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Rashmin Sanghvi & Associates

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Budget 1997

III. The Economy


Indian Political scene is like a high voltage drama.

 

1. Political Scene

Indian Political Scene is like a High Voltage Drama. You cannot skip a single scene of the drama or Indian politics.

The drama moves from a crisis to another crisis to another crisis. From one climax to another climax to anti climax. It appears, there is no normal week. There is no low voltage scene. For an outsider waiting for stability, the elusive stability never comes.

And yet the common man on the street continues his life unconcerned. Who cares for politicians - except for idle talk !

Indian Economic Scene continues to be that of a growth.

The real growth rate may fluctuate from 5% per year to 7% to 6%. But it is almost always growth. Politics does disturb Economics, but may not overpower economics.

If political and economic scenes can be charted, they may appear as under :


Government has two roles to play - The short sighted, selfish politician keeps damaging the Indian economy. The middle and lower level bureaucrats are still saddled with the idea that they, the "superior tribe" have to "Rule" the "subjects". They cause red tape and slow down everything.

The top level bureaucrat does a heroic effort to liberalise Indian economy and to give it stability plus growth.

The result is, growth. Slow growth. But growth.

An industrialist doing direct business in India with good understanding of the Indian culture can make good profits. Foreigner not understanding India can make grand losses. (Probably, this may apply to most countries.)

Examples of foreign MNCS who have stayed in India for several decades, understood the culture and made it good are :

Unilever's subsidiaries - Hindustan Lever, Brooke Bonde, Lipton and Ponds. Others - Colgate, BASF, ABB, Castrol, Glaxo, and Nestle.

Almost all foreign mutual funds, speculators and gamblers have made huge losses.

     

Foreigners may stay away from portfolio investments.

 

2. Stock Market

Like the political scene, the share market is also deep in controversies and crisis. The entire scene is overshadowed by greedy operators, promoters, merchant bankers and brokers. In this situation, investor looses. And the enforcement machinery is just unable to help the investor.

While some steps are being taken by the Government to streamline the machinery, it will still take many years before the acceptable market mechanism is available.

In such a situation, an NRI or foreigner may stay away from portfolio investment in India. An NRI may make direct industrial investment if he has in-house managerial resources. Otherwise, wait and watch till India resolves her own internal mess.

     

Coalition Government has convinced all the parties that liberalisation has to be there.

 

3. Benefits of a Coalition Government

Primarily, everyone is worried that a coalition Government can not be a steady Government. This has created a crisis of confidence, and a depressed market sentiment.

However, there are certain benefits of all these parties coming to power for the first time.

3.1 Some parties were protesting against the terms imposed by WTO. Having come to power, they have, for the first time realised the responsibility. Now they know the hard facts of international competitive markets; and the "Give and Take" that has to be accepted in an international organisation - like WTO. For a long time, we have not heard even a whisper of protest against WTO.

3.2 The liberalisation policies which were started by the Narsimha Rao Government, have been continued by the Gowda Government and also by the Gujral Government. BJP has always complained that Narsimha Rao has followed BJP policies. So really, there is no opposition to liberalisation. For the first time, there is a unanimity on liberalisation. And this unanimity has been established beyond any doubt by the "Common Minimum Programme" and the Budget, 1997.

3.3 Pushed by IMF and advised by western "experts"; Government of India tends to go over board in liberalising. A Government with a thumping majority would have ignored the communists. The fact that no party has clear majority has made the communists exercise their power (though limited) and prevent the Government from going overboard.

On the whole, we can say that the 1990s decade has been a great churning process for India - on political as well as economic fronts. The churning is going to be painful. However, at the end of the process, India is bound to come out a leaner country with a competitive spirit.

How long the churning will continue, is anybody's guess. And as long as it continues, short term portfolio investment will be highly risky. However, people who are interested in setting up their own industry; who are in for the long term; may expect good benefits in the long term.

     

Budget has NOT been balanced

 

The Government kept on attaching funds belonging to financial institutions and banks

 

Now it has attacked petroleum industry

 

4. Government Finances : Balancing the Budget

A question is raised by many persons :

"With all these tax reliefs, how will the Government get its revenues ?"

4.1 Let us attempt a reply :

Government will not get adequate revenues, budget will not be balanced. If some miracle does not happen, Government finances will be grounded.

The Government has inherited a thoroughly mismanaged economy.

In the past, when Governments did not have funds, they used to print notes. General public did not understand what is "Budgetary Deficit". However, when inflation struck, people protested. Mrs. Mrinal Gore and thousands of ladies came out on the streets of Bombay with "Thali" and "Velan" (Rolling Pin). She became famous as the "Panivali bai" and Indira Gandhi had a tough time.

