The Hindu Business Line : Budget for these priorities

The imposition of a Sterilisation tax and the levy of capital gains tax on long-term capital gains are all serious options to be looked into. We must plan for an economy “worthy of a more expensive rupee.”

T. C. A. Ramanujam

“Wall Street used to work for industry, now industry works for Wall Street. The calculus of economic efficiency has overtaken considerations of social justice”.

Robert B. Reich in Super Capitalism, the Transformation of Business, Democracy and Everyday Life.

A rising rupee, worrisome inflation and a threatened fall in GDP have attracted the attention of the Government, apart from the usual volatility in the stock market. India’s currency has strengthened about 15 per cent against the dollar in the past year and over 10 per cent on an inflation-adjusted, trade-weighted basis, since August 2006.

The IT industry and labour-intensive manufacturers are badly hit. Textile exports have fallen by 11.7 per cent. The Commerce Minister fears that exporters may shed two million jobs. The central bank faces a dilemma in taking action to avert the appreciation of the rupee.

Making the rupee cheaper may stoke inflationary fires. Sale of sterilisation bonds may help in the short run. Many are wondering how the Chinese yuan does not have the pressures that the rupee has been facing. For the past 15 years, our partial opening up of capital account convertibility has led to liberalisation in the financial markets. Whether it is FDI or FII, we welcome it with open arms.

As Ila Patnaik and Ajay Shah of the National Institute of Public Finance and Policy point out, India yearned, for long, for a sustainable flow of foreign finance to supplement domestic savings. There has been far too much of inflow of foreign funds into our capital markets. The net inflow was of the order of $45 billion by March 2007 compared with $23.4 billion a year earlier.

Sterilisation Tax?

For nearly two decades now, countries across the globe have been toying with the idea of a sort of Tobin tax to throw some “sand in the wheels” of international finance. Chile tried to force foreign investors to deposit a fraction of their money in an interest-free account.

This did help to deter short-term investments. But in the long run, it did not arrest the appreciation of the Chilean currency. A docile central bank and captive savers helped China accumulate huge foreign reserves and, at the same time, some degree of sterilisation also.

The Economist pointed out, “The banks are force-fed sterilisation bills, which yield even less than the central bank earns on its foreign reserves. They nonetheless survive because they rely on a steady supply of deposits from China’s savers, who have few other places to put their money.”

India’s savers are more choosy. They can invest in bank deposits, the stock market, real-estate or jewellery, whichever is attractive. Our banks, therefore, will not be tempted to buy the RBI’s sterilisation bonds.

That means the Government has to plan alternative modes of controlling the inflow of foreign capital. The imposition of a sterilisation tax and the levy of capital gains tax on long-term capital gains are all serious options to be looked into. We must plan for an economy “worthy of a more expensive rupee.”

Monetary vs Fiscal Policy

The limitations of monetary policy in controlling inflation are now well-known. The Government fears a slowdown in the economy. There is a danger of stagflation. Luckily, inflation, at 4 per cent, appears contained. The Finance Minister has advised banks to cut interest rates, even though the RBI did not.

Mr Dominique Strauss-Khan, Managing Director, IMF, wrote recently: “While cutting interest rates is still effective, it may not work to stimulate investment and consumption as fast as usual.” He has advocated a mix of fiscal and monetary measures. As far as India is concerned, fiscal stimulus is the need of the hour.

Tarun Khanna, the Jorge Paulo Lehmann Professor at Harvard Business School, points out in his Billions of Entrepreneurs: How China and India are Reshaping their Futures and Yours that China’s reforms started with the villages whereas India is yet to have a close look at its villages and city slums. In an economy that is not yet fully monetised, fiscal policy should promote growth and arrest inflation.

Fiscal remedies can boost demand more quickly than interest rate cuts. Professor Alan Blinder of Princeton, a Former Fed Governor, argues for a “combined monetary-fiscal effort- deficit spending or tax cuts financed by printing money” in order to stop the decline in growth rate.

The Rural-Urban Divide

Over the past several years, Plan expenditure has been declining (it was Rs 99,353 crore last year) and non-Plan expenditure is rising (Rs 2,69,549 crore).

The non-Plan expenditure helps mainly urban India. The vast mass of unorganised labour in rural India is untouched by the Budget and the Plans. One-third of the people live below the poverty line on less than Rs 12 per day in rural India. No wonder, 113 districts of the country are afflicted by the naxal menace.

The Prime Minister showed an acute awareness of the issues involved when he declared that “the problem of Naxalism is the single biggest internal security challenge ever faced by our country”.

He added, “Exploitation, artificially depressed wages, iniquitous socio-political circumstances, inadequate employment opportunities, lack of access to resources, underdeveloped agriculture, geographical isolation, lack of land reforms — all contribute significantly to the growth of the Naxalite movement”. It is these problems that the Budget will have to address, and not merely issues concerning stock market volatility.

Professor Robert B. Reich of California, winner of the prestigious Vaclav Havel Foundation Prize for pioneering work in economic and social thought, compares the condition of the American society in the two periods 1947 to 1973 (democratic capitalism) and 1974 to 2004 (super-capitalism).

Real family incomes of the poorest in the US grew by 115 per cent in the first period and by 2.8 per cent in the second period.

The Professor bemoans, “Capitalism has invaded democracy”. This is no less true of conditions in India. It is fashionable to talk of inclusive growth. The Budget should ensure that the vast bulk of the poor are insulated against the global onslaught of super-capitalism.

(The author is a former Chief Commissioner of Income-Tax.)