The Hindu Business Line : Critical two months ahead

The economic thinking of the new government will be revealed with the presentation of the Budget. The draft CMP not only indicates a continuation of subsidies and a shift in the divestment policy, but also promises to raise expenditure on agriculture, infrastructure, and the social sectors. All this and the rising oil prices could complicate the fiscal issue, says A. Vasudevan.

THE next two months are critical for the country because the course that economic policies would take would help economic units or participants to decide on their future spending and investment plans.

The new Government at the Centre will unveil the Budget for 2004-05 keeping in view the ideas contained in the Common Minimum Programme of the United Progressive Alliance. State governments too will present their budgets for the fiscal year in line with their respective political circumstances.

Policy-makers will find that three factors seriously constrain initiatives that would normally point towards realisation of better macroeconomic balance. There is, on the other hand, an optimistic element in the growing signs of fairly certain economic recovery in the US and in some countries of Europe.

The three constraints are: Continuance of government subsidies, divestment of only non-profit making public sector undertakings (PSUs) and oil price increases.

The subsidy issue has been much discussed and has become almost a holy cow insofar as fiscal economics is concerned. Subsidies have not benefited the poor and the disadvantaged, and there is substantive evidence of the rich gaining benefits out of subsidies.

Advocacy for divestment of only non-profit making PSUs is a recent politically bargained position. This decision does not seem to recognise the fact that public sector presence in most manufacturing and marketing activities has not in general helped the mass of the people either in terms of lower prices or of quick delivery of goods and services. Nor has it helped to improve competitiveness.

The decision also does not indicate the limitation that would be placed on public sector's overall holding of stakes. Going by the statement that the Government would have 51 per cent stake in public sector banks, one has reasons to speculate that the public sector would have control over management and the financial position of the units.

But the question is: Who will buy these shares? The Government can no doubt persuade banks and other financial institutions in the public sector to buy the shares, but the purchasers would not be able to trade them.

An idea was floated that the non-profit making PSUs could raise funds from the market in order to work out orderly transition from loss making units to making profits. This would imply issuance of bonds or new equity capital, the latter for purposes of modernisation or diversification or expansion of activities. Bonds may be declared as `approved' securities for purposes of SLR holdings by banks.

Similar mechanisms could be put in place for other financial institutions as well. But such an action may not work when banks already hold SLR securities to the extent of about 44 per cent of their net demand and time liabilities. Besides, banks would find them less liquid in character even if incentives are provided in the form of higher interest rates and guaranteed payments of principal and interest amounts on due dates. Government guarantees would also increase contingent liabilities and affect the country's rating.

Mobilising resources through issue of new equity capital is not easy as investors need to be convinced that the PSUs would be better managed and give attractive dividends. The processes and mechanisms that need to be put in place to turn bad managements to sound and sustainable ones would, however, take time.

The continuance of subsidies and shift of policy on divestment of PSUs would place the fiscal position in considerable stress, especially because of lack of adequate buoyancy in tax receipts. The room for changing direct tax rates is limited while the VAT (value added tax) initiative has not yielded the desired results.

Extension of direct tax base to cover a large number of activities in the services sector is critical. The average growth of the services sector has been about 7 per cent in the last eight years or so. But extension of base to services has not been found to be easy.

Improvement in tax administration and larger tax compliance as an alternative are advocated in every Budget but could not be accomplished on a sustained basis partly because of poor application and understanding of tax laws and partly because of absence of stability in tax policies.

In any case, this factor would still not take care of the promised improvements in expenditures on account of agriculture, infrastructure, and social sectors including drinking water.

It is not that an increase, say, of 25 to 50 basis points in the Centre's deficit over the revised estimate of 4.8 per cent of GDP for 2003-04 that would be a source of concern for the fiscal authorities. It would be worrisome if deficits of State governments and public sector enterprises also rise — a possibility that cannot be ruled out in the present political climate of the country.

The fiscal issue is likely to be further complicated by the rising oil prices. There has been growing resentment over the gasoline prices in the US in recent weeks and some observers have gone to the extent of asking the US government to release a portion of strategic oil reserves to douse the oil price inflation.

A few observers have commented that the US should increase the productive capacity of the industry — an idea that would not fructify unless the stringent environmental standards are not relaxed.

The OPEC chief (the energy minister of Indonesia) has ruled out possibilities of softening of oil prices in the foreseeable future on the ground that the present flare up in prices was due to speculation, geopolitics and structural problems in the United States.

He also stated that the OPEC is producing more than the quota. Saudi Arabia, however, has called for increasing the quotas to ease price pressures, but the OPEC chief has argued that it has become difficult in the short run to overcome problems of shortage of refinery capacities and other downstream bottlenecks.

There is an expectation that crude prices would go up further much beyond the current $40 a barrel.

The implication of oil price increase for India needs to be noted. India has always been oil deficient and is likely to be so for a number of years. But what is pertinent is that oil price increases would sharply increase the cost of production of all manufactured goods and oil-based products and transportation costs.

The cost-push factor would be economy wide and accentuate commodity inflation and render India less competitive in international markets.

This would be particularly unfortunate since the major economies of the world (the US economy, in particular) are showing signs of good recovery.

Rising inflation (from oil price increases) would also affect tax receipts and expenditure but the effect on the former would be lagged while that on the latter would be almost immediate.

The public sector deficit would, as a result, be higher than what would be had oil prices been stable.

Commodity inflation over the recently projected 5 per cent would seriously undermine investment calculations. It would have to be addressed by non-accommodative fiscal and monetary policies. But given the fiscal woes at present, the burden of adjustment would fall on monetary policy.

Would this mean that the Monetary Policy for 2004-05 needs to be revisited soon after the Centre presents its Budget? Fortunately, there is no rule that the stance of policy for the year once announced cannot be changed when circumstances shift sharply and all of a sudden.

(The author, a former Executive Director of the Reserve Bank of India, can be reached at asurivasudevan@hotmail.com)