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North Block on tightrope walk
January, 14th 2008
A resurgent Indian economy in calendar 2007 would have ordinarily meant a New Year bash for the North Block team. However, given the scenario in which it embarks upon preparation for the 2008 Budget; it seems highly unlikely that the task would be less challenging.
 
Whereas, Indias oft-repeated growth story backed by strong fundamentals, forward looking policy initiatives and vibrant corporate sector notwithstanding political compulsions for big bang reform process it remains to be seen how we retain our glory chalked out last year.
 
North Blocks conservatism in estimating the expected growth rate of GDP at 7.9 per cent for the second half of the current fiscal year has spelt its doubts about a possible deceleration in economic growth amidst the euphoria about the current statistics.
 
Fiscal sustainability, appreciating rupee against dollar, limited capacity building in infrastructure sectors, meeting the social sector needs, internal pre-poll preparations and emerging geo-political scenario are prime amongst the challenges that the economy faces in 2008.
 
India is undoubtedly better prepared to face a global slowdown, as the recently released Mid-Year Economic Review 2007-08 correctly observes. The first half of the current fiscal exhibits an impressive growth rate of 9.1 per cent.
 
The governments initiative on revenue mobilisation has undoubtedly reaped significant rewards whereby direct tax collections show an impressive 42.36 per cent growth to become the largest contributor to the exchequer. Impressive growth rates are also exhibited in corporation tax collections (39.84 per cent) and personal tax collections (50.06 per cent).
 
Tax buoyancy has enabled us to move up the tax-to-GDP ratio and it is slated to exceed the target of 11.8 per cent for the year.
 
The government lauded itself on the improved tax administration system and promised that the new Income Tax Code and the implementation of Goods and Service Tax shall provide further boost to tax reforms process.
 
Despite, all efforts, the fact remains that our tax-to-GDP ratio is relatively low compared to other emerging economies and remains the biggest obstacle to our sustainable growth model. We certainly need to mobilise more revenues to meet our growing developmental needs.
 
The statistical highpoints exhibited in the Mid-Year review document might have eased the pressure on North Block to meet the fiscal targets though continuation of reforms process and this holds the key.
 
Given that we have limited change in our expenditure model, buoyancy in tax-collections continues to be the primary source of finances to cater to development needs of social and infrastructural sector.
 
Tax-to-GDP ratio, if not improved further at an accelerated rate could render the reform process ineffective. The finance minister has urged for better compliance, but experience suggests that better compliance can be ensured only if government adheres to phased reduction of tax and tariff rates simultaneously with administrative reforms.
 
For India, higher tax rates have discouraged corporate taxpayers to join the compliance bandwagon and historically stringent compliance norms have only added to the woes. Whereas, considerable progress has been made to ease compliance norms, phased moderation of tax and tariff rates would auger well in the medium to long-term.
 
The current tax rate of income tax for Indian companies is 30 per cent (33.99 per cent, including surcharge and cess); whereas for a foreign company is subject to higher rate of 40 per cent (42.23 per cent, including surcharge and cess). Further, the arbitrage is more than offset due to imposition of dividend distribution tax of 16.995 per cent.
 
In order to increase voluntary compliance, the coming Budget presents an opportunity for a phased reduction of effective corporate tax rates. This should primarily serve twin objectives of enabling parity among tax payers and promoting enhanced compliance.
 
However, while implementing tax reduction, it must be kept in mind that an immediate 4-5 per cent decrease could result in 13 per cent fall in corporate tax collections and hence a phased out implementation is sought.
 
The shortfall could be more if incentives are extended to the exporter fraternity, a demand that would be difficult to resist given the exchange rate parity. In 2005 following recommendations by Kelkar taskforce the budget effected reduction of corporate tax rates from 35 per cent to 30 per cent in anticipation of enhanced compliance.
 
It is probably appropriate to conclude that the 2005 rate reduction decision has paid off. It is probably apt time that a reduction is further effected on the backdrop of economic growth to catch up with the international standards of tax-to-GDP ratio.
 
However, it may not be as easy as it appears. Economic policies are governed by inter-linked factors and the recent appreciation of Indian rupee against the US dollar by almost 10 per cent coupled with looming fears of an American recession has been the major contributor to this scepticism.
 
An US recession will slow down US purchases from the rest of the world and US being Indias biggest trade partner could impact Indian exports. Software products, textiles, leather goods, gems and jewelry are amongst the industries already reeling under pressure of a weak dollar. Exporters impacted by the appreciating rupee have resulted in demand for sops and Udyog Bhawan has taken up their cause with North Block.
 
Interestingly, one of the basic tenets for finance ministry to improve tax-to-GDP ratio is to remove exemptions. It will be interesting to see, how in the coming days the situation unfolds as the differing views remains, pending with Prime Ministers Economic Advisory Council chairman, Rangarajan.
 
Economists have noted that though a possible global recession will have some adverse effects on Indias growth statistics, Indias strong economic fundamentals are equipped to withstand the shocks. Apprehensions regarding global economic slowdown should not deter India from its broader reform objectives. Though, finance ministry may ultimately have to swallow the bitter pill to provide export sops, resource mobilisation efforts are not likely to be impacted drastically.
 
In summary, coherence of conflicting objectives amongst all ranks of the government is of utmost importance and that will be tested in the coming weeks.
 
Amidst all activities, one can hope Indias development need does not pay the price for political compulsions necessitated by elections in the coming months and Indias progress towards fiscal consolidation effort is not stalled by a conservative Budget devoid of significant reform initiatives.
 
Mukesh Butani
(The author is a Partner with BMR & Associates and views are personal)
 
 
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