The Hindu Business Line : Interim Budget: On populist and reformist tracks

There are broadly two tracks in the Interim Budget. One is populist, while the other seeks to carry the liberalisation agenda further on the back of 8 per cent growth rate, a booming stock market and bulging foreign exchange reserves. Alok Ray < /B>looks at the major implications of the package.

Author of a twin-track Budget, the Finance Minister, Mr. Jaswant Singh, has tried to please all constituencies.

WHAT are the implications of the Interim Budget and the series of fiscal announcements made over the past few weeks by the Finance Minister, Mr Jaswant Singh? Other than the election implications, that is. To be fair, there are broadly two tracks in this package. One is populist, while the other seeks to carry the liberalisation agenda further on the back of 8 per cent growth rate, booming stock market and bulging foreign exchange reserves.

First, the populist part. Farmers are to get loans at 2 per cent below the PLR (prime lending rate at which banks lend to customers with very good credentials).

Similar low interest rate has been prescribed for bank lending to infrastructure projects, rural housing, small and medium enterprises and students.

Alongside, the external commercial borrowing norms for Indian business have been substantially liberalised — ECB up to $500 million for a five-year or higher period will now get automatic approval. This means that many blue-chip Indian companies will use this route instead of borrowing from domestic sources.

Indian banks, especially those in the public sector, will be squeezed from both sides. They will lose the good customers whereas they will have to lend to riskier clients at below-PLR. Unless the banks are able to put in place a proper project and risk appraisal system, they may well face a crisis.

Either their non-performing assets would rise or they would be forced to ever-green the bad loans. In the short run, this would avoid loans being classified as non-performing but only be 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 China's) will be tested if these new government directives are enforced. Indian banks have so far played safe by lending mainly to blue-chip companies and the government.

According to a recent EPW research study in calendar 2003, 78 per cent of the incremental bank deposits was invested in government and other approved securities, whereas the SLR requirement is only 25 per cent. Chinese banks, on the other hand, have lent vigorously to investment projects.

The 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, it remains to be seen how the Indian banks will cope.

Another populist move with far-reaching implications is the merging of 50 per cent of DA with the basic salary of Central government employees. Soon enough this would have to be extended to State government employees. It would immediately increase the outgo on house rent allowance (calculated as a fixed percentage of basic pay), as also the employer's (the government's) contribution to provident fund and the pension liabilities. All this would strain the already precarious government finances, especially for the States. 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 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 by 5 to 15 percentage points, 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.

As always happens with import duty cuts, some will gain while others would lose.

Many Indian industries will benefit from cheaper imported inputs and find their competitive position improving vis-à-vis foreign goods in home and the export market.

For instance, the reduction in duty on coal from 25 per cent to 15 per cent would 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 locally-produced steel and aluminium. The coal industry would, however, feel the pinch.

The same is true when the import duty on capital goods is lowered. The capital goods industry would lose whereas all the industries installing new machinery (both imported and domestically produced) would 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. The tax concession to the power sector has been extended to 2012. For Indian companies, the $100-million cap on investment abroad has been removed in favour of 100 per cent of net worth.

All this should help Indian businesses in their effort to be big global companies through acquisitions. For all these reasons 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 the rising rupee vis-à-vis the dollar is an additional factor, that on top of falling import duties, would make imported goods progressively cheaper. This will also help to contain inflation.

One may argue that the concessions in import and excise duties would benefit only the rich and the upper-middle-class. It is true that computers, cell phones, VCDs, and DVDs as also air travel will become cheaper. The major price reductions would be for cars in the premium segment where much of the components are 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 can promote tourism. In that case, the benefits would trickle down to a lot of ordinary people in this labour-intensive industry.

Mr Jaswant Singh is taking a lot of credit for keeping fiscal deficit for 2003-04 at 4.8 per cent of GDP — well below the earlier projection of 5.6 per cent. Higher growth of GDP (revised upward to 8 per cent from the earlier projection of 6 per cent, mainly because of a good harvest following a bad one) has helped the Finance Minister in two ways: The higher growth has contributed to higher tax revenue (at unchanged tax rates) and a hence a lower absolute fiscal deficit figure. Moreover, a higher growth rate means a higher level of GDP and, consequently, a larger denominator in the fiscal deficit-to-GDP ratio. On both counts, the fiscal deficit-to-GDP ratio has come down.

Even if it is largely a product of good luck, the BJP and its allies are sure to 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 reached at alokr@iimcal.ac.in)