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What India Expects FM Nirmala Sitharaman To Do

BW Businessworld gets M Govinda Rao, member, fourteenth Finance Commission; Arun Kumar, former JNU economist; Yoginder Alagh, former Union Minister; and Lord Meghnad Desai to debate the key priorities for Union Finance Minister Nirmala Sitharaman in the run-up to the Union Budget

Photo Credit : Ritesh Sharma



1. What should be the key priorities in Union FM Nirmala Sitharaman’s maiden Union Budget?

M GOVINDA RAO (MGR): Accelerating the growth of the economy and creating  employment are the two most important priorities.  There is also the issue of alleviating farm distress, but as Agriculture is a State subject in the Constitution.  With the capacity utilisation in the industrial sector reaching very high levels much of the growth in industry has to come from new investments.   This requires increasing public investments, rejuvenate industrial climate by, inter alia, banking reforms to make them lend more.

ARUN KUMAR (AK): One can’t predict what the FM would do. My suggestion would be to address the problems faced by the unorganized sector urgently. The current slowdown in the economy originated in the unorganized sector which has been declining since demonetisation. It was further hit by GST and then by the NBFC (crisis). Attempt to force digitization is further damaging it. This has led to the demand shortage which is now also impacting the organized sector. To revive the unorganized sector, a simpler GST (which I have been proposing) is required and credit availability to this sector improved. Businesses in this sector are short of working capital and cannot cope with GST even though they are exempt from registration under GST. The farming sector is a major component of this sector and needs support because the farmers’ incomes have been affected adversely. All this has impacted employment generation adversely. So, investment in employment generating sectors like, education, health and rural infrastructure, needs to be greatly stepped up. These need to be the government’s priorities.

YOGINDER ALAGH (YA): Two priorities are important in the second quarter.  The first is to finance a credible package of relief and recovery after a bad monsoon from the angle of drinking water and sowing. The second is to revive investment. The Economic Survey and Budget Speech must, as in the past, reflect thinking on critical issues and not score brownie points. For example the PMEAC has rightly said that Arvind Subrahmanian's critique of GDP changes us silly, since estimating a relationship between GDP and some variables in the past misses the point that productivity is rising, but more serious critiques, like those of the Expert Group under Sudipto Mandal and past members of the Statistical Commission, have been ignored. An assurance from the JNU trained FM that institutional integrity in the Statistical and IMD systems will be respected will be welcome. Her views on real priorities will be eagerly awaited.

MEGHNAD DESAI (MD): Reassure the public that despite recent lower growth estimates, the economy is basically sound. The downturn was probably caused by uncertainty regarding the election and continuing fragility in credit markets following the ILFS fiasco.

2. What should the FM do to address the rural distress  -- even if the Union Budget is not the best vehicle for it?

MGR: As mentioned above, farm distress is real, but this requires a lot of initiative from the states. The immediate issue facing the farmers is the spectre of drought once again with the projected subnormal monsoon.  The coverage under farm insurance must be expanded quickly.  The coverage of Kisan Credit Card and the borrowing limit requires to be increased.  Initiative towards creating cold storage and marketing facilities, model laws relating to contract farming and land consolidation and incentives for agro-processing industries must be put in place.  The model APMC Act must be brought in.  In all these, the Government of India will have to work with the States so that the process of implementation is smoothened.

AK: To address rural distress, the Minimum Support Prices (MSP) mechanism, which is very weak at the moment, has to be strengthened. Today, the farmers don’t get the price that they are supposed to get. Their access to markets must be improved. If MSP is fixed as per the Swaminathan Commission report of 50% above the full cost, farmers’ incomes will rise and that would lead to increased demand. Further, credit has to be made available to the farmers, rural infrastructure has to be created like, small irrigation, investments in schools, dispensary, and so on. This would make available good quality public services at low prices and supplement rural incomes.

YA: Rural Distress is real. The first is to recognise it . Drinking water, improving efficiency of existing irrigation systems, rural finance, including temporary waiver of loan repayments,all need funds, which the affected States dont have, since rich States like Punjab and Haryana are not affected.. The priorities stated in the Niti Aayog 's Ciuncil meeting are correct. But they dont have allocation powers. The Budget should provide funds and an assurance that allocation will be rule based, as in the erstwhile, Planning Commission formula's, rather than by political whims.

