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Fund for infrastructure
November, 26th 2008

The government is reportedly considering setting up a Rs 50,000 crore dedicated fund to provide loans to infrastructure projects to ensure they are not held up for want of funds. This is certainly a better way of providing a boost to the economy than through selective industry-specific sops and tax cuts. Even before the credit crisis surfaced, investments had begun to slow down.

Investment growth in the first quarter of the current fiscal had dropped to single digits, first time since 2002-03. A Citi report estimates that in the second quarter (July-September) as many as 45 investment projects worth Rs 42,700 crore were abandoned or shelved.

The stress has only become acute with the supply of overseas funds almost drying up. The only point of debate is whether infra-sector spending is the best way of providing a boost to the economy, particularly when the government does not have the same flexibility, say, as that of China, because of the high deficit.

Tax cuts, arguably, are a quicker way to provide a stimulus through an immediate consumption boost. In the case of a reduction in income tax, disposable incomes would go up while cuts in indirect taxes (sales tax and excise) the same income would buy more because of a drop in prices, if reductions are passed on.

However, in a situation of severe wealth destruction, most direct tax cuts are likely to be for the time saved by individuals or used to repay debt, as was the case with the $100 billion tax rebates in the US. Cash-stressed corporates would, on the other hand, retain the reductions in indirect taxes as profits and not necessarily pass on the same to consumers through price cuts.

Therefore, tax cuts look unlikely to cause consumer spending to go up commensurately. It, therefore, makes sense to use resources judiciously. Any deficit financing would add to public debt. If that debt goes into creating infrastructure then the capital created can help increase output and improve productivity, which would in turn justify the extra debt.

Of course, in case of India, allocating funds is often not enough, we also need capacities to spend. The government needs to think of that as much as about finding the funds.

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