Then the Government thought of borrowing from banks. They could spend merrily and there would be no inflation. Nationalised banks had no option but to finance the Government under the guise of Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR). Mrs. Indira Gandhi liked the idea of exploiting the banks so much that she even used bank funds to buy votes through "loan melas". RBI strongly protested, to no avail.

LIC, GIC and UTI all financial institutions' funds are attached by the Government in the name of sale of Government securities. Financial strength of all these institutions is affected.

Then came the year 1991 and the deep crisis in Balance of Payments. IMF and World Bank always knew Government's games but couldn't do anything significant. Now, when Government of India (GOI) went to them for additional loans, they imposed discipline in the form of control on fiscal deficit.

But the borrower is at the mercy of the lender only before he takes loan. Once the borrower has received the loan, it is a moot question - who is at whose mercy ! Once the loan was taken and Government was in a better position ; the discipline slipped.

In the process of liberalisation, government started reducing tax rates all over; reducing Banks' SLR and CRR, etc. But the process of expenses always being more than income continued. So the need for huge funds continued. Next victim was the "Oil Pool Account".

Ultimate position has been reached where :

Government did not pay to IOC., and others. IOC did not pay to ONGC and others. ONGC did not pay royalty to the North-Eastern States.

These States' finances came to a stand still and the Ex-Prime Minister Mr. Gowda had to send special emissaries to chalk out the States' financial crisis.

In conclusion.

Government's finances are in a deep crisis. While we can not blame this Government for the inherited crisis, the fact remains that the crisis is very much there and no effective steps are taken to solve the crisis.

Steps are not taken because, no one has any solution which may be politically acceptable.

In this crisis, the Finance Minister has played the gamble of reducing taxes all around. Probably hoping that :

The budget will boost market sentiment and morale

This will increase the investments. Industry, and the economy will start expanding. GDP will grow. And hence, tax revenues will grow.

Looks like a gamble. Or a day-dream.

But this policy has worked when Mr. V.P. Singh and Dr. Man Mohan Singh reduced tax rates. Let us see whether the present gamble succeeds.

   

4.2 Let us see some other views :

4.2.1 It has been proved in the past, that whenever tax rates are reduced, the tax revenue has actually gone up. The growth in GDP and better compliance, both have resulted in increase in revenue.

4.2.2 India is very much a part of World Trade Organisation. WTO has always been insisting on reducing the rates of customs duty. Instead of dodging the issue, this Government has decided to go ahead and reduce the customs duty rates.

Apart from WTO requirements, the global markets require that to be competitive, your tax rates have to be lower.

If customs duty rates are reduced, excise rates also have to be reduced to make the domestic production more competitive.

Thus, an all round tax reduction has taken place.

     

Rupee depreciation is a major cause of inflation

 

5. Rupee Depreciation

The Government and RBI are somehow convinced that -

- If rate of inflation in India is higher than the rate of inflation in U.S.A.; rupee must depreciate to the extent of the difference.

- to make Indian exports more competitive, rupee must be depreciated.

We believe, both these beliefs are patently wrong in the present times. However, to disprove these theories would need a long discussion. Let us simply see the impact of depreciating the rupee.

Because rupee has depreciated from Rs. 31.35 to Rs. 35.85 by Dr. Man Mohan Singh, the cost of imported crude has gone up for IOC. If the increased cost is passed on to the retail market of petrol, diesel, LPG etc.; then there will be a cost - push inflation and a public protest.

To avoid the public protest, petroleum prices are not increased and IOC has to keep suffering.

     

95% of the Government's revenue is spent on debt servicing

 

6. Debt Trap

What is a Debt Trap ?

"When a person or Government has cash outflows (expenses and debt servicing) in excess of its income so that further borrowing is unavoidable, he or it is in a debt trap."

Consider the cash flows of Central Government of India.

Central Government Revenues

For the year 1996-97

As per Budget - February 1997


    (Rs. Crores)
Tax Revenues   97,000
Other Revenues   34,000
     
    1,31,000
Loans etc.   64,000
     
Total Receipts   1,95,000
Interest Payments   59,000
Loan Repayments   66,000
Debt Servicing   1,25,000

95% of Revenue is spent on Debt servicing. For the regular expenses, Government has to take loans.

Indian Government's External Debt


During Dr. Manmohan Singh's term as Finance Minister - Debt in US $ has grown from 84 billions to 92 billions (less than 10% increase). Debt in Rupees has almost doubled from 1630 billions to 3150 billions. The reason - Devaluation of the rupee from Rs. 18 per dollar to Rs. 33.5 per dollar (in March '96).

Indian Government's Total Debt


During Dr. Manmohan Singh's term as Finance Minister, the Government debt has increased by Rs. 4230 billions - almost equal to the total debt borrowed during earlier 43 years.