MD: A lot has been done by the government both in the February budget with PM Kisan Yojana and it’s extension since then to all farmers.The Budget is not an instrument for long run policy intervention, Rural distress is due to low inflation in food prices and too many farmers with tiny pieces of land who should be moved to better paying non agricultural jobs. Two thirds of farmers are surplus. 

3. What should the FM do to create jobs?

MGR: Creation of jobs is the biggest challenge for the Finance Minister.  The major hurdle in increasing labour intensity in manufacturing has been the stringent labour laws.  Even if the government can not immediately change the labour laws, it should work out relaxation in selected labour intensive sectors.  In fact, it is important to recover the lost grounds in textiles (readymade garments) and leather industries. Encouragement to agro-processing is another area.  Perhaps, the sectors like tourism and hospitality industry are other areas.

AK: To create more jobs, investment has to be focused in job creating sectors. The organized sector does not create much employment due to rising automation. For instance, modern organized construction, creates few jobs. Large number of jobs are created in education, health, small irrigation, rural infrastructure like, telecom and roads. So, the need is to step up investment in these areas. Further, if the unorganized sector revives due to the steps suggested above, then a lot of employment would be generated.

YA:Job creation will depend on the revival of industrial production, continuing growth of exports and agricultural revival. In the short run more money will be needed for MNREGA.These allocations should be clear. Best should be compared to last year's BEs and not with REs as in recent Budget speeches.The Budget should concretely raise public investment to revive private investment to reverse the declining growth rate in every quarter.

MD: FM cannot create jobs but she can create conditions for the economy to grow at a steady pace.

4. Do you think India’s fiscal consolidation under the Modi regime is a myth? Do you agree with reports that India’s ‘adjusted fiscal deficit’, factoring off-budget liabilities, may well be over 4.5 per cent of the GDP? Should the FM address this?

MGR: Unfortunately, no serious fiscal expert believes in the fiscal deficit numbers put out in the budgets.  The creative accounting has gone too far and the credibility of the numbers is low.  Apart from pending payments to Food Corporation of India, fertilizer companies and oil marketing companies and inter-public sector enterprise sales producing disinvestment receipts, various other transactions between the Consolidated Fund and Public Accounts hide the real deficit number. The real fiscal deficit of the Union government itself could be anywhere between 4.5 to 5 per cent of GDP and that of the States could be close to 3 per cent. 

AK: Yes, fiscal consolidation has been done via creative accounting and in reality the deficit in the Centre’s budget is higher. There are two things. First, revenues are shown to be higher and later it turns out to be short. At that point, to maintain the deficit target, expenditures are cut. This results in shortfall in capital expenditures and essential sectors which can generate employment. Revenue has been short by about Rs.1.6 lakh crore and expenditures have been cut to this extent. This has an impact on demand. Second, disinvestment targets are fulfilled through sales of assets to the public sector and greater reliance is on the public sector via Internal Extra Budget Resources (IEBR). So in a sense, deficit has been shifted from the Centre on to the public sector. That is not the right way to do it. But most budgets resort to these stratagems.

YA:The Fiscal Deficit is a real issue and leads to pressures on the Bank Rate and Exchange and  rates. The suggestion is to raise resources by taxation and not to play to the lobby by not cutting Consumption by Government and the non Government sectors.  There are no free lunches and the FM knows that. She must give that stern message.At kesst in the first post election year we have to be honest.

MD: This is difficult to say. Due to a large public sector with financial companies such as banks and LIC the consolidated public sector accounts would have to be constructed to answer your question truthfully. The UK has carried out the exercise of constructing a consolidatedbalance sheet for the public sector. If the deficit is 4.5% rather than 3.4% that is not  bad at all . 

5. Is there a case for hiking minimum exemption for income tax to Rs 5 lakh from Rs 3 lakh?

MGR: There is a case for making inflation adjustment for both exemption limit and tax brackets. But this should be accompanied by elimination of tax concessions and preferences.  In fact, the government has been pursuing too many objectives through tax policy which opens up avenues for evasion and avoidance and distort the resources in unintended ways.  Take the case of deduction for insurance.  It does not benefit anyone except the insurance companies.  Is it the objective of tax policy to encourage insurance companies?  The people expected do not get any benefit.  Most poor and middle income people do not buy insurance and claim deduction.  Only the rich take it and this is not a measure to ensure better health services but simply expanding insurance.  Why should the government give tax concessions to selected saving instruments?  In fact, if one saves for five years, his marginal tax benefit from additional saving is zero and he simply rolls the savings over to claim deduction!  The examples can be multiplied. 

