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05.03.2001

Budget 2001-02: Who Pays for Reform?

Over the last week television viewers have been subjected to judgments of Budget 2001-02 by a host of experts, who have declared it a dream budget, rating it anywhere between 7 and 10 on a scale of ten. In different ways all of them argue that Mr. Sinha has managed to spur growth while keeping the deficit under control. At first, these arguments are not easy to understand. A budget spurs growth by providing a fiscal stimulus. No such stimulus is provided by this budget. As Chart 1 shows, not only has the rise in the ratio of revenue expenditure (net of interest payments) to GDP since 1996-97 been reversed in this budget, but the absolute level of that ratio (8.0 per cent) was way below the level it stood at in 1989-90 (9.6 per cent). On the other hand, the ratio of capital expenditure to GDP, which fell from 5.9 per cent in 1989-90 to 3.1 per cent in 1996-97 and rose only marginally thereafter has slipped to around 2.5 per cent over the last two years and is slated to stay there in the coming year's budget as well.

This failure is provide any fiscal stimulus is surprising since, on the eve of Budget 2001, India's economy offered the government an unprecedented opportunity to stimulate growth. That opportunity stemed from two sources. First, the accumulation of huge stocks of foodgrains, estimated at 45 million tonnes, with the government. Second, the comfortable foreign exchange reserves position of the central bank, with its foreign currency assets alone amounting to $41 billion.
 
When foodstocks are aplenty and foreign reserves comfortable, the manoeuverability of the government is substantial. It can undertake expenditures without the perennial fear that plagued it in the past that such expenditures, by raising employment, incomes and the demand for food, could create a food shortage that triggers an inflationary spiral. And even if the economy, in the wake of such expenditure, runs into temporary supply bottlenecks in particular sectors (such as say, sugar, edible oils or onions), the available foreign exchange reserves can be used to resort to imports to ease supply and dampen price increases. The danger that expenditure increases on the part of the government would trigger inflation hardly exists.
 
This ability to increase expenditure without triggering inflation constituted an opportunity because it occurs in a context where demand in the economy is sluggish and poverty remains high. India's GDP growth rate is estimated to have declined from 6.6 per cent in 1998-99 to 6.4 per cent in 1999-00 and 6 per cent in 2000-01. What is more even this rate of growth has been ensured because of the buoyancy of the services sector, whereas the commodity producing sectors have been performing quite poorly. Industrial growth placed at 8.2 per cent in1998-99 fell to 6.5 per cent in 1999-00 and is expected to be considerably lower this year. And there is little disagreement on the fact that the sluggishness in industrial growth is a result of slackening demand growth in the system.
 
Since a decade of reform has not triggered the promised consistent export boom, which would have served as an external stimulus to growth, domestic demand generation is a must for a revival of growth. In the current context, there is no other instrument that is likely to be more successful in stimulating increases in demand then higher government expenditure.
 
What is more, the availability of food stocks with the government can be used to ensure that a part of state expenditure could raise employment substantially, by being allocated to food-for-work programmes that build much-needed rural infrastructure. Higher employment in such programmes has and will impact positively on poverty. This is especially important because the incidence of poverty has remained stubbornly unresponsive to growth during the 1990s, as the available comparable estimates show. [See Abhijit Sen, Economic and Political Weekly December 16, 2000.]
 
Part of the reason why this opportunity goes abegging is the obsession with controlling the fiscal deficit. This comes as part of the neoliberal ideological baggage that the economic-policy establishment carries. Mr. Sinha, in his budget speech, provided a common sense explanation for this obsession. To quote him: “Why am I so concerned about the fiscal deficit? Let me try to explain.  The total receipts of the Central Government in the current year according to BE are about Rs. 281,000 crore. Of this amount Rs. 72,900 crore is States' share of the Central taxes and grants. The Central government is, therefore, left with Rs. 209,000 crore. On the expenditure side, about Rs. 101,000 crore was to be spent on interest, Rs. 59,000 crore on defence, Rs. 23,000 crore on major subsidies and Rs. 16,000 crore on pensions. The net amount left for meeting all other Government expenditure totaling Rs. 123,000 crore was, therefore, only Rs. 12,000 crore, I have, therefore, to borrow Rs. 111,000 crore in the current year to make both ends meet. The most worrisome aspect is that over Rs. 77,000 crore was for financing unproductive revenue expenditure. This will add to my interest burden next year forcing me to borrow more and ultimately fall into a debt trap. I am deeply conscious of the burden which is falling on future generations, by our extravagance. I cannot allow this situation to continue.”
 
