developments, the pre-budget scenario is similar to the ones that we have seen in the past several years.

Except for demands relating to stock market crash, rupee appreciation and project subsidies, the pre-budget scenario  is virtually same as in previous years. The corporate and political lobbying for tax sops and other financial favours is thus gaining pace.

As usual, the influential industry associations are peddling their memo through various channels of communication. Their formal and informal representatives are also interacting with powers that be to underscore the urgency for dole-outs.

The less influential ones are putting advertisements in bare their real and perceived injuries caused by various factors. The Ludhiana-based United Cycle & Parts Manufacturers Association, for instance, has issued an advertisement in Business Standard dated 25 January, demanding reduction in customs duty on steel, withdrawal of export incentives for steel exporters and levy of export duty on steel.

In its appeal to Prime Minister, Finance Minister and Steel Minister, the association says: “the Central Government for Aam Aadmi seems to close its eyes on the plight of Aam Aadmi, an industry dependent on steel simply cannot run the way steel prices ae being manipulated through cruel cartelization. Aam Adami will be rendered jobless.”

Then there is recurring story of anti-dumping cases. One month prior to Finance Ministry imposing anti-dumping duty on polyvinyl chloride (PVC) suspension-grade resins, four plastic processing industry associations issued an advertisement in the Economic Times dated 21 December, opposing the levy.

The associations say: “PVC resin is in perennial shortage for the last one decade with frequent price changes…. PVC processors should not be deprived of the right of procuring raw material from abroad at competitive price.”

The story of infighting among different stakeholders is similar in several other sectors. The infighting is as much as due to businessmen’s zeal as due to distortions in policy and regulatory framework including taxation.

Mr. Chidambaram should recast indirect and direct taxes in such a way that no section of industry prospers at the expense of other. He has to do much more than tax anomalies that linger for years and crop up with each Budget or post-budget tax changes.

First guiding principle of budget-preparation for any finance minister should be mustering courage to phase out crony capitalism. And this can be done by creating level playing field for each segment in each sector and for competitive products across different sectors.

Taking this level-playing principle forward, Mr. Chidambaram must either unshackle oil and gas especially refineries from informal and formal pricing controls or reintroduce time-tested administrative price mechanism (APM). Ditto for urea industry that is subject to statutory controls and other fertilizer units that are subject to ad hoc price controls.

The incidental benefit of this would be termination of creative accounting in the form of oil bonds, fertilizer bonds in lieu of cash subsidies as well as roll-over of subsidy over-dues to the next budget. Such creative accounting has helped Mr. Chidambaram reduce fiscal deficit at the cost of oil and fertilizer companies. The burden of redeeming such bonds would have to be borne by Government several years later. They would be accounted for the fiscal deficit only in which they mature for redemption.

The second principle of budget-preparation should be radical restructuring of subsidies.  This also calls for injection of pragmatism in policy formulation instead of blindly following market capitalism that does not work in all circumstances.

The Finance Minister can easily whittle down fertiliser, food and petroleum subsidies by shifting the subsidies to the point of origin of the value chain instead of offering them on fertilizers, transportation and cooking fuels and grain distributed through public distribution system (PDS).

The subsidy multiplies manifold with the addition of value to products in the value chain. The usage of optimum quantity of fertilizers, for instance, increases grain yield of high-yielding varieties 10 times. Thus, the Government has to subsidize 10 times more quantity in addition to subsidizing fertilizers.

If the Government buys all natural gas at reasonable prices from domestic and overseas suppliers and sell them to fertilizer companies at prices comparable to the ones prevailing in the Gulf, then there would be no need to subsidize urea and diammonium phosphate (DAP). The urea prices should, in fact, decline, which in turn, should obviate the need for increasing procurement prices of grain.

Similarly, the Government should scrap all levies on domestic and imported crude and bring refineries under the ambit of APM to reduce subsidy on sensitive products as well as cross-subsidize them with decontrolled products such as aviation turbine fuel and naphtha.

Unlocking market value of Government assets should be the third guiding principle.

The Finance Minister should also stop the growing menace of privatizing public sector assets under the garb of joint ventures as this tantamount to under-invoicing of national silver. He should be bold enough to go for selective outright sale of public sector assets to get the market price for them.

The Government should identify surplus land in Government hands across the country and start selling them to cash in on real estate Boom. Mr. Chidambaram can easily raise Rs 10,000 crore per year over next five years by selling bungalow land in cities and shifting the occupants to apartments elsewhere. This would also help slash the snowballing expenditure on VIP security and logistics.

The fourth guiding principle should be radical simplification of tax structure. This would require reduction in excise & customs slabs, removal of surcharges, additional taxes and cess. It would also be accompanied by across-the-board cut in incentives and re-writing of all tax laws and rules to the barest minimum, thereby wiping out scope for litigation.
The fifth cardinal norm for budget-preparation should be saving mother India from the impact of energy guzzling and population explosion-triggered pollution. This would call for recast of direct and indirect taxes.

Let Mr. Chidambaram make a beginning by restructuring taxes and offering incentives for national movement to replace incandescent lamps and tube-lights with compact fluorescent lamps and light emitting diode-based lighting systems.

Let him introduce higher excise on energy-guzzling cars, refrigerators, air-conditioners, motors, pumps, etc and reduce excise on the ones that save energy in accordance with verifiable norms laid down by Bureau of Energy Efficiency and other credible entities.

Mr Chidambaram should take head on the ticking population bomb that has already bred poverty nth time and created socio-economic tensions across the country.

He should introduce strong financial incentives and disincentives within all Government entities to enforce the norm of two children per family and encourage one child per family.

The public has to be told time and again in no uncertain terms that each birth means creating a new and long-term avenue for polluting mother earth in the form of additional demand for food, clothing, housing, travel, sewerage, plastics, etc.  

After running national campaign for two years airing the collective resolve to save mother India from population catastrophe, the Finance Minister should introduce pollution control tax on each additional child. This tax should increase with each subsequent child.

In any case, let him make a beginning by imposing pollution control tax on those who keep pets, as they too eat and excrete, and thus strain Mother India.

Those nations that live beyond their collective means not only mar the future of coming generations but also multiply the seeds of socio-economic chaos that can ultimately result in implosion.