AK: This step was a political step before the election. But it is not justified on grounds of equity. Rs 5 lakh is about 5 times the per capita income. Given the rapidly rising disparities in the economy, we need to raise much more from direct taxes and reduce indirect taxes because indirect taxes tend to be inflationary. The poor and the middle classes are more affected by the indirect taxes than direct taxes so it is the indirect taxes that need to be reduced. Further, as argued above, we need to simplify GST to help the unorganized sector. I would even suggest that rates of tax above an income of Rs.1 crore (100 times the per capita income) should be raised and wealth taxation should be reintroduced. Gift tax and estate and estate duty should also be reintroduced. Given the rapidly rising wealth disparity even a small tax can raise a lot of resources.

MD: India is a lightly taxed country and hardly anyone pays income tax but those who pay make a lot of noise and newspapers support them. I am not a friend of low taxation either in UK or here. But if someone had the courage they could abolish income tax altogether and substitute expenditure taxes. But this will need to be thought out. Before 2014, there was talk of a financial transaction tax which could yield a lot and will be easy to collect. Another source would be a tax on mobile phone messages or e mails. 

6. As some industry bodies have demanded, is there a case for abolishing 10 per cent surcharge on incomes above Rs 50 lakh and 15 per cent surcharge on incomes above Rs a crore?

MGR: The real objective of levying these surcharges seems to have been to generate non-sharable revenues with the States.  While the abolition of these surcharges simplifies the system, the government will not simply do it for reasons of revenue.

AK: I think that should not be done.  In fact, the rates should be raised. Income over Rs.1 crore means earning of 100 times and Rs.50 lakh means 50 times the per capita income. To cater to the schemes announced by the government these incomes should be taxed higher to make income tax more progressive. This would generate additional demand without raising the deficit and lead to increase in production and higher incomes to precisely this section of people which may be required to pay more tax.

MD: Business men always want lower taxes, low interest rates and less regulation. These concessions are not urgent. It should be a first priority to raise enough revenue to cover expenditure. 

7. Industry wants corporate tax to be reduced to 20 to 25 per cent from the existing slab of 30 per cent. Do you think the FM should listen to this advice?

MGR: This is the promise made by the Union Finance Minister three years ago and there will be pressure on the government to act on it.  However, I do not see that happening in this year’s budget for both revenue and political reasons of being branded as pro-business.  It makes sense to reduce the marginal rate, and hopefully the matter will be addressed at least in the next full year budget.

AK: This has been already done for small businesses but it should not be extended to the bigger businesses at this time since a lot of resources are required for additional expenditures on education, health, etc. These would benefit the corporates the most by making available more productive manpower. USA has reduced its rate of tax so should we also do so? But, we are not America or Ireland since our situation is quite distinct from theirs. We have, on an average, poor quality education, health, etc. leading to low productivity. To boost growth and productivity in the economy, these expenditures are essential. As growth accelerates, profitability would rise and investment would rise and even foreign capital would get attracted more.

YA: In my view there is no scope for such concessions demanded by industry groups.

MD: No. 

8. The banking sector is under stress. What should the FM’s prescription read like?

MGR: The banking system is under stress and I am sure, the budget speech will have some important things to say about it.  Besides recapitalisation and talk about consolidation, the government will have to initiate real structural reforms.  Perhaps, the issue of creating a Holding Company and transferring the ownership to that as recommended by the P. J. Nayak Committee may be the starting point.

9. And for the NBFCs?

MGR: I am afraid, although there may be a lot of concerns about NBFC expressed in the Budget Speech, the government may not be able to do much in the budget except by stating that the regulators – the RBI and SEBI will take appropriate measures to deal with the crisis and ensuring liquidity and adequate measures will be taken to prevent of contagion.  Government itself may not get into the matter.

AK: NBFCs are in a crisis because of crony capitalism. That was clear in the case of IL&FS. There was diversion of funds and so on. So, there is a need for a proper regulation of the NBFCs. I also feel that the spread of banking has to increase (so that) proper loans can be given to the small and tiny sectors. This would reduce their dependence on shadow banking, and informal money markets. But, to do so, due diligence should not be given up otherwise NPAs would rise as is currently the case with our banking system. The government wants to give loans up to Rs.50 lakh automatically but that can create big problem. Whatever loans have to be given from the banking system must be through due diligence but without causing harassment or creating space for corruption. Procedures can be simplified and made transparent.