This rather simple explanation of his and the government's plight is, of course, ridden with assumptions that render the argument trivial and wrong. To start with, the assumption is that receipts are given. What the Minister failed to note is that between 1989-90 and 1999-2000 the Centre's net tax revenues to GDP had declined from 7.9 to 6.6 per cent, or by 1.3 percentage points (Chart 2). This decline occurs in a context where India's tax-GDP ratio is low compared to many other developed and developing countries, providing a case for raising the tax-GDP ratio over time. Instead what we have is a decline.

Two factors underlie this decline. First, huge fiscal concessions given to the corporate sectors and the upper income groups in the name of encouraging private initiative. Second, significant reductions in customs duties as part of trade liberalisation. The net result has been the shrinkage of the tax base of the government. Even if net tax revenues remain at the 6.6 per cent of GDP level in 20001-02, as the budget assumes they will, revenue foregone as a result of liberalisation would amount to Rs. 28,000 crore.
 
The second problem with the Finance Minister's reasoning is that the observed rise in interest payments was unavoidable given the level of borrowing resorted to in the past. However, what is missed here is the fact that in recent year's financial reform has involved doing away with low interest borrowing by the central government from the Reserve Bank of India against the issue of ad hoc Treasury Bills. In 1989, around 30 per cent of the central deficit was financed in this manner at interest rates which were far below those payable on borrowing from the open market.
 
It has been argued that monetising the deficit in this manner reduced the autonomy of the central bank and its ability to use monetary policy as an instrument for growth and against inflation. In practice, central bank maneuverability has been considerably constrained by the need to buy dollars and accumulate huge foreign currency reserves. This has become necessary in order to prevent the rupee from appreciating in the wake of surges of portfolio capital inflows facilitated by financial liberalisation.
 
Thus while the autonomy of the central bank has not increased post-liberalisation, the policy of forcing the government to borrow from the open market has substantially increased the interest burden on the budget. Our calculations show that if the share of central bank borrowing in the financing of the fiscal deficit had remained at its 1989-90 level, the saving in the form of the interest burden would have amounted to Rs. 15,698 crore (Chart 3). This, together with the revenue foregone on the tax front noted above, amounts to more than Rs. 44,000 crore or as much as 40 per cent of the shortfall in revenues that the Finance Minister has been forced to cover through borrowing.

Third, even the level of the interest rate paid on open market borrowing has been unduly high because of the regime of high interest rates that had been ushered in by reform. As the Finance Minister himself has stressed, real interest rates in India are extremely high by international standards. What he failed to mention was this was largely a 1990s phenomenon resulting from a monetary policy that kept interest rates high partly in order to attract foreign capital inflows in the wake of financial liberalization. If this had not been the case, the interest burden on the budget would have been even lower.
 
Finally, subsidies on food which were budgeted at Rs. 8210 crore in the budget for 2000-2001, have turned out to be close to 50 per cent higher at Rs. 12125 crore not because of the largesse of the government vis-à-vis the poor. Rather it is the result of the foolishness of the government in raising issue prices repeatedly to levels even higher than warranted by the increase in procurement prices, in order to reduce food subsidies. The net result has been a sharp fall in offtake from the public distribution system. As result, even in a year when foodgrain output growth has been low, the government has found itself saddled with huge and rising stocks, which increased its outlays on the costs of carrying these stocks. A wrong policy aimed at reducing subsidies has ended up bloating subsidies even further. But even here, it must be noted, despite this the total subsidies relative to GDP have not changed substantially in 2000-01, as Chart 4 illustrates.

In sum, the argument attributing the fiscal deficit to a tendency for expenditures to ‘automatically' overshoot beyond that warranted by a given level of receipts does not wash. What has been responsible for the size of the deficit last year is a set of wrong policies and more crucially a fiscal strategy over time involving policies such as direct tax concessions and customs duty reductions, along with financial policies that have substantially raised the interest outlay in the government's budget.
 
