'Second generation reforms will continue in this Budget'

Dr U Sankar

In the Budget, the second generation reforms initiated during the last Budget continue. It aims at consolidation of the reforms process. It appears that it has to generate the type of excitement like last year's Budget.

Perhaps the market expectation was not realised and that is why the Sensex has fallen above 150 points immediately afer the Budget speech.

Indian economy is likely to revive in the next few months. The export performance in January is very good. US economy is also likely to revive. The pace of progress depends on to what extent the reforms proposed in the last year's Budget and this year's Budget will be executed.

There is some uncertainity in speeding up the reform process because of the coalition government which lacks majority in the Rajya Sabha.

There is no hit on the salaried class as there is no change in the personal income tax structure except for the 5 per cent surcharge which is common to all income tax assessees. Only the government servants face the threat of exit beacuse of the government's downsizing.

LPG hits all the middle class. This is expected because LPG is highly subsidised. Dismantlement of administered pricing regime for petroleum products was announced many years back. Hence it is no surprise.

There has been no change in the standard reduction. There are some changes with respect to section 88, which will affect only the people in higher income groups.

As far as power sector reforms are concerned, The FM says they want to change the emphasis from generation to transmission and distribution. This means that the reforms will be on improving the transmission efficiency, reduction of transmission loss, reduction of power theft and reform of retail electricity prices so as to make the electricty boards financially viable.

If the state electricity regulatory authorities are set up with competent experts and if they follow rule based and transparent procedures and there is very little political interference, power generation and distribution can be accelerated.

I must say much depends on the political will of the state government in giving up their powers to the regulatory authorities.

Bank rate changes come under monetary policy and therefore only the Reserve bank has statutory power to undertake policy change in the area of bank rate, open market operations, marginal reserve requirements and credit policy.

Fiscal policy can have indirect influence on monetary policy. However, the FM has announced a scheme of linking interest on bonds with interest rates on deposits and small savings.

I don't think this Budget is anti-poor, anti-farmer, pro-World Bank or pro-MNC. In fact, this Budget is in many ways pro-farmer because it has a number of proposals for reviving agriculture and rural developemnt. Any FM has to keep in consideration his country's commitment to international agencies.

For eg, the Budget has to reflect India's commitments to WTO. The customs duty reform and also our trade policies reflect this commitment. As far as other indicators like fiscal deficit, revenue deficit and tax structure, we undertake reforms in our own interests.

For that, we must realise that in an open globalised economy, our tax and industrial policies cannot deviate too much from our neighbouring countries. Some amount of harmonisation of policies is inevitable if we want to access the foreign invesment and foreign markets.

As far as industrial growth is concerned, the FM has noted the global recession and also the slow down in industrial growth during the last year. He has raised the import duties for certain products like steel to prevent growth of foreign imports.

But the industrial recession can be overcome only by generating the demand for industrial products. The strategy proposed is large invetsments in national highways, housing and other public and prvate infrastructural activities. If these invetsment are materailsed, demand for steel, cement and building materials would increase.

The nominal interest rates are much lower in India now compared with what it was in the past. This is true of both the lending rates and the borrowing rates. However, many people, particularly the industrialists believe that the real interest rates, that is, the nominal rate of interest minus the inflation rate is high.

For example, three years back, the nominal rate was 14 per cent. The inflation rate was 8 per cent. Therefore, real rate of interest was 6 per cent. Now, the nominal rate of interest is 12 per cent, but the inflation rate is 4 per cent or less.

Hence the real interest rate is 8 per cent. We must also note that in many developed countries such as USA and Japan, the interest rates are very low namely 2 per cent or 3 per cent. That's why there was an expectaion that interest rates on many items including small savings would be reduced.

The FM has announced fiscal concessions in last year's Budget particularly purchase of new houses. He also tried to increase the housing finance avaialble. According to him, there has been a 30 per cent increase in the housing finance last year.

Now the interest on house laons are lower and also there are many new entrants in the house loan market including banks and financial institutions. Despite these changes, the construction industry is not booming beacuse the procedures for various clearances in getting building and other permits must be simplified.