YA: The clean up of the Banking and NBFC sectors should be honest and that needs funds. These are outside the Budget, but determine the Fuscal Deficit.  So the Flow of Funds in the Budget Papers must honestly reflect that.

10. Should there be a single regulator for the entire financial sector, instead of multiple regulators?

MGR: Having a single specialised regulator, in fact, was the spirit of Financial Sector Legislative Reforms Committee’s Report (FSLRC) chaired by Justice Sri Krishna. Financial products have become complex and there are several hybrid products and you need specialised agencies to regulate them.  Banks deal with insurance and superannuation funds and have to face regulators from various sectors.   Apart from multiple compliance requirements, there have been inter-regulatory differences and conflicts and considerable regulatory arbitrage.  The ideal model is the one adopted in Australia where Australian Prudential regulatory Authority (APRA) and Australian Securities Exchange Commission (ASEC) deal with regulation and the Reserve Bank has given up regulation completely. There is considerable synergy between the institutions, however, as they meet regularly and coordinate. 

AK: The financial sector is very complex and increasingly so. So, different specialization is needed to deal with different kinds of institutions. So, a single regulator may not work and specialized agencies may be needed for regulating different components. For instance the need of the small and cottage sector needs a different approach than the loans to the large and medium scale businesses. So, different agencies working under the supervision of the RBI maybe needed.

YA: Reform systems are sector and Branch Specific. In every reform scheme we provide that deviants and cheats will be punished by Regulators. But the Chokshis and Mallaya's escape. We need sector specific Regulators. Agencies like NCLT, FMCs and SEBI are over stretched. Again they should be manned by experts and not civil servants, however distinguished they are. Why do the Urjit Patels, Panagriyas and Arvind Subrahmanians, leave?

MD: The above questions are interrelated. The best thing the FM could do is to finish the half built architecture of cleaning up the Augean stables of credit markets. The PSU banks have been a disgrace mainly because until UPA 2 crony capitalists were allowed to borrow with no blighting to repay. The IBC and the Company Law Court have been a tremendous innovation, But with the appellate court now available all the Old disease of judicial delay has come back. The NBFC scandal is a warning  that the entire financial sector is fragile. 

The financial regulatory structure needs an overhaul. The present structure is fragmented and as the ILFS scandal shows full of holes. As we did in the UK post 2008 you need to have a Central Bank plus a Financial Conduct Authority and Prudential,Conduct Agency as well.  India will have to legislate for some such arrangement . For an economy aspiring to be middle income country, the regulatory system is primitive.

The government needs to finish the task of consolidating PSU Banks ,cleaning up their balance sheets , recapitalising them ( they are worse than Air India ) and then selling of a substantial portion.i doubt the government has the courage to do this.

11. Should there be a move towards land aggregation, and more land reforms?

MGR: It is important create a proper framework for land consolidation as well as contract farming. The fragmentation of land holdings and the migration of many young persons from the farm sector has created the situation where many find it difficult to do farming leaving the farms fallow.  A proper framework will help to increase farmers’ incomes and enhance agricultural productivity.

AK: Certainly, land reforms are required but it has to be done sensitively. I think given the structure of land ownership with large number of small farmers owning small packets of land, their needs have to be fulfilled. Land is their major asset and it provides them security. So, aggregation should not be implemented in such a way that the big land owners or businesses end up benefitting at the expense of the small guys. There is need for transparency and proper diligence at the local level with due permissions, involvement of panchayats, etc. It should not be imposed on the people in the villages and the rural areas because it has been seen in many cases that businesses and land mafia have acquired land through surreptitious means. People and local bodies are manipulated by the powerful. That should not be allowed to happen.

YA: Land Aggregation should be done with a proper Land Survey, Computerised and Sattelite based Record System and with efforts at sponsoring Producer Companies, etc. to support the ones who lose. The problems raised by the NSS round of 2012, should be addressed and success stories as in Gujarat and Karnataka replicated. Funds should be provided for that and the Central Scheme for reviving Land Statistics revived. I submitted a Report to the Statistical Commission which has the details. An expert like Dr. Ramesh Chand can supervise the operational aspect.

MD: The important thing is first to establish a register of land rights which I believe is difficult. They could use blockchain to do this. Then the Government needs to repeal the Land Acquisition etc Act 2013 passed by UPA 2. They tried in 2014 but did not have legislative strength but an ordinance now lapsed is on the books. This should be passed. 

