The good, the bad and the ugly

When I agreed to a suggestion to review the recent "mini budget" (henceforth MB) of the NDA government, I didn't realise that MB referred to an ongoing process rather than a one-off event! The sop story goes on and on, seemingly without end.

For manageability, if nothing else, I shall confine my appraisal to the major announcements made in the fortnight between January 8 and 22. I shall also sidestep the very important issue of the legitimacy of making budget-type policy announcements on the eve of a general election and during a parliamentary recess, other than to note that that the MB clearly breaches (at least in spirit) the long-established conventions of restraint on such matters.

Mini-Budget 2004-2005: Complete Coverage

To begin at the beginning (much easier to find than the end!), let's start with the tax measures announced on January 8. The unquestionably good part of the MB is the reduction in the "peak" import duty on non-agricultural goods to 20 per cent (from 25 per cent) and the abolition of the special additional duty (SAD) of 4 per cent.

These measures are genuine acts of unilateral trade liberalisation that economists have long advocated and merit full support. They are also consistent with the government's announced strategy of reducing customs duties "to East Asian levels" to promote better integration with the world economy, in general, and the dynamic East Asian economies, in particular.

The measures are all the more praiseworthy since they do not pander to any populist lobby. Most Indians believe (wrongly) that import duties are borne by foreigners and so reducing duties helps them, not residents.

Actually, of course, lower duties benefit consumers/buyers of imports and exporters. They also spur productivity improvements in protected industries.

The NDA government has been reasonably consistent in gradually reducing peak import duties and opening up to foreign investment (including the recent relaxation of equity caps in some sectors). In these important dimensions there has been substantial continuity (of external policies) with the major liberalisations undertaken by the Congress government of 1991-96.

This is all the more remarkable (and welcome) when these policy actions are juxtaposed against the inward-looking "swadeshi" rhetoric of the BJP election manifesto of early 1998. Full credit must go to the PM and successive FMs for managing this delicate transition.

The import duty changes in the MB are by no means flawless. For one thing, they do not fulfill the earlier promise to cluster all import duties into two bands of 20 per cent and 10 per cent, let alone the economists' recommendation for a single, unified customs duty rate.

Second, as in the last budget for 2003-04, there is a great deal of unnecessary and unsound tinkering with many duty rates to favour some industry or the other. Third, the engineering and capital goods industries once again get short shrift, with duty rates reduced well below the rates applied to their main inputs, such as steel.

The result is negative protection for these crucial industries at just the time when demand for investment goods might be picking up. Leaving aside old slogans of "self-reliance" and "swadeshi", the playing field is tilted against these industries.

What is bad about the MB's tax measures is the failure to broaden the revenue base of either central excise or income taxes. As various tax reform committees and analysts have pointed out, the steady (and desirable) reduction in distortive customs duties and revenues needed to be compensated through effective broadening of the base for the other major central taxes, notably excise, income and company taxation.

This has become increasingly urgent against the backdrop of a falling tax-GDP ratio and very high fiscal deficits. But there is not even a whiff in the MB of the exemption-cutting recommendations of the Kelkar task forces of yesteryear.

Indeed, like the previous budget (for 2003-04), the MB takes the opposite, retrograde tack of shrinking the tax base through more exemptions, for example for DVDs and VCDs. The crucial importance of the unified 16 per cent Cenvat rate (supported by additional special excises on a few luxury commodities), achieved substantially by Yashwant Sinha, was seriously undermined in the last budget by the legitimisation of a concessional 8 per cent rate.

The MB aggravates this error by reducing the excise on computers and aviation fuel to 8 per cent (if computers merit concessional treatment, why not most other goods?). Similarly, the waiver of income tax filing obligations for certain categories weakens the base of income taxation. Jaswant seems to be rolling back some of Yashwant's tax reforms!

So much for the good and the bad. What about the ugly? Well, perhaps that's too strong a word. "Unsound" or "unfortunate" may be more appropriate descriptions for the MB's spawning of huge new "funds" for spending on agri-infrastructure (Rs 50,000 crore), small-medium industry (Rs 10,000 crore), infrastructure/manufacturing (Rs 50,000 crore), urban amenities for rural areas (or was it the other way round as reported in this paper!?) and what have you.

As far as I can make out from the terse and confusing press notes announcing these initiatives, they boast some common features. First, they are a trifle vague on where the money is going to come from; there is talk of "capital markets and budgetary resources".

Second, they will be managed by existing financial intermediaries: Nabard, Sidbi, IDBI, IDFC, etc. Third, they all involve subsidised lending to the concerned beneficiaries, typically at an interest rate 2 per cent below the prime lending rate. Fourth, Government will, in all cases, underpin the operations through budgetary support or guarantees or both.

If these initiatives are serious, they can inflict serious damage on our already precarious fiscal situation (third largest fiscal deficit in the world, 85 per cent government debt-to-GDP ratio and all that) and further weaken the strained balance sheets of some of our major financial intermediaries.

Our own financial history (and that of many other countries) demonstrates how large-scale subsidised lending undermines the viability of banks and other financial intermediaries and destroys the banking and credit culture.

They also provide fertile breeding grounds for crony-lending and other scams. Ultimately, the imprudence spawns large balance sheet holes, which have to be filled by budgetary transfers (recall UTI, IFCI, RRBs, banks…).

Against this background, it's puzzling how such half-baked schemes continue to proliferate. Perhaps the eternal (and unsound) appeal of interest subsidies is the prospect of leveraging large flows at "small" upfront budget cost.

Such myopia ignores the huge capitalised cost of interest subsidies and the major damage to efficiency and probity of concerned financial intermediaries. It's also puzzling how the MB's schemes passed screening by RBI. Or was that venerable institution not consulted by the Leviathan? Or over-ruled?

Perhaps these "fundy" schemes are not meant to be taken seriously? After all, who remembers the last budget's Rs 60,000 crore (Rs 600 billion) "thrust to infrastructure" which was to be leveraged through "viability gap funding" of only Rs 2,000 crore (Rs 20 billion) from the budget? My prediction then that there was likely to be more "gap" and less "viability" appears to have come true.

But the announcement of non-serious schemes (even on the eve of elections) is not costless. They divert a great deal of administrative energy from government's serious spending programmes and policy efforts. They breed widespread cynicism about public policy. They also undermine the credibility of the central government at a juncture when this scarce resource is vital for the nation's long-term health.

Bottom-line: the (ongoing!) mini budget has some good parts, some bad parts and some…er…unsound/unfortunate parts.

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