Budget 2001: A Primer

The Prime Minister's Economic Advisory Council (EAC) has recently submittedits report. Given the eminent economists on the Council, the government canget no better advice. For the first time in the last five years there hasbeen a bold, uninhibited and clear articulation of the reforms and anattempt is made to reach out to the disenchanted segments.

The EAC is right when it argues that real interest rates are far too high toenable growth to be sustained at the desired medium-term objective of 8-9per cent, and the report stresses that even the present 6 per cent growthcould be choked if high real rates of interest continue. The EAC does offerhard but sane advice when it recognises the dangers of large monetisationand emphasises the need for a time-bound programme for reducing the fiscaldeficit by one half of one percentage point per annum.

What is, however, worrisome is that the EAC recommends a cut in the present11 per cent interest rate on National Savings Certificates(NSC) and thePublic Provident Fund (PPF). It argues that the interest rates on theseshould be lowered to no more than 2 percentage points above the inflationrate of the previous six months. This would enable a reduction, in thepresent rate, by two percentage points. It is almost certain that Mr Sinhawill, in his budget speech today, accept this recommendation in principle.

The NSC and PPF are relatively longer-term savings instruments and it wouldbe hazardous to use the EAC formula; extreme volatility in the interestrates on these longer-term instruments would be detrimental to the growth ofsuch savings. A far better formulation would be to use a five-year movingaverage inflation rate with a distributed lag wherein the weights could be5, 4, 3, 2, 1 for years t (year 5), t - 1 (t minus 1), t - 2, t - 3, t - 4respectively. This way the NSC and PPF rates could be set each year but themovements in the interest rates could be gentle and volatility avoided.

The fear is that the finance minister may resort to an ad hoc reduction of 2percentage points in the present rates from 11 to 9 per cent. Such a strongsignal would be welcomed by industry, and government would expect areduction in its rate of interest on borrowing. Such a drastic cut, however,would be disastrous for the economy as it would go into a boom and bustphase and adversely affect household-sector savings which are the mainstayof the economy.

Ideally, one would hope that the FM would remit the calibration formula to acommittee but the likelihood is that he will announce a one percentage pointin the NSC and PPF rates. A scatter-brained idea floating around is thatwithdrawals from PPF and other provident funds should be added to income fortax purposes as in the case of the National Savings Scheme (NSS). Theanalogy is erroneous as contribution to NSS enjoyed a 100 percent deductionfrom income. One hopes that the FM rejects such half-baked suggestions.

What other things need we watch for in the budget? The budget for 2000-01had a Budget Estimate (BE) for the gross fiscal deficit of 5.1 per cent ofGDP. A satisfactory containment by one half of one percentage point in2001-02 should be over this and not over some higher figure which may bereflected in the Revised Estimate (RE) for 2000-01. One should not becarried away by the primary deficit numbers as the government uses a faultycalculation. This had been a matter of analytical dispute between the RBIand government. The RBI deducted net interest payments and governmentdeducted gross interest payments to derive the primary deficit. The absenceof a primary deficit on government's calculation has no significance.

The net market borrowing programme in 2000-01 (BE) was Rs 76,383 crore whilethe gross borrowing was Rs 117,704 crore. If the net market borrowing in2001-02 is the same as in 2000-01, the gross borrowing in 2001-02 would beRs 120,643 crore. A net market borrowing in 2001-02 in excess of the 2000-01figure of Rs 76,383 crore would be a negative signal.

Another figure to watch is the RBI transfer of profits. As per the budget2000-01 (BE) the transfer was Rs 6,179 crore but the RBI in its largessetransferred Rs 9,350 crore. One fears that the government would use thehigher transfer as the base and expect an even higher transfer in 2001-02(BE). The transfer of profit to the government is a fig leaf formonetisation.

Reports are that the Talwar panel on weak banks has recommended arecapitalisation of Rs 2,400 crore. Such a large recapitalisation would becounter-productive as these banks would not be able to utilise such largeamounts optimally. Recapitalisation is not a costless exercise merelybecause banks invest the funds in government securities. These securitiesare redeemed in instalments. Granting Rs 2,400 crore to Gujarat would bemore humane than wasting this money on weak banks. In all probability,however, Mr Sinha will listen to the pleas of weak banks than the agonisingwails from Gujarat - such is our polity.

The measure that one would dread most is the reduction or abolition of thedividend tax along with adjustments in the minimum alternative tax. If MrSinha yields to these predatory pressures he would be giving up distributivejustice.

The National Calamity Fund had been set up many years ago but it is anational ignominy that the states, which had control over the funds,squandered these resources before a calamity occurred. It is hoped thatfuture accruals to the Calamity Relief Fund would be in the custody of theRBI and only the high-powered National Disaster Management Agency should bepermitted to undertake transparent withdrawals from the fund. Would Mr Sinhaset the ball rolling today, overriding all priorities? Finally, analystswould do well to reserve judgement on today's budget as the devil is in thedetail!