The stamp duties must be lowered. Housing plots with all infrastructural facilities and good access to different markets must be made available. These reforms have to be done by state and local governemnts.

At the state level, many states have not amended the urban land ceiling act and simplified the procedural formalities. The state governemnts must follow the reforms.

Foreign investors come to India with an expecation of earning a rate of return higher than what tehy would get in their country. In computing the rate of return, they also take into account various risks involved including political risks.

Therefore, to attract foreign invetsment, you must have a regulatory regime which is transparent, rule based and gives credible commitments to the contracts. Factors like political corruption and not honouring the commitments undertaken by previous governments increase the political risk.

In the case of Enron, they made a number of errors in the power contract. A contract based on rate of return does not provide incentive to minimise cause. Also, there was an external factor with increase in the international price of the fuel and full adjustment in the contract price.

Enron power became very costly to MSEB. Also, MSEB did not take serious efforts at the bargaining stage about the nature of the power demand.

The Narasimhan committee on financial setor reforms brought to the public attention about the Non Performing assets of many public sector banks and also financial institutions such as IDBI and IFCI.

There are also international capital adequacy norms. Now the governemnt of India has tried to help some public sector banks like Bank of India and more recently Indian bank by providng some help.

The FM announced a similar support for IDBI. There is also a proposal for speedy recovery of the loans which are due for a long period. The banking sector is a problem not only in India but also in Japan and many south Asian countries. Apart from the accounting norms and institutional chanages, the banking sector must be distanced from politics and be made autonomous and accountable.

Infrastructure investment has some special charactersitics. It has long gestation periods, lumpy and no second hand market. Hence invetsments in roads, railways, ports and power are called sunk investments. Hence the investors expect some assurance that they can recover the capital cost over the life of the assets.

In many countries, this problem is taken care of by setting up independent and transparent regulatory authorities. This institution arrangement gives some confidence to the investors that they can get the money back.

In India, there is a heavy invetsment in the telecom sector. The success is here bacause we have TRAI and also there is little political influence. In the case of power, almost all state governments interfere in the timing and extent of tariff revisions.

Further, many state electricity boards are almost bankrupt. That is why the investors hesitate to invest in the power sector. Investment in the road sector is also sunk. But we have some success stories.

In the IT sector, there are already quite a bit of concessions for the IT sector in the previous Budgets. IT sector can grow faster if the other sectors grow fast. Also, when the external environemnt improves.

I think there is no increase in the tax on two wheelers or any other vehicle. However, the quality of the 2 wheelers particularly the switch from 2 stroke engines to 4 stroke engines and other changes to make them enviroenmentally friendly will be required in view of the auto fuel policy of the government which enviasges Euro 3 norms by 2005.

Otherwise, the pollution intensity of most of the existing 2 wheelers is very high.The Budget continues the second generation reforms. It does not contain any revolutionary changes, but only gradual chnages are being made. It is a step in the right direction, you can say.

The constitunal amendment for urban sector development gives more powers to the local bodies like municipalities and panchayats. Unfortunately, despite the appointmnet of the state finance commission most state governments are reluctant to transfer resources to the local bodies or give them powers to raise the resources needed for developing of the areas.

With the rapid growth of urbanisation, the quality of urban infrastructure has been declining. We need better roads, better water supply, better sanitation facilities, less pollution, better schools and hospitals.

At present, the funds with the urban governments are grossly inadequate. There is some proposal to give the muncipalities to issue municipal compounds to fund the urban projects.

But the problem is that the borrowed amounts must be paid along wth the interest. That means the urban bodies must device a user charge system so that the revenues collected is sufficient to pay the debt with interest.

There is a proposal to link the interest rates to government bonds. That means, reduction in the interest rate is likely.

The government will restructure UTI. That is a major task beacuse of its huge size and because of its underperformance. The 10 per cent tax on mutual funds or corporations is removed, but the dividend recepients have to bear the tax at the rates applicable to them.

This means the IT assesees have to keep all the records and file them. That's high transaction cost for the assesees. Also, more paper work for the IT department.

Dr U Sankar, a noted economist is the former director of the Madras School of Economics and now Honorary Professor with the same institution.

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