A Tough Juggle

After a decade of his so-called 'dream budget' in 1997 during his first stint as FM, Palaniappan Chidambaram has learnt several bitter lessons. He realised that lower taxes don't necessarily translate into higher revenues for the government. He found that fiscal prudence is probably the best parameter by which the world judges the performance of any FM. He figured that a FM needs to protect his turf in the fiercest possible manner. And that, because he didn't take these issues seriously then, his budget turned into a nightmare.

Even today, during his second spell as FM, those learnings haunt him in his sleep. That's probably why he's decided he wouldn't give in on any of these fronts this time. That's possibly the reason why Chidambaram finds himself pitted against cabinet colleagues, powerful taxpayers' lobbies, and even Prime Minister Manmohan Singh. "It's the FM's obsession with higher revenues and a lower fiscal deficit that's creating friction between his ministry and others, including the Planning Commission," feels a Mumbai-based economist.

Chidambaram has few options left. He has set optimistic revenue targets for this fiscal (2006-07); so, he has to explore all avenues to expand the tax base and/or force existing taxpayers to cough up more. Couple this with the stark fact that the Congress supremo Sonia Gandhi wants the UPA government to spend more on social sectors. If the FM has to rein in the fiscal deficit, he has to stall all moves to hike government expenditure or lower taxes. That's proving to be tricky and he's losing a few of these battles.

Last week, the FM was engaged in a furious fight with Planning Commission chief Montek Singh Ahluwalia. The bone of contention: Ahluwalia's insistence on more resources for planned programmes (social sectors and welfare schemes) under the 11th five-year plan (2007-12). Chidambaram is against it as he thinks that adhering to targets "in respect of fiscal and revenue deficits is critical" and "fiscal discipline" should be the "major factor in determining investment (in such projects)."

The finance ministry contends its hands are tied due to the Fiscal Responsibility and Budget Management (FRBM) Act. Under it, all governments have to reduce fiscal and revenue deficits to pre-determined targets each year to eliminate revenue deficit and bring down the fiscal deficit to 3 per cent of GDP by 2009. Explains Ashok Lahiri, chief economic advisor, department of economic affairs, "There's a law and we have to abide by it. The debate whether we're obsessed or focusing more on revenue and deficit targets is intellectual in nature and is subjective."

Montek doesn't "care for FRBM targets as long as we get the money." He thinks the Indian policymakers should open their fists, rather than tighten the belts, even in an era when the GDP is witnessing frenetic growth rates. He's being influenced by 10, Janpath, which feels this government needs to intervene directly to improve the quality of life of the poor people. As Montek said in a recent interview: "While our growth performance has improved, there are concerns about whether this is doing enough for the poor and excluded groups." He's backed by Union HRD minister Arjun Singh, who says "there's a breath of fresh air in the suggestion that we need not be constrained by the FRBM Act."

Economists are divided in their views. Ashima Goyal, professor of economics, IGIDR, sides with Montek. "The FM is giving too much attention to fiscal deficit. If we look at China, it's invested huge amounts on infrastructure and witnessed high GDP growth rates in years of high deficits. India can afford to do the same," she says. Others add that the FRBM targets are "not realistic" and have been "blindly borrowed from western economic models".

A few experts criticise Chidambaram for doing things to please foreign capital (read foreign investors, multilateral agencies and global credit rating agencies). For instance, the World Bank has pointed out the "disconcerting reality of the growing gap in economic progress and service delivery for the best and the worst segments of the (Indian) society." It has also said that "the headcount poverty rate in rural Orissa (43 per cent) and rural Bihar (41 per cent) is higher than similarly measured poverty rates of African countries such as Malawi or Ghana."

In this dispute about deficits, the RBI is with Chidambaram. In the past, the central bank has warned that the government's credibility with global rating agencies will "further erode" if it does not stick to the FRBM targets. It has argued that fiscal profligacy or indiscipline is likely to act as an obstacle in achieving the "full potential growth" of the Indian economy. In fact, the RBI thinks that deficit figures are already "understated" by nearly 1 per cent of the GDP and, therefore, need to be looked at even more carefully.

But many say the RBI and the finance ministry are worried about less important issues. Explains B.B. Bhattacharya, vice-chancellor, JNU, "Theoretically, there is no optimum limit for fiscal deficit, although there are targets for monetary deficit. There's no optimum limit for domestic borrowings, although there is one for external borrowings. I would agree with the Planning Commission because India needs to create jobs, invest in public infrastructure and provide basic amenities, and reduce wasteful expenditure, not essential ones."

