The finance
minister is like CFO of a business corporation. His job is to keep account of
the receipts and expenditure of the government; manage resources necessary for
executing the plans approved by the Cabinet; ensure optimum utilization of
available resources; and keep adequate provision for meeting contingencies.
He is accountable
to all the stakeholders, insofar as the transparency of accounts is concerned.
His discretions are however limited to choosing the sources of revenue needed
for executing the plans of the government.
In specific
Indian context, FM has to decide how much resources to raise from (a) taxation;
(b) sale of national assets; and (c) borrowing.
In taxation, a
balance has to be maintained between direct and indirect taxes to keep the
incidence of tax just and equitable.
Sale of national
assets (mines, airwaves, PSE shares, land etc.) has to meet the criteria of
sustainability, development, transparency, viability, socio-political
expediency; etc. and depends heavily on the current market conditions.
Borrowing depends
on consideration of fiscal discipline, servicing capacity, and market
conditions. Historically, we have borrowed from domestic lenders only. However,
in recent years the role of foreign lenders has been rising; the exchange rate
volatility has therefore become a consideration. The FRBM Act also guides the
extend of borrowing.
The importance,
or otherwise, of the annual budget presentation must be seen within this
framework. Although, the attention that is paid to the annual budget speech has
diminished in past decade or so, it still evokes intense interest from the
financial market participants. I feel it has more to do with the marketing
success of business news channels rather than anything else. A number of TV
shows are hosted to propagate an environment of expectation, hope and fear
amongst market participants.
The anticipation,
that is sometimes far beyond the realm of reality, guides the market
volatility. The representatives of various interest groups and lobbyists for
pressure groups demand from FM, what he has no jurisdiction to give. For
example, someone asks FM to allocate more money for infrastructure spending.
Whereas, this request should logically be made to the concerned ministry and
departments, which shall make a plan, and get approved by the cabinet. FM will
be obliged to provide resources for a plan approved by the cabinet. A defiance
could see him losing his job.
I believe that it
is high time that the development agenda of the government be completely
separated from the budget presentation. Let budget be an accounting exercise
with a reasonable degree of predictability and transparency.
Let public
appraisal of the development agenda be a continuous process through regular
reporting by the concerned departments and ministries.
Somewhat similar
is the situation of many Indian corporates and banks today. The profligate
capex funded by indulgent borrowing by the businesses in past 15years has
severely damaged their balance sheets. Unable to bear it, most have
conveniently passed the pain over to lenders.
The promoters are
naturally worried that a close scrutiny by Supreme Court and RBI may set the course
right by holding them accountable for their accesses.
The markets which
have cherished every bit of their profligacy in the past are also naturally
worried.
The government is
seeking to structurally reverse the persistently negative interest rate on
financial savings which in past decade have discouraged household savings, the
very backbone of our economic growth. The tax incentive on savings has also
become a totally ineffective tool in the current inflationary scenario. A
reform here – to fix the savings rate at CPI plus one percent would make many
businesses unviable.
The family
businesses which have long thrived on subsidized capital from banks and
financial institutions shall have to dilute their equity, should they be forced
to borrow at competitive terms. Do they really want it? Similar is the case
with labor reforms, tax reforms, etc.
Not many
businesses seem to be welcoming lower tax rate with rationalized exemption
regime.
Zero tax on long
term capital gains on listed equities is another bone of contention. The mere
hint of withdrawal of this exemption has made markets jittery. But to develop a
vibrant debt market an encouraging start ups, brining parity in taxation of
debt instruments, unlisted equity and listed equity might become necessary.
...but not me
Last evening I
heard some bankers and economists at a seminar. The common running idea in all
formal presentations was how to revive investments without compromising fiscal
discipline. But none, yes none, suggested higher taxation on businesses or the
rich.
Many wanted tax
sops to encourage private sector investment and higher protection to the
globally uncompetitive industries facing challenges from cheaper imports. But
no one explained that how businesses will be motivated to invest in new
projects when the economy wide capacity utilization is at cycle lows and export
demand is clouded!
On February 28,
2015 Shri Arun Jaitely presented his first full budget amidst great
expectations. The market which was already on roll for past many months, scaled
new high within three trading sessions after presentation of the budget.
However, since then it has been a rather disappointing journey downhill.
This year heading
into the budget presentations, the markets are badly beaten, extremely jittery
and expecting little from FM. Save some minor tax concessions here and there,
the market is mostly praying for a status quo.
Given the
constraints like:
(a) the substantial pay commission and OROP
payments already overdue;
(b) disinvestment targets already scaled down due
to poor market conditions;
(c) commitment to implement food security law in
FY17;
(d) RBI Governor's and global rating agencies'
strong urge to not compromise on fiscal discipline;
(e) lower nominal economic growth leading to
muted tax revenue growth;
(f) political urgency to provide for social
spending in view of the key state elections due in FY17 (TN, Kerala, WB, UP and
Punjab) - expecting any radical proposals from FM in the budget seems
unrealistic to me.