The reason the Finance Minister seeks to ignore these aspects of the problem is not hard to find. Driven by the ideology of neoliberal reform, he wants to continue with the practice of handing out direct tax concessions, in the hope that this would spur growth. In this budget these concessions have not merely come in the form of the withdrawal of surcharges on income taxes, of 10 per cent in the case of corporates and 15 per cent in the case of non-corporates, without substituting them with other direct tax levies, but through several other measures. These include : a reduction on dividends distributed by domestic companies from 20 to 10 per cent; the exemption from taxation of capital gains from sale of securities and units so long as they are reinvested in primary issues of public companies; and the provision of a host of tax holidays to investments in a range of sectors varying from infrastructural areas, to ISPs and broadband networks and those involved in “the integrated business of handling, storage and transportation of foodgrains”. These, combined with other concessions, are expected to result in a revenue loss of Rs. 5,500 crore of direct taxes in a year. In addition, the drive to reduce customs tariffs even when they are below those specified in WTO commitments, is expected to result in a revenue loss of Rs. 2,128 crore.
 
These losses do not, however, bother Mr. Sinha. He has partly made up for them through an ostensible “restructuring” of excise duties aimed at moving to a single 16 per cent rate of CENVAT on all commodities. It hardly bears stating that a common rate of duty on commodities, varying from manufactured necessities like soap to luxuries like automobiles, is regressive by definition. Yet the Finance Minister's excise homogenization initiative has involved reducing duties on a range of luxuries varying from automobiles to refrigerators and increasing them to double their current ad valorem levels on many mass consumption goods. The net estimated effect is additional revenue mobilization to the tune of Rs. 4,467 crore from indirect taxes other customs duties.
 
However, the shift to a more regressive and inflationary taxation structure does not help cover the loss of revenue from direct taxes and customs duties. There are a number of ways in which the Finance Minister makes up for this debilitating fiscal strategy, in order to reduce the fiscal deficit to 4.7 per cent of GDP while maintaining a stable expenditure to GDP ratio. First, he plans to squeeze capital expenditures. As Chart 5 shows, the ratio of non-defence capital expenditures to GDP has fallen sharply in the last two years and is budgeted to remain at that level in the coming year. Second, he believes that tax buoyancy and voluntary compliance will increase tax revenues by more than 14 per cent next year. Third, he provides for a record Rs. 12,000 to be garnered from disinvestments of equity in public sector corporations. Fourth, he has chosen to reduce interest rates on small savings schemes by a large 1.5 percentage points so as to reduce the interest paid by the government on such savings. Finally, he has decided to revamp the pension scheme so as to reduce the outgo on pensions in future. It takes little to judge who gains and who loses from these initiatives.

It must be noted that even the revised figures for 2000-01 provide for Rs. 2,500 crore from disinvestments. Thus far, the government has managed to garner only Rs.788 crore from privatization, Rs. 552 crore of which comes from the BALCO deal, currently under attack for undervaluing a profitable public sector unit (PSU). This implies that over March hasty privatization to the tune of Rs. 1712 crore would have to be gone through to validate the budgetary estimates. Big bargains await those who are cash-rich. And those bargains would get better still when the rush to find another Rs. 12,000 crore from privatization in 2001-02 gets underway.
 
Small savers, including retirees, on the other hand are to be squeezed. This not only helps reduce the interest burden on the government's budget. It would also force many small savers to turn to mutual funds and stocks in search of higher returns, though the risks involved are large, especially given recent stock markets trends. The increase in liquidity in the markets would of course cheer financial players who have also been given a bonanza in the form of exemption from tax of capital gains from sale of securities and units so long as such capital gains are reinvested in primary issues by public companies.
 
All of this jugglery, including the obviously irrational and shortsighted drive to hastily divest highly lucrative public assets at extremely low prices, does not help generate revenues to raise real expenditures and provide the system with a much needed stimulus from the fisc. It is this which constitutes the real fiscal crisis as opposed to the fiscal deficit per se. But within the neoliberal ideology of reform there is no solution to the problem, only a tendency to aggravate it further.
 
Given this fundamental ‘structural' constraint internal to the liberalization thrust, ways have to be found to divert attention from the real fiscal problem and provide alternative arguments as to how growth is to be triggered. Attention is diverted by making the fiscal deficit the fundamental problem, which it is assumed cannot be resolved from the revenue side but has to be done from the expenditure end. And, to show that he takes the problem seriously, the Finance Minister spends much time declaring that one of the ways he plans to reduce expenditure is by downsizing government. With attrition in the government establishment placed at 3 per cent of the current labour force, he decides to reduce employment in government establishments by 2 per cent a year by keeping new recruitment to 1 per cent of the current labour force. If this is done over the next five years, as he claims it would, government would be downsized by 10 per cent of current employment, which is the goal he sets himself.
 
