The Danger Signs Flashing

Updated: Jan 26 2004, 05:30am hrs
If there had been any doubt about the motives that prompted finance minister Jaswant Singh to announce what amounted to a mini-budget this month, they were removed by Prime Minister Vajpayee when he announced that the National Democratic Alliance would go for a poll in April. While the BJP hopes to capitalise on the so-called feel good factor, and turn it into a mindless frenzy that would sweep the NDA back to power, a closer look at the concessions that the finance minister announced shows that what is good for the BJP in politics could prove disastrous for the economy.

Where is the money doled out to come from The central government is already living way beyond its means, with high fiscal deficit and revenue deficits. Is this the time to be further reducing taxation Mr Jaswant Singh claims his tax cuts will have no effect on revenue. This is pure deception. Every finance minister in the past decade has made the same claim as he has reduced taxes, but the fact is that during the nineties, the ratio of tax revenues to GDP has fallen relentlessly and is now a measly 9.7 per cent.

In this case the claim is doubly false. Since nearly all the tax cuts are falling on imports, the only way to recover the money is by importing a great deal more. But India already has a massive trade deficit and is again in a balance of payments deficit. Mr Jaswant Singhs panacea will only make that imbalance worse.

Apart from the Centre, the states too will suffer from the tax cuts. The states share of taxes collected by the Centre will go down too. Almost half of the burden of the tax cuts will, therefore, fall upon them. This will increase their revenue deficits too, and these are even higher than the revenue deficit of the Centre. The truth is that while a case can be made for lowering import duties, it has to be part of a scheme of tax reform that ensures that the overall revenue-raising effort does not suffer. That would require raising some tax rates while others are lowered. But this is precisely what a government in election mode has not done.

The governments liberalisation of the external account is fraught with peril for the country. Mr Jaswant Singh has justified it on the grounds that India now has more than $100 billion of foreign exchange reserves. India can therefore afford to move closer to full convertibility of the rupee. But this is a calculated and infinitely dangerous deception. Unlike China, whose reserves are real because they have been earned through trade surpluses, Indias $100 billion are almost entirely borrowed. Two-thirds consist of what the CMIE calls vulnerable liabilities money that can leave the country at relatively short notice. All that the investors need is a shock to their confidence in the stability of the Indian rupee.

The government is doing its best to create the conditions in which they could receive such a shock. Its decision to allow free external commercial borrowing up to $500 million per borrower could create precisely the conditions that led to the Thai economic collapse in 1997 and started the South-east Asian meltdown. Today, it is possible to borrow abroad at 3 per cent per annum, when the domestic minimum interest rate for even prime borrowers is around 9 per cent. Freedom to borrow abroad will therefore start a rush to international markets. But the borrowers will, for the most part, be selling their goods in the home market for rupees.

So how will they repay their loans Somebody else will have to earn the foreign exchange through exports. But how will that happen when India is already in a balance of payments deficit and the rupee is appreciating against the dollar And how will exports rise when the inflow of borrowed dollars will itself push up the exchange rate further and make Indian goods less competitive abroad This was exactly what unrestricted private borrowing abroad under conditions of high domestic interest rates did to Thailand.

The truth is that for a handful of extra votes that it may not even need, the BJP is putting the future of the Indian economy in dire peril. One can only pray that ones fears are not realised.