The Hindu Business Line : A Budget through the backdoor

Though there are two tracks in the recent mini-Budget — one populist and the other seeking to carry forward the liberalisation agenda — the fact that economics, and not divisive politics, has been given prominence is welcome, says Alok Ray.

THE recent bombardment of fiscal notifications by the Finance Minister, Mr Jaswant Singh, is clearly aimed at the electorate before the early Lok Sabha polls. Leaving aside the moral propriety of such an exercise, what are the major implications of the so-called "mini-Budget"? To be fair, there are broadly two tracks in this "Budget." One is populist whereas the other one seeks to carry the liberalisation agenda further on the back of 7 per cent plus growth rate, booming stock market and bulging foreign exchange reserves.

First, the populist part. The most significant implication here is the cost imposed on the banking sector. Farmers will get loans at 2 per cent below the PLR (at which banks lend to their top-rated customers) from a newly created Rs 50,000 crore fund. Similar low interest rate has been prescribed for bank lending to infrastructure projects (another Rs 50,000 crore), rural housing, small and medium enterprises and students. Alongside, the external commercial borrowing norms for Indian business has been substantially liberalised — ECB up to $500 million for a five-year or longer period will now get automatic approval. This means that many bluechip Indian companies will use this route instead of borrowing from domestic sources.

Indian banks will feel the pinch from both sides. They will lose the good customers and also have to lend to riskier clients at lower than prime lending rate. Unless banks are able to put a proper project and risk appraisal system in place for the less established customers with questionable collateral, the banks may well face a crisis. Either their NPAs will rise or they will be forced to relend to the defaulting borrowers so that they can pay the interest by using new loans. In the short run, this will avoid loans being classified non-performing but only by postponing the day of reckoning and creating a bigger crisis in future.

The much-vaunted better financial health of the Indian banking system (compared to the Chinese) will be tested if these new directives are strictly enforced. Indian banks have so far played safe by primarily lending to bluechip companies and the government.

According to a recent EPW research study, 78 per cent of the incremental bank deposits in India has been invested in government and other approved securities in 2003, whereas the SLR requirement is only 25 per cent.

Chinese banks, on the other hand, have lent vigorously to investment projects from all and sundry. Chinese policy has promoted high growth by risking the viability of the banking sector. Indian banks maintained their health by buying safe government securities. If the rules of the game change, then it remains to be seen how the Indian banks will cope.

The Finance Minister has announced bonds with higher returns for pensioners though the details are not yet known. A social security scheme for workers in the unorganised sector has been unveiled. However socially equitable such schemes may be, they still mean additional costs for the next government.

Now, the reforms part. The peak rate of Customs duty for all non-agricultural products has been brought down from 25 per cent to 20 per cent. Recall that this rate was 150 per cent in 1991. So, India has come a long way along the path of globalisation, though its average tariff rate is still one of the highest in the world, certainly much above the ASEAN level.

For agricultural products, the import duty even today remains as high as 65 per cent in some cases. In addition to reducing import duties on a variety of products, the 4 per cent Special Additional Duty (SAD) — introduced in the first NDA Budget of 1998 to bolster its swadeshi image — has now been withdrawn.

Since the SAD was imposed at a rate of 4 per cent of the value of goods inclusive of basic and additional Customs duties, its actual impact on domestic prices was in the range of 5.5 per cent to 6 per cent of the international price of the imported product.

Thus, the total impact of the 5 percentage point reduction in basic duty and the abolition of SAD would imply imports becoming cheaper by more than 10 per cent. It would be even higher for products for which the reduction in the basic duty is more than 5 percentage points.

For example, the duty on imported machinery and equipments for `big' projects worth Rs 5 crore and above has been slashed by 15 percentage points (from 25 per cent to 10 per cent). It seems the government is moving towards the goal of a near uniform Customs duty of 10 per cent at the end of 2005-06, as recommended by the Virmani Task Force.

As always happens with import duty cuts, some will gain while some others will lose. Many Indian industries will benefit from cheaper imported inputs and would find their competitive position improving vis-à-vis foreign goods in home as well as export markets.

For instance, the reduction in duty on coal from 25 per cent to 15 per cent will reduce the cost of production in domestic steel, cement and aluminium industries as also in industries such as auto components which use a lot of domestically produced steel and aluminium. The domestic coal industry will, however, feel the pinch. The same is true when the import duty on capital goods comes down.

The capital goods industry will lose whereas all the industries installing new machinery (imported or domestically produced) will benefit. On the whole, the downward impact on domestic costs is being regarded as more significant than the competition from cheaper imports. The sharp reduction in import duties for big projects should reduce the cost of infrastructure projects, helping Indian industry.

Further, a Rs 50,000-crore fund is to be set up to provide cheap loans to infrastructure projects such as power plants, ports, airports, roads, and telecom. For Indian companies, the $100-million cap on investment abroad has been removed in favour of 100 per cent of net worth. This will help Indian businesses in their effort to be big global companies through acquisitions. For all these reasons the CII, Assocham and other industry bodies have generally welcomed the recently-announced reductions in import duties, unlike the days of "Bombay Club".

In a sense, it shows the growing maturity and confidence of Indian business in their ability to compete with the best in the world. Remember that the rising rupee against the US dollar is now an additional factor, on top of falling import duties, which will make imported goods progressively cheaper.

One may argue that the concessions in import and excise duties will benefit only the rich and the upper middle class. It is true that computers, cell phones, VCDs, DVDs and air travel will become cheaper. The major price reductions will be for cars in the premium segment where a large part of the components is imported.

Ordinary people may not benefit as consumers. But if the price reductions cause a rise in demand and production of these "luxury" products, even ordinary workers may gain as employment expands in these and related sectors. The significant reduction in air travel costs may promote tourism. In that case, the benefits may go to a lot of ordinary people in this labour-intensive industry.

Above all, if consumption and investment demands pick up — as a result of more bank lending, higher investment in infrastructure and good monsoon induced boosting of rural demand — then the BJP and its allies will spread the message that their management of the economy has been better than their predecessors. So, they should be elected to keep up the good work. Regardless of whether this is correct or not, it is certainly better for the nation than harping on the divisive mandir-masjid issue.

(The author is Professor of Economics, Indian Institute of Management Calcutta. He can be contacted at: alokr@iimcal.ac.in)

More Stories on : Economy | Budget | Excise and Customs

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Policy illusions

Farm sector — III
Walking away from the problem

A Budget through the backdoor

Not done, Governor!

Foreign direct investment

Mercosur and India