With both its eyes on fiscal deficit, the finance ministry is equally concerned about possible loss of revenues. A case in point was Chidambaram's tussle with Union commerce minister Kamal Nath over policies relating to special economic zones (SEZs). Since the SEZs have been given a plethora of tax and other sops, the finance ministry calculated the revenues loss at Rs 1,75,487 crore in the next four years. So, it wanted to restrict their number to 150, compared to 388 applications received so far.

However, Kamal Nath said the FM was exaggerating the possible losses. According to his calculations, the government was likely to earn Rs 44,000 crore from the SEZs. In addition, it would result in world-class facilities and thousands of new jobs. His view was supported by several chief ministers and the real estate lobby. The matter came to a head and the empowered group of ministers on SEZs, headed by Union defence minister Pranab Mukherjee, decided to remove the cap and review the situation only after 75 of them become operational.

Although Chidambaram lost out to Kamal Nath, he has managed to fend off similar attempts by petroleum minister Murli Deora, the Left parties and the corporate lobby in the oil sector. Despite huge increases in global crude prices, India has artificially pegged retail prices of petrol, diesel, kerosene and LPG at lower levels. Obviously, the government doesn't want to displease its votebank. But this has impacted the bottomlines of oil marketing firms, both state-owned and private.

Deora and the Left parties have argued that a cut in duties on petroleum products is the best way to enable a hike in retail prices, and still reduce the impact on consumers. The private sector has urged the finance ministry to extend the partial subsidies that it gives to the oil PSUs. Chidambaram has refused to budge on both issues, because it'll lead to revenue loss and, hence, result in a higher fiscal deficit. (To put it in perspective, the various taxes on petroleum products account for nearly a third of central government's annual revenues.)

Each time, the finance ministry smells a revenue-loss rat, it oils its tax trap. Last week, Parthasarathi Shome, advisor to the finance minister, chided a senior executive of a south India-based motorcycle maker for asking for tax incentives on capital exports, or investments abroad. At an Assocham conference, he said, "If Indian companies go abroad because of opportunities, we'll encourage it. We're not stopping them. But why should Indian authorities give tax incentives so that capital could go abroad.... That doesn't make sense to me."

Many corporates have realised the best way to get the FM's attention is to raise the spectre of revenue losses. Anil Ambani did that recently, when he thought that he has been discriminated against by the petroleum ministry while finalising the bids for ten coal-bed methane blocks. Anil, who alleged that he should have got six blocks, rather than four, categorically made the point that this would lead to a revenue loss of over Rs 2,000 crore. At a subsequent cabinet meeting, the final decision on the ten blocks was postponed, but the FM's role is unclear. In the case of several production-sharing contracts for oil and gas fields auctioned to the private sector in the past few years, the government has rejected sale at lower prices, or opposed payment of royalty and cess to it at old rates, for the same revenue-loss reason.

But the FM knows that plugging revenue losses can only help him in the future. He has to simultaneously do something to increase revenues this fiscal. To achieve this objective, Chidambaram has turned the heat on the taxmen. The latter have been asked to look at every alternative to earn extra revenues. For example, the ministry tried to change the Saral tax return form to make it more difficult for individuals to avoid taxes. It was withdrawn due to opposition from the middle class, but the rationale for it was clear.

The taxmen have been asked to screen returns of securities transaction tax (STT). This will help the tax authorities to cross-check all returns of the same individual. The ministry has told banks to provide the pan of credit cardholders who have run up bills of over Rs 2 lakh. The reason: the feeling that some of the 20 million card holders are avoiding taxes and will be caught if their expenditures are cross-checked with their IT returns.

Since the government does not have the political will to dramatically expand the tax base—it has tried to do so with service tax—the finance ministry is forced to go after the official taxpayers. This has angered the urban middle class, which feels that they're being targeted unnecessarily. Agrees IGIDR's Goyal, "The taxpayer is always a soft target for the finance ministry."

In the interim period, it's the middle class and the corporates who'll have to shell out more to help the FM to contain the fiscal deficit. From the revenue collection figures available for the first quarter this fiscal, Chidambaram's efforts have yielded results. While government expenditure was up 40 per cent, its revenues went up by over 30 per cent. As Lahiri puts it: "The figures prove that we're on the right track."