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Tuesday, Jan 31, 2006


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Non-tax revenues — Correcting the fiscal imbalance

Vipin Agarwal

The fundamental problem behind arresting the revenue deficit is the rising expenditure unmatched by corresponding means of finance. Although the tax rates have been moderated, the incidence of indirect taxation remains high. Correction of fiscal imbalance arising from public sector enterprises by not allowing them to become centres of wealth erosion has become urgent.

THE FINANCE Minister recently tabled a statement before Parliament under the Fiscal Responsibility and Budget Management Act, 2003, for providing a framework of the Governments' fiscal policy and adjustments needed to attain the objective of eliminating the revenue deficit by 2008-09.

The annual minimum reduction of revenue deficit is 5 per cent of the current GDP. As per Budget estimates for the current financial year, the revenue deficit is likely to be Rs 95,312 crore, against Rs 85,165 crore last year, representing about 2.7 per cent of the GDP.

The Finance Minister needs roughly Rs 15,000 crore to achieve the target of 0.5 per cent reduction, assuming GDP grows at 7-8 per cent net of inflation. Reiterating his Government's commitment to eliminating the revenue deficit, the strategy of improving the tax-GDP ratio to mitigate the revenue deficit calls for a review.

The fundamental problem in arresting the revenue deficit is the huge expenditure on interest arising from the spiralling effect of financing the deficits, growing expenditure on Defence and police, subsidies on fertilisers and pension to employees — that is, rising expenditure unmatched by corresponding means of raising finance.

Possibly, the revised estimates on the current year's Budget are likely to present a shortfall in the projections of revenue deficit as a percentage of GDP.

Although the tax rates have been moderated after withdrawing a number of exemptions/rebates, the incidence of indirect taxation in India remains very high.

To quote the last part of paragraph 24: "Some large receipts had accrued in recent years, such as licence fee from telecom operators, etc., which are non-recurring in nature. With additional levies largely being recycled within the telecom sector through the mechanism of the Universal Service Obligation Fund, and fiscal concessions extended to Bharat Sanchar Nigam Limited, the telecom sector's contribution to the Central Government's non-tax revenue is unlikely to be very significant.

"The profit-making public sector enterprises (PSEs) have large investment needs, thus non-tax revenue as a proportion to GDP is set to decline progressively."

Prima facie it is prudent to invest more money in profit-making enterprises. However, it may not be pragmatic to invest in enterprises losing their market share and witnessing a decline in the return on capital employed. The profit figures may change substantially if the prescribed standards of accounting are followed and relevant guidelines complied with.

To elucidate this further, let us analyse the latest available detailed annual report of Bharat Sanchar Nigam Limited (BSNL) for financial year 2003-04, since detailed financial statements are not available for 2004-05 on the company's Web site as on date.

BSNL posted a turnover of Rs 31,400 crore with earnings before interest, depreciation and taxes at Rs 6,500 crore and net profits after taxes at Rs 5,900 crore.

The company has an asset base of approximately Rs 1,00,000 crore, with an average annual addition of approximately Rs 6,500 crore.

Figures of profits and assets read with the auditors' report of BSNL highlights a number of lacunae with respect to internal controls, upkeep of accounts, type of assets and absence of generally known principles of business prudence. The assets of the company comprise obsolete or unusable assets worth Rs 151 crore subjected to depreciation charges instead of being written off. Auditors have reserved their comments on the accuracy of the quantum of depreciation charged and assets capitalised in the absence of relevant information.

Account reconciliations with banks, vendors and intra/inter companies have not been carried out leaving a complete disclaimer from the auditors with respect to the possibilities of financial implications of such non-reconciliations.

Absence of reconciliations gives susceptibility to hidden write offs or cover-ups for financial irregularities. There is a long list of non-compliances with respect to disclosures required as per Schedule VI of the Companies Act.

BSNL's associate Mahanagar Telephone Nigam Limited (MTNL) spent approximately 50 per cent of its revenues on establishment costs — that is, employee costs and administrative overheads — and posted a turnover of Rs 5,600 crore from an asset base of Rs 6,200 crore. The asset utilisation of MTNL is far better than BSNL and certainly calls for a review of the year-on-year capital investment plans of BSNL.

The establishment costs for both BSNL and MTNL seem to be on the high side compared to the operations of private sector operators, even after attaining maturity of scale of operations and remaining free from market competition.

BSNL could improve its free cash by Rs 1,200 crore by reducing the provision for doubtful debts by 50 per cent, Rs 800 crore by reducing the administrative and operative overheads by 10 per cent, Rs 1,500 crore by reducing the current assets merely by 10 per cent and Rs 2,000 crore by improving the asset utilisation by 10 per cent.

Similar initiatives in MTNL could generate another Rs 1,000 crore and the telecom sector can easily contribute a sum of over Rs 6,500 crore by the simple means of infusing marginal efficiencies in operations. Therefore, the contribution from the telecom sector itself could cover nearly half the target revenues to meet the guidelines of the Fiscal Responsibility Act.

The Economic Survey for 2004-05 refers to the change in structure and composition of telecom growth since the entry of private players in the industry. The worry for incumbent operators arises from their losing the market in their traditional domain of fixed line business while facing increasing competition in the emerging market of mobile telephony. Extrapolation of these trends only translates to higher revenue risks to incumbent operators in terms of protecting the current base and quotient of probable growth in cash-flows from subscriber revenue.

The telecom sector contributes about one per cent of India's GDP and, given the conservative estimates of GDP growth vis-a-vis telecom growth, the contribution from this sector is poised to grow by another one per cent.

In the backdrop of new demand in telecom being captured by private sector, the large capital investment plans of the telecom PSUs deserve to be looked at closely to ensure they can generate the expected returns on capital investments.

Increasing market risks in the revenue streams of incumbent operators, coupled with huge capital investments and the given form of governance as evident in the audit report, will continue to restrict the Finance Minister's options to extract revenues in spite of exponential growth of the telecom industry.

The correction of fiscal imbalances arising from the public sector enterprises by not allowing them to become a breeding ground of inefficiency and wealth erosion has become urgent.

(The author is a chartered accountant.)

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