As I said above there are far too many small farmers. They cannot obtain a living from farming and derive a substantial portion of their income from off farm activities both rural and urban. Now that road infrastructure has improved rural urban connectivity, it should be possible to offer incentives to farmers to quit farming.  They can be reskilled if necessary but at least halving the number of farmers would be a good target. The Budget has nothing to do with this. 

12. Incentives provided by China to its exporters go even up to 17 per cent of total value of exports. Does India need to have a similar measure in place?

MGR: Any incentive given has to be within the framework of WTO.  The biggest incentive the government can do is to ensure competitive infrastructure and minimise bureaucratic interference and ensure realistic levels of exchange rate.

AK: No! I don’t think we can afford this kind of expenditure out of the budget given other more urgent needs. Instead, we need to make our workers more productive so that cost of production declines and exports become cheaper. Our lack of export competitiveness is result of poor skills and poor health condition of the workers. Skilling is a slow process, no doubt, so in the interim, we may need to give some support but not to the extent of 17%. We should also focus attention on some sectors and develop technology there rapidly. That may help boost exports.

YA: We have to compete in their efforts to undercut our advantages in software and gems and jewellery exports. The necessary infrastructure and financial incentives must be there. Schemes of Cluster based growth will need funding..

MD: I am suspicious of subsidies. If you subsidise exports you are admitting that your currency is overvalued. The question must always be asked if any tax cut or subsidy, who pays ? 

13. Gross fixed capital formation in India has dipped to 31 per cent from 34.3 per cent of the GDP in 2014. How should the FM address this?

MGR: There has been a sharp reduction in both saving and investment in the country. As mentioned earlier, the government needs to revive the investment climate by dealing with the twin balance sheet problem.  It has to contain its fiscal deficit to ensure reasonable real interest rates at which the industry can borrow.  It should ensure competitive levels of infrastructure and above all, it should minimise bureaucratic interference.

AK: It is necessary in the Indian economy to increase private investment. Public investment is constrained by the requirement of keeping the fiscal deficit low. Since, tax revenues are not increasing rapidly capital expenditures cannot rise quickly enough. Private sector investment depends on profitability and for that demand has to be revived. RBI data shows that capacity utilsation is running at around 75%. Unless this rises to around 90%, private investment will not take off. If employment is generated in the unorganized sector and through investment in employment generating areas like, education, health and rural infrastructure, then demand would rise and industry will invest more. Tax concessions to businesses is unlikely to boost investment unless demand rises. When there is spare capacity more investment will only lead to losses and cut back on investment.

YA: The heart of Economic Policy in the short run is to give fewer lectures on reform, which is well spelt out but to raise Government investment at the Central, State and parastatal level. The economy is suffering from the decline in investment ratios, which given the ICORs explain the declining growth rate, which itself is below the potential of 8% or so. This Budget will be judged on that.

MD: Given the poor quality of Indian data, all we can say is that it was lower but who knows by how much. I am against too much intervention. The FM must not rush at every percentage point decline in this or that indicator and mess around with intervention. It is often counter productive.If credit markets are cleaned up . People may acquire   more confidence . 

14. Gujarat has shown 10 per cent plus industrial output growth leads to systemic changes, with the share of non-agricultural sector rising in the workforce. Can this template be used pan-India?

MGR: Gujarat has a history of being a business - industry friendly state and has a veritable culture of saving and investment.  The large sea-coast helps in its expanding trade.  There have been large investments made in petrochemicals.  Agriculture too have been vibrant due to Narmada Sarovar project and that has helped the State in expanding agro-processing industries.  The governance in the State has helped economic activity to grow.  These conditions do not necessarily occur in all the States. Each State should to prepare its blueprint based on its resources and provide a push to industrialisation.

AK: India is a union of states with a great deal of diversity. What may work in Gujarat may not work in other states. So, we have to see what worked in Gujarat and draw lessons from that. For instance, Gujarat may offer more docile workers and a state government which is more pro-businesses. It is also a prosperous state where demand is not short so that industry can sell more profitably. These conditions do not prevail in all states so that this template may not work everywhere and, especially, in the poorer states. We tried to turn Mumbai into Shanghai and that never worked since models cannot be copied across different socio-political structures. In brief, there is need for an all-India model which recognizes the diversity in the country.

YA: Gujarat's experience conclusively shows that a high enough manufacturing physical output growth rate, reduces the work force dependent on Agriculture. Even with an employment elasticity of 0.25, with a 12% growth in IIP, employment rises by 3%, which is  double the work force growth rate. So 

jobless growth is our own creation.

MD: Who knows!

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