The devil in Chidambaram?s Budget

By now, Chidambaram does not need any more certificates applauding what is widely regarded as a balanced Budget. Even four weeks later, endorsements outstrip criticism, though some endorsements are cautiously couched, suggesting the Budget at least does no harm to the economy?s growth momentum. This is no mean achievement. The Budget carries forward tax reforms ? lowering corporate taxes to highest marginal rate for personal income tax, (we hope the 10% surcharge would be temporary), greater convergence of excise rates towards the 16% Cenvat, alignment of customs duties towards Asean rates and personal income tax slabs mirroring the impact of inflation more closely. Enhanced outlays for the social sector, infrastructure and weaving rural progammes under the Bharat Nirman initiative are well conceived. Nevertheless, some issues deserve closer consideration.

First, it must be conceded the balancing act has been achieved by keeping all contentious issues out. Apart from a commitment to review Plan schemes every five years, there is no commitment to subject schemes carried forward for the last 10 Five-Year Plans to any intensive scrutiny. Nor can vague statements on subsidy reviews, or better targeting, add comfort. Privatisation is on the back-burner and banking reforms left to the Reserve Bank. There are no other significant moves on FDI or on labour reforms, nor is there any commitment to continue structural reforms in infrastructure. By pushing the pause button on the FRBM, Chidambaram is being honest, as you cannot have tax breaks, mounting expenditure and fiscal rectitude all at the same time! This would have medium-term implications. Economic policy making is a continuing exercise and if Chidambaram proposes to address the more contentious issues during the course of the year, there is merit in this approach.

Second, Chidambaram shows touching faith in public expenditure! Outlays for the social sector and infrastructure are significantly enhanced. But reforms on approval procedures and accountability on time and cost over-runs, tracking utilisation of outlay spent and ensuring greater symmetry between outlays on education and health with long postponed reforms in these sectors remain neglected. Enhanced outlays must be accompanied by enhanced vigil on expenditure quality.

Successive studies, for instance, reveal that increased outlays do not result in better education outcomes. These come with measures to raise enrollment, minimise dropout ratios, define a teacher recruitment policy, improve quality of teaching and create greater competition among schools to compete for funds and greater involvement with parents? associations. Equally complex issues for higher and technical education include faculty retention and greater autonomy.

Third, the proposed fringe benefit or cash withdrawal taxes would be onerous to implement, would enlarge discretion of revenue officials and go against the objective of tax simplification. They are weak revenue instruments and ill designed to addr-ess tax evasion. In Brazil, the Provi-sory Contribution on Financial Tran-saction (CPMP) is controversial. In Australia, it is known as the BAD Tax, or the Bank Account Debit levy and is being phased out. Variations in Argentina, Colo-mbia and Ecuador have not had great success. This is unsound economics, distortionary in altering consumer choice on preferred financial instruments and with some passing exceptions, has been generally discarded.

Finally, there is a creature in the Budget called the Special Purpose Vehicle (SPV). This paragraph in his speech is opaque, both conceptually and operationally. Is the SPV designed to create a new debt window for infrastructure borrowing, both for parastatals and private entities? Is it a recognition that the existing financial institutions have failed, or are handicapped by inadequacy of resources? What about the Infrastructure Development Finance Corporation, created precisely for financing infrastructure? Is there much value in creating a new entity, instead of integrating it with one of the existing institutions? Presumably, the SPV with modest seed capital will borrow from the market, based on a sovereign guarantee and would increase the sovereign?s contingent liability. Assuming the SPV does borrow on attractive terms, how are these funds to be on-lent to project entities and who will undertake the project due diligence, both technical and financial? Assessing risk in project finance is a complex task that specialised entities such as IDFC do well. But this translates into a higher cost of debt for projects. If the objective is to reduce the cost of debt to infrastructure, while not compromising on the quality of the diligence process, one solution would be to on-lend funds raised at lower rates appropriate to the sovereign-backed SPV through IDFC. This would make the SPV an instrument for delivery of ?subsidised debt? to projects that may otherwise not be financed. But debt financing is not enough. Equity must also be mobilised. In fact, IDFC?s expertise should be used not only to on-lend SPV funds, but also to ensure this debt is appropriately structured, in combination with the requisite equity financing (including viability gap funds).

These areas still lack clarity. Budget proposals are invariably reviewed in the light of subsequent analysis and fine-tuned to meet desired ends. This one can be no different. The Devil, as they say, is always in the Detail.