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The country's new finance minister has his task cut out: restore the growth momentum by clearing stalled projects, revive investments, correct the fiscal imbalance, check the rise in prices, strengthen the state-owned banks and maintain a healthy balance-of-payments situation. In addition, he will have to find a solution to the several mega tax disputes, especially with multinational corporations like Vodafone, which arose during the rule of the United Progressive Alliance, or UPA, and dimmed the country's attraction as a global investment destination.
The first goal of the finance minister will be to boost growth from 5 per cent to 8 to 9 per cent. The slowdown, more so in manufacturing, has led to fewer job opportunities. This was a big factor in the recently-concluded elections, especially for young first-time voters. The slowdown has been influenced by external factors as well as domestic issues such as the massive cuts in developmental expenditure by the government and the long list of stalled projects. These are awaiting clearances for environmental impact, conversion of forest area and land acquisition. Some face protests from tribes and some have stalled due to judicial orders.
As of May 6, as many as 243 projects involving an investment of Rs 12.79 lakh crore were pending with the Project Monitoring Group in the Cabinet Secretariat. But the finance minister has little elbow room here as most of the projects are stuck at the state level. According to a report by Credit Suisse, only a fourth of the stuck projects are dependent on the centre for approvals. So, if the finance minister has to fast-track these clearances, he will have to take on board the state governments. The states that are ruled by allies may be more helpful than those ruled by rivals.
In addition, work on the Delhi-Mumbai Industrial Corridor needs to be hastened. The National Manufacturing Policy needs to be revised to get investments going. "In the foreign direct investment policy it should provide clarity with regard to defence, and information & broadcasting. E-commerce should be given a boost," says a finance ministry official. Global retailers are watching with bated breath the fate of foreign investment in multi-brand retail.
In order to revive growth, the new finance minister will have to reassess the balance between inflation and interest rates. The Reserve Bank of India (RBI) has kept interest rates high to tackle inflation which has stubbornly remained high at the wholesale as well as retail levels. RBI's efforts have not yielded results as inflation is mainly due to supply-side constraints. On the contrary, it has made credit costlier for industry. With some help from the states, the Centre can try to address supply-side bottlenecks. Lower inflation will mean lower interest rates and thus cheaper funds for investment.
Fixing the fiscal deficit
The role of the government in reviving growth cannot be underestimated. The UPA's fault was that it raised the subsidy bill substantially, and then to contain the fiscal deficit cut developmental expenditure ruthlessly. If the new finance minister can rationalise expenditure by minimising subsidies and give a boost to developmental expenditure, he can kill two birds with one stone: it will not only contain the fiscal deficit but also give some support to growth. In the interim Budget for this year, Finance Minister P Chidambaram projected fiscal deficit of 4.1 per cent (of GDP), but he kept Plan expenditure at last year's level of Rs 5.55 lakh crore. "UPA focused too much on inclusion. So when they had to cut expenditure, it was in productive areas. when you try to control fiscal deficit, don't let major schemes suffer," says a former finance secretary who does not wish to be identified.
According to finance ministry officials, the Plan expenditure has to rise when the full Budget is presented and in order to retain fiscal deficit at 4.1 per cent, some changes in tax rates may be required. The government may have to minimise exemptions to improve the tax base. The new direct taxes code (DTC) and goods & services tax (GST) are inevitable. But as their implementation would take time, the government will have to implement tax administration reforms without any delay to improve compliance. A report from the committee led by Parthasarathy Shome will soon submit its report outlining some possible actions.
Replacing the existing Income Tax Act with a much simpler DTC should not be difficult for the new government, but GST implementation will be a challenge. This is another area where the Centre would need support of the states. GST implementation has been blocked primarily by two states: Madhya Pradesh and Gujarat, both ruled by the Bharatiya Janata Party, or BJP. While the party has said it is in favour of GST, Narendra Modi, the Gujarat chief minister and BJP's prime-ministerial candidate, has raised questions on the preparedness of the Centre's information technology infrastructure. Finance ministry officials argue the Centre is ready with its infrastructure and now the states have to work towards it. Similar views were echoed by Shome in a recent interview to Business Standard. Modi has spoken about ensuring fiscal autonomy of the states in GST. That will address their concerns but it runs the risk of diluting the basic principles of GST.
The new government should also try to bring down disputes with taxpayers and address some vexed issues like the Vodafone case at the earliest. Under the existing law it can ask Vodafone to pay the principal amount which is due to the government, while waiving off penalty and interest, thereby reducing the company's liability to about one-third. "Industry is badgered by the investigations. That has affected investor sentiment. You can't arrest a person for wrong assessment of tax," adds the former finance secretary.
The new government will have to carefully watch foreign inflows and outflows that gave incessant headaches to the UPA government. Chidambaram tackled the problem of the current account deficit (CAD) primarily by curbing gold imports. This, however, led to a sharp rise in smuggling of the yellow metal which now attracts a customs duty of 10 per cent. With CAD under control at 1.7 per cent of GDP this year, against 4.8 per cent last year, the restrictions on gold imports may be reviewed.
As the banking system is the backbone of the economy, the government will have to recapitalise state-owned banks adequately and make sure their stressed assets come down. Their needs are assessed at Rs 5 lakh crore by 2019. As the government cannot meet the financial needs of the banks from its budgetary resources, the finance ministry is evaluating options such as a special purpose vehicle, a holding company and employee stock options. It should consider the report of an RBI panel which talks of divesting stakes in state-owned banks to less than 50 per cent. It may also look at consolidation of public sector banks which UPA could not do. To achieve economies of scale, it is imperative and bank unions should be taken into confidence.
Besides, the long-pending reform of increasing foreign investment limit in the insurance sector from 26 per cent to 49 per cent will need the government's attention. It was blocked by BJP when it was in opposition. Now it remains to be seen what it would do if it comes to power. Irrespective of the outcome of the elections, the finance ministry is preparing templates depending on various scenarios for the next government. The budget may be tabled in the last week of June or first week of July.