Anybody with an understanding of the poor state of public services, including services such as sanitation, health and school education in non-metropolitan India would agree that India needs far more people employed in areas such as public health and education. The share of employment accounted for by government in India is much smaller than in developed and developing countries that offer better public services to its citizens. More and not less government employment is the need of the day. And the incomes generated by such employment will contribute not merely to better human development indicators, but to demand as well, providing a part of the stimulus spoken of above. This is not to deny that there may be overmanning in departments at Delhi and the state capitals, warranting some redeployment of the existing labour force. But the need to redeploy an existing labour force does not become the basis for arguing that total government employment is low. That would amount to condemning much of India's population to social services that are even worse than their currently poor levels.
 
But that is not all. The downsizing that the Finance Minister speaks of would yield little by way of expenditure reduction. As Table 1 shows, there are currently close to 3.5 million employees in government employment. However, of these 2.2 million are employed in the Railways and the postal department, both of which undertake a huge task given the size of the country, and are known to have accomplished their task creditably given the complexities involved. Another, 50,000 are employed in the departments of atomic energy and space, which like defence need to be kept out of the downsizing initiatives of the finance ministry. That implies that Mr. Sinha's downsizing exercise can apply only to around 1.2 million employees earning Rs. 11,459 crore by way of pay and allowances. Even if he successfully implements his downsizing threat, the amount saved in a single year would work out to just 0.08 per cent of total revenue expenditure, making the 10 per cent saving to be garnered in 5 years just 0.4 per cent of total revenue expenditure. Making much of this exercise is clearly a conscious or unconscious effort at diverting attention. In other contexts it would have even been dismissed as the work of a confidence trickster.

This issue need not detain us here, however. The real question is : if expenditures are not being raised substantially, if capital expenditures relative to GDP are to stagnate, how is the government to deliver on its promise that the downslide being experienced by the economy over the last two years, and underlined by the official Economic Survey, is to be reversed and the promise of a new 9 per cent growth trajectory redeemed. Obviously, the advocates of the neoliberal reform strategy within the government believe that the route to growth is more reform, even though reform thus far has failed to deliver and has even put the economy in recessionary mode. As a result, the stimulus to growth in Mr. Sinha's budget comes from what in financial accounting parlance would be considered “off-budget' initiatives. Borrowing heavily from the report of the Economic Advisory Council to the Prime Minister, the Finance Minister has argued, among other things, for more rapid privatisation, a revamping of the food procurement and distribution system in the country and a change in labour laws.
 
To deal with the embarrassment of rising food subsidies in a period when issue prices of food released through the PDS have been raised sharply, the government has decided to virtually wind down the system of procurement. The FCI will now procure only the amount required to maintain a “security reserve” – an estimated 10 million tones. If implemented, this would mean no procurement for the coming few years, since the government holds more than 45 million tones of food in stock.
 
Meanwhile, food movement and food distribution throughout the country is to be freed and privatized and the task of servicing the public distribution system is to be left to the states who would be provided “financial assistance” to meet the subsidy for the population below the poverty line. This would mean that the PDS is to be in large part dismantled. Markets would reach food to the people, including those who live in food deficit states. Immediately, this would spell disaster for the farming community. And if bad monsoons persist and stocks dry up, it would mean that rising food prices would erode the real incomes of consumers. Some section would lose heavily at all times. The only gainers would be the large private conglomerates, which would now enter the area of handling, storing and transporting foodgrains, who are to be provided long-term tax holidays to undertake the requisite investments.
 
This attack on food price stability and security is combined with initiatives that threaten a sharp slowdown in employment. As mentioned earlier, government employment is to be reduced at the rate of 2 per cent a year. Firms employing up to 1000 workers are to be allowed to close and/or retrench and layoff workers freely, providing the levers for a sharp reduction in total organized employment. Finally, in some of the sectors such as leather goods, shoes and toys, where small scale units employ large numbers, dereservation of production for the small scale sector is bound to lead to closure and retrenchment.
 
With incomes and purchasing power eroded as a result of slow growth and falling employment and prices set to rise because of higher indirect taxation and the dismantling of the PDS, the stage is set for growing inequality. Unfortunately it comes with low growth as well. The macroeconomic strategy implicit in the budget is one which is stagflationary. And that is combined with sectoral measures that would only aggravate the problem. The implication is clear. If the mandarins in the Finance Ministry have learnt anything from the experience with ten years of reform, it is a sense of irrational brazenness. Hopefully, Indian democracy would not tolerate such brazenness for long.