I believe, the
market fully understand the dilemma of the finance minister and hence does not
expect him to dole out any goodies from his hat. Save for the customary
pre-budget memorandums by the trade and industry representatives, I do not see
any pressure on FM from the market side.
...conjuring
up fears which FM can easily allay by inaction
To the contrary,
to keep the spirit of its participants alive, the market has itself conjured up
some events - not happening of which will make people relieved; return of long
term capital gain tax on listed equities being the most prominent one.
Having observed
the working of the finance ministry closely in past 21months, I am reasonably
assured that both the finance minister are exceedingly sensitive to the
financial markets. At this juncture, I do not expect them to do anything that
will trigger a sell-off in the market.
Having said that, I think that exemption to
the listed equities from LTCG (provided STT has been paid on the sell trade) is
an anomaly that would need to be corrected at some point in time, sooner than
later.
Tax break on LTCG defy logic
Evaluating holistically, the activity of buying
and selling equity shares in secondary market per se does not provide any risk capital to the underlying
businesses.
It in effect just changes the beneficial
owner of the business. Prima facie it sounds illogical why should someone who
is actually transferring his risk, be rewarded with lower (or no) taxes?
It is extremely difficult to support the
argument that holding a listed stock for more than one year in any way helps
the economy or the markets.
The logic of holding a security for longer
term, if at all, enhances the chances of higher returns for the investor. Why
should the investor be given tax breaks for enhancing his return prospects?
One could appreciate the "development of
capital market" argument in case of investing in IPOs, PE funds, or venture funds etc., as in such cases the
businesses get the much needed risk capital. But the secondary market
transactions do not pass this muster.
The incentive for longer term holding period
has, in my view, failed miserably in improving market liquidity or minimizing
market volatility.
It is common
knowledge in market place that the LTCG exemption for tax has been abundantly
misused for money laundering purposes.
In fact last
year, the regulator and taxation authorities have also initiated action in many cases for misuse of LTCG taxation
provision for money laundering.
In fact, to the contrary, the day traders, jobbers
and market makers who provide the much needed liquidity to our shallow markets,
and hence motivate risk taking, deserve serious tax incentives.
Abolition of Securities Transaction Tax (STT)
may actually lead to material rise in daily volumes and deeper markets, thereby
materially lowering the transaction cost.
Similarly, providers of unsecured debt take
much higher risk and therefore deserve more tax incentives.
In absence of a functional retail debt
market, companies depend heavily on "fixed deposits" from household
investors for meeting their working capital requirements. These deposits are
fully unsecured and entail high risk for investors, in lieu of marginally
higher interest rates as compared to bank lending rates.
I have been insisting that "reform"
must be distinguished from mere administrative correction. A policy measure in
order to qualify as "Reform" must change the status quo materially.
The businesses, investors and consumers need
to assimilate that economic reforms do not necessarily result in more profit in
the immediate term. To the contrary, economic reforms are more likely to cause
pain and inconvenience in the immediate term as these involve fundamental
changes in the processes and practices of doing business and consuming goods
& services.
From this view point, I suggest the following
10 illustrative reform measure that may change the status quo materially. If
you find these are highly idealistic, and impractical to implement, I beg to
differ.
(1) To
exploit the demographic dividend fully and generate demand, accelerate the
wealth transfer process. Defining the upper bound of wealth and introduction of
material estate duty on people above the upper bound could be one method.
(2) Transfer
the power to impose direct taxes, to the local governments.
(3) Transfer
the ownership of natural resources to local governments. Encourage industry and
investors to partner with local governments for setting up business ventures.
(4) Introduce
competition in Railways. To begin with allow point-to-point private railways
for intercity travel up to 100kms.
(5) Transfer
all PSUs under a listed holding company. Majority voting power in this listed
holding company may be owned by Indian citizens with no individual owning more
than 1%. All these companies should be professionally managed with no
intervention from the government whatsoever.
(6) Allow
and encourage the federal states to have bi-lateral trade, labor and resource
(water, energy, logistics etc) sharing treaties.
(7) Bring
the Return on Investment (ROI) for elected representatives close to Zero level,
by stripping all their discretionary powers.
(8) Constitute
a Clean India Regulatory Authority (CIRA). Make all elected representatives
from local government level to the members of parliament accountable to this
authority. Each member should be mandated to submit a quarterly return of
cleanliness in their respective constituency to this authority. The authority
should cause an independent audit of such certificates. A wrong certificate
should disqualify the person from contesting elections for 25years.
(9) Enhance
the Right to Education (RTE) to the Right to Uniform Education (RTUE).
(10) Reorganize
farm sector with "collective farming", "cooperative food
processing" and "national market" at the core.
