Dilemmas facing Yashwant Sinha

Updated: Feb 8 2002, 05:30am hrs
As he enters the penultimate lap in the preparation of the Union budget for 2002-03, finance minister Yashwant Sinha faces at least three major dilemmas.

First: should he craft a fiscal strategy that enables fiscal stabilisation and empowerment, reducing the fiscal and revenue deficits, or should he spend public money to stimulate demand and economic growth Second, should he place more funds in the hands of economic ministries and encourage them to spend productively so that more income and employment are generated, or should he give incentives to private investors and consumers that encourage them to invest and spend more and thereby create new incomes and employment in the private sector Third, should he pursue economic reform by reducing customs and excise duties, or worry about the impact of such moves on domestic industry and the fisc, at a time when industrial growth is subdued and the deficit is high, and postpone action for a year

One can list other dilemmas but on most of them the finance minister seems to have taken a view. Finance ministers have faced a dilemma in the past on direct versus indirect taxes. On this issue Mr Sinha shared his thinking with this newspaper a few weeks ago saying he was convinced that additional resource mobilisation should come more through the direct tax route rather than through indirect taxes, alluding to classical principles of equity and progressiveness. It is also true that indirect taxes have proved to be a less buoyant source of revenue in recent years. There are other dilemmas like the trade-off between higher defence expenditure and public investment in social and economic infrastructure, or that between reducing interest rates on small savings versus removing tax exemption for salaried employees.

Let us consider the major dilemmas facing Mr Sinha. On fiscal stabilisation versus fiscal stimulus there has been a heated debate among economists the world over. Should developing countries seeking to create new assets and sustain high rates of growth worry overly about fiscal stabilisation At a time when the country faces a secure external economy, with high forex reserves, low current account deficit and manageable external debt, can some fiscal laxity be risked

A pragmatic approach would be to set a medium term agenda and take practical steps that signal the direction of change. Priority number one on the fiscal front is to signal an end to fiscal laxity. The direction of movement of fiscal indicators is presently more relevant than the speed of movement, and movement should be in the direction of fiscal empowerment. Mr Sinha has already signalled that his priority is to cut the revenue deficit rather than be obsessed only by the fiscal deficit. This is correct, but in both cases there must be a convincing movement downwards of the relevant ratios. What Mr Sinha does at the central level will influence his ability to discipline state governments where fiscal laxity is running riot.

Consider the second dilemma. Should the budget focus directly on the demand side and use fiscal instruments to stimulate demand and thereby growth, or should it focus on the supply side and pursue policies that encourage private spending and investment Put simply, will a rupee of purchasing power in private hands go farther in stimulating productive economic activity and consumption than a rupee in government hands

There is no simple answer to this. Public investment and expenditure can in theory stimulate demand but funds must be used efficiently and productively. Of late government departments have been incapable of even spending what has been allocated to them. The inefficiency of government departments has become an institutional bottleneck throttling growth even where fiscal resources are available. On the other hand, making funds available to private entities does not automatically translate into increased consumption and investment if households and firms hold back spending due to the prevailing environment of uncertainty and negative expectations.

In either case, the ability to multiply the growth impact of a given pool of resources is a function of governance. If government becomes an efficient spender, public investment can stimulate growth. If it can foster a positive sentiment in the marketfeel good factorit can alter the environment for private enterprise. Good and focussed governance can shape positive decisions in both cases. It is a political economy and governance issue. Indeed, this is more so in ensuring the success of off-budget initiatives. Given the fiscal constraint Mr Sinha faces, he will, like last time, spell out many policy initiatives aimed at encouraging credit provisioning by financial institutions for investment. The success of this will also rest on good governance.

Finally, in the case of tariffs and excise, as indeed in the case of direct taxes, this years budgetary strategy must be based on principles rather than interests. Populist governments tend to neglect principles. Moreover, the National Democratic Alliance-led government has over the past year acquired the dubious reputation of letting interests overawe principles in economic governance. There is an important signalling value in letting principles shape decisions this time.

What are the principles worth espousing Mr Sinha has already espoused a worthy principle on direct versus indirect taxes. More citizens must become tax payers and the tax to GDP ratio should be pushed up. On tariffs, India must signal to the world that it is willing to take a step, even if it will be a small step this year given the problems of slow growth at home and the breathing space provided by the time-table of World Trade Organisation negotiations, towards scaling down tariff walls and rationalising rates across raw materials, intermediates and final goods. On excise duties, movement must continue towards rationalisation of rates and the objective of making domestic enterprise more competitive must be pursued.

However, the bottomline should be to ensure that the tax to GDP ratio makes a turnaround and starts going back to what it was a decade ago. It is on the foundations of such fiscal empowerment that Mr Sinha can construct a growth oriented and investment augmenting budgetary strategy. However, translating budgetary intent into action on the ground, turning words into deeds, is a governance challenge for the entire ministry and cannot be borne by the finance minister alone.