The Hindu Business Line : Testing the Budget-maker's skills

As the Finance Minister fine-tunes the Budget numbers to accommodate the political compulsions and also bring some relief to the common people hit hard by the recent resurgence in inflation, he cannot afford to brush aside weighty counsel on maintaining fiscal prudence and staying on the reform path to draw investors, both domestic and foreign, says G. SRINIVASAN.

ALL EARS for the counsel coming in from various quarters, seems the Finance Minister, Mr P. Chidambaram. — Kamal Narang

As the countdown for the Union Budget begins, there is no shortage of counsel, both domestic and foreign. Mostly, they are on how the various stakeholders in the economy would like the proposals to be so that they do not have to bear the burden of revised tax rates or fresh moves to mop up resources for taking up capital expenditure or sustaining current consumption.

However, certain other voices — for instance, of the International Monetary Fund (IMF) or investment bank Goldman Sachs — are also heard during this time, but in the overall interest of ensuring high economic growth and sustaining it.

On January 25, the IMF organised a conference call on the completion of the 2006 Article IV Review of the Indian economy in Washington, following the meeting of the Fund's Executive Board on December 20, 2006. The discussion focussed on the economic policies needed to sustain and raise economic growth, reduce poverty and improve living standards. It concentrated on four priorities: Guarding against overheating; reducing the Budget deficit and public debt, while allowing for social and infrastructure spending; developing the financial market; and pursuing structural reforms.

Praise for RBI

On overheating, the Fund gave high marks to the Reserve Bank of India, which has gradually removed monetary accommodation and tightened prudential standards, besides issuing guidelines to banks on stress tests and undertaking an assessment of financial stability. For instance, the RBI, in its third quarter review of Monetary Policy on January 31, conceded that "the combination of high growth and firming inflation, coupled with escalating asset prices and tightening infrastructure bottlenecks, have complicated the conduct of monetary policy."

In the wake of asset prices edging up, the RBI rightly tightened prudential standards further, including raising general provisioning requirements and boosting risk-weights on high-growth areas, such as real-estate. That is why the IMF, while concurring that vigilance is needed to guard against any overheating, rightly appreciated the RBI's stance of continued gradual removal of monetary accommodation.

Broaden tax base

While the Centre's finances are perhaps in the best shape in over a decade, the Budget deficit and debt remain high and need to be pruned to make space for social and infrastructure spending, the Fund said, adding that both can be achieved by "broadening the tax base — by eliminating corporate income tax incentives, cutting exemptions and continuing to work towards a national goods and services tax."

Going by the recent pronouncements of the Prime Minister and the Finance Minister, the Government could make a crucial call in Budget 2007 on removing or reducing the tax exemptions corporates enjoy so that their effective tax rate, now at 17-18 per cent, gets a tad better to bring in the gravy for the exchequer.

The IMF wants the policy-makers to push ahead with the host of unfinished reforms, including in the insurance sector and in developing the financial market by broadening the investor base in the context of pension reforms so as to broaden the channel for long-term funding of infrastructure.

In this regard, a report by investment banker Goldman Sachs titled "India's Rising Growth Potential" sets store by the country pursuing "growth-friendly policies". Dubbing its strategic proposal as the "FORCE" factor policies and thus critical to sustaining growth, the paper explains FORCE as `Financial' sector growth, `Openness' to trade, `Rural'-urban migration, `Capital' formation, `Education and Environment'.

Growth forecast

According to the paper's baseline projections, India can sustain growth rates of about 8 per cent till 2020, significantly higher than the 5.7 per cent that a 2003 paper by Goldman Sachs had projected.

The latest paper says the Indian economy has logged high growth rates thus far without significant increases in domestic or foreign direct investment. If India could accumulate significantly more capital to supplement its favourable demographic and ongoing productivity gains, the economy could reach a growth rate of 10 per cent by 2010 and sustain it thereafter. This assumes that productivity growth will be sustained at 3-3.5 per cent till 2020, If so, the investment-GDP ratio must go up to 16 per cent. India would have to boost its savings rate by roughly 16 per cent of GDP to finance the investment required for a sustained 10 per cent growth.

Hinges on reform pace

But this is all contingent on "policies to open up the financial sector remain on track, including the entry of foreign banks starting from 2009." Goldman Sachs economists expect financial deepening to continue and contribute to increases in productivity in the medium term. Alongside, they say India will need to make progress in reducing the fiscal deficit and enhancing education at all levels. They caution that lack of education could be a key constraint to the growth of the knowledge-predicated IT sector. "The demographic dividend may not materialise if India fails to educate its people."

India would need to remove supply-side constraints to absorb the labour exiting agriculture and to sustain the growth momentum. "It takes an entrepreneur 35 days to start a business, 270 days to obtain various licences and permits, 62 days to register a property, nearly four years to enforce contracts and a shocking 10 years to close a business," they cited from a recent IFC document, `Doing Business'. This clearly points to the overarching need to ease entry and exit policies for enterprises.

Pointing out that India's imminent urbanisation process has implications for demand for housing, urban infrastructure, and demand for consumer durables, the Goldman Sachs economists expect the completion of major highways, particularly the Golden Quadrilateral, to drive growth in the transportation sector, spur demand for vehicles, increase real-estate values along the corridor, and boost construction of suburban homes as people move out of congested cities. They also see "substantial investment opportunities in all spheres of activity" under the Special Economic Zones (SEZs).

Multiple objectives

As the Finance Minister fine-tunes the Budget to accommodate the compulsions of coalition government and also to bring some relief to the common people hit hard by the resurgence in inflation, he cannot afford to brush aside weighty counsel for maintaining fiscal prudence and staying on the reform path to draw investors, both domestic and foreign. How deftly he balances these multiple objectives will, of course, be known only on the `B-Day'.