     

Oil pool deficit is also a part of fiscal deficit

 

7. Oil Pool Account

7.1 Government has not paid almost Rs.18,000 crores to the Oil Pool account.

Refineries' cash flows are affected and they cannot print notes. They have no money to buy / import crude. Magnanimous Government gives them freedom to borrow abroad. IOC's External Commercial Borrowing (ECB) limit is raised to $ 3 Billions !

Government has a clear and present liability to play.

It simply does not pay.

Government budget is prepared on "cash" system of accounting. So whatever is not paid, does not come in the budget. The deficit ratio remains within limits.

Isn't this a misrepresentation, and abuse of "cash system" of accounting ?

7.2 Finance Minister has reported budgetary deficit for the year 1996-97


  Rs. Crores
Oil Pool Deficit : Opening Bal. 5,000 6,900
Closing Bal. 18,000 13,000
Increment 13,000 19,900
Annual Budgetary Deficit    

Even the largest misrepresentation by any of the private sector companies, must be less than Rs.19,900/- crores.

7.3 Finance Minister has reported fiscal deficit Rs. 63,000/- crores @ 5% of GDP. IMF managing director Michel Camdessus has stated that the total deficit considering Central and State Governments and Oil Pool deficit is 10% of GDP.

     

Can Government attach public money and call its own money!

 

With more liberalisation, the economy will be less and less dependent on the government

 

8. Maharashtra Government - Liquidity crisis

Recently there was a report in the papers that the government of Maharashtra has diverted funds from Maharashtra Krishna Valley Development Corporation (MKVDC).

MKVDC - a Maharashtra Government owned corporation - had floated a bond issue for Rs.250 crores with a right to retain an additional Rs.50 crores. The funds were to be used for investing in irrigation projects along the Krishna River Valley. The issue received Rs.620 crores from the public. Inspite of objection from SEBI, the government decided to retain almost the entire amount. This was on top of the fact that the Maharashtra government had not contributed its own share of Rs.200 crores out of its budgetary support.

Out of these funds, Rs.200 crores have been diverted by Maharashtra Government for paying salaries to its own staff and other expenses. Further Rs.100 crores may be diverted. The government is not paying any interest to MKVDC.

First of all the diversion of funds to the Government is wholly illegal. The funds have been raised for one purpose, but are being used for another purpose. We are all against promoters of Public Limited Companies diverting the funds. Here the government itself is doing the same.

When an official was questioned whether such diversion of funds could be done, the reply was - "The funds are our own"! "Government has guaranteed the payment of interest & principal".

Misuse of a corporation's money is wrong. The fact is that the SEBI's very function is to prevent such misuse; and that it has not been able to fulfill its duty is wrong. On top of this, the Government officers have the audacity to say that the funds are their own !!!

Despite the serious crisis in Central and State Government finances, we feel that :

1. Government's financial position should not be equated with the nation's financial position. The fundamentals for Indian economy have been good and continue to remain good.

2. It is true that Government's Credibility always reflects on the international credibility of Private and Public Corporations.However, with more and more liberalisation, this impact will get reduced. The economy will be less and less dependent on the Government.

3. The 1990s is a decade of churning process for India. Political as well as Economic. Right now we are passing through difficult period. However, there is great potential after a few years. This potential can be realised provided the whole nation works hard for it. If we don't work now, the potential will be wasted.

     

Full convertibility can be looked at as "means" and not an "end"

 

9. Rupee Convertibility

9.1 Finance Minister has declared a clear intention to make rupee fully convertible. However, instead of making haste like Mexico and Russia and throwing the whole economy into chaos, - the Government of India and RBI would like to take cautious, measured steps and achieve the target in good time.

9.2 RBI Governor has stated that full convertibility cannot be brought about until the following conditions are fulfilled :

1. India has comfortable Fx reserves;

2. The rate of inflation in India is comparable to the rate of inflation in major trade partner countries; and

3. Financial sector reforms are completed and Indian real rate of interest compares with the rate prevailing in partner countries.

9.3 Mr. Michel Camdessus, managing director, IMF has stated that India is ready for capital account convertibility. The necessary requisites exist :

1. Present Fx reserves are comfortable;

2. Banking/financial situation is sound; and

3. Macro fundamentals are strong.
GOI should initiate the action on convertibility.

9.4 We submit that -

Full convertibility is not an "end."

Consider it as a "means".

It will cause a flight of capital inward.

Which will bring in massive Fx reserves; bring down the interest rates, cause rupee appreciation and if managed properly, reduce inflation. Funds availability for large projects will also become easier.

Full Rupee convertibility may be the ultimate step in liberalising the Indian economy - ushering in good times for India.


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