The Hindu : Business : Govt. role as investment catalyst

Online edition of India's National Newspaper
Monday, May 31, 2004

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Govt. role as investment catalyst

The whole approach of the CMP of the new government does make economic sense but marks no major changes in sectoral policies. An advantage is the absence of financial constraints but major implementation issues will pose problems, according to the authors.

THE COMMON Minimum Programme, as announced by the United Progressive Alliance, is an important document that should in the normal course define the economic agenda over the next five years, till 2009. Given this background, it is worth exploring whether various aspects of the CMP make coherent economic sense.

The two key points to focus on are the desire to achieve an average growth rate of 7-8 per cent in the coming years, with the proviso that revenue deficit of the Central Government will be eliminated by 2009. As most of the Government's revenue expenditure including salaries, defence expenditure and interest payments cannot be brought down easily, the only way to eliminate revenue deficits by 2009 will be to improve tax collections. Increase in tax rates is not politically acceptable, hence improving compliance and introduction of a comprehensive value added tax will probably be the approach adopted by the new government. Of course higher GDP growth rates can improve tax collections. There is also a mention that black money will be targeted. There are various methods of tackling black money including conducting raids, encouraging voluntary disclosure and introduction of a comprehensive VAT.

One can expect a substantial portion of the improved tax collections to go towards decreasing revenue deficits, thus leaving little surplus for capital expenditure. Then how to achieve a 7-8 per cent average growth rate that will require an annual investment of over 30 per cent of GDP depending upon the incremental capital output ratio? In order to increase investment, the Government will mainly have to depend on public financial institutions and private capital both domestic and foreign. In the case of public financial institutions, the public sector banks and the Life Insurance Corporation are flush with funds and no new avenues to lend. Hence a dynamic government can act as a catalyst for investments.

There are also enough funds coming in from outside the country, led by NRI remittances as well as investments by foreign institutional investors. With an investment friendly climate enough money will be available. In this connection, the statement in the CMP regarding stoppage of misuse of Double Taxation Avoidance Agreements (DTAA) is uncalled for. There is no reason why government policy has to be dictated by the Sensex, but that does not mean that the ruling alliance needs to keep international fund mangers guessing about government policy. A buoyant stock market will enable both public and private sector companies raise funds for their projects, which any way cannot be funded in any substantial manner from budgetary resources.

An issue for banks is the capital adequacy norms in vogue. As banks have been cleaning up their balance sheets during the last few years, backed by the high returns from treasury operations, the capital adequacy ratios of most banks are above the minimum norms. Hence, this should not act as a constraint in the near future. However, in the event this becomes a constraint, public sector banks can approach the capital market to raise funds. The CMP allows them to do so till they reach the minimum government holding of 51 per cent. The 51 per cent minimum holding by Government may not act as a constraint just now, but in future the situation may change. This is why it is necessary for foreign banks to be provided some leeway to operate in the Indian market. The proposals of the NDA Government regarding removal of 10 per cent ceiling of voting rights in private banks for foreign banks, allowing foreign banks to set up subsidiaries in India and similar enabling measures should be pursued.

FDI needs more active approach

The CMP fortunately does not discourage foreign direct investment. However, saying India wants FDI is a general statement; what is important are the steps that the Government will be willing to take to actually attract FDI. Here the left parties also need to show some restraint with their statements. FDI brings not only money but also technology, management expertise and access to foreign markets.

Another constraint that the CMP imposes on the Government is the decision not to make strategic sales in profitable PSUs and also not to bring down the Government's stake to below 51 per cent. This is a complicated issue. Generally, privatisation improves productivity and profitability. Even if it is intended to sell the large public sector units to the Indian private sector, there are just a handful of private sector groups that can buy these units. Already these groups are becoming too powerful in the absence of proper competition laws.

PSU shares to the public preferable

A better approach will be to divest shares in PSU to the general public and allow these companies to become large publicly held companies, with major shareholdings by banks, insurance companies, FIIs and mutual funds. This will also allow them to have managerial autonomy. Allowing them to remain in the public sector probably destines a number of them to a slow death. Governments usually promise autonomy but in practice in India they remain handmaidens of the political-bureaucratic nexus. There is no particular reason to believe that this time it will be different, except perhaps for the new guiding light in the form of the Prime Minister.

Funds for agriculture, infrastructure

Large investments are proposed in agriculture and infrastructure. While investments in the agricultural sector will mainly have to be funded out of the budget as well as rural lending by banks, infrastructure can be funded from non-government resources. Given the large foreign exchange reserves, increased capital goods imports will not pose a problem. However, substantial increase in lending by banks in areas like infrastructure and agriculture will entail enhanced risks. Infrastructure investments have offtake risks which can be mitigated by independent regulators. Prices of agri commodities are extremely important to farmers as they will justify higher investments. It is not easy to ensure this in India.

There are several proposals to co-opt the needy into the development process. The fate of the NDA Government has convinced the new Government that the votes of the poor also count. The proposal to levy a cess on Central taxes to fund education is welcome. Similarly, with the high level of foodgrain production, enhanced food-for-work programmes are necessary. This will also imply investments in rural infrastructure. The proposal to increase Government spending on health to 2-3 per cent of GDP is unexceptionable. However, the Government cannot increase expenditure on such schemes in any significant manner without improvement in revenue collection, given the imperative of removal of revenue deficits by 2009.

So, to put the various CMP proposals in perspective, the whole approach does make economic sense, except for a few aberrations. Major implementation issues relate to controlling revenue expenditure, increasing investments in infrastructure along with containing offtake risks, transferring resources to the poor in the form of food-for-work programmes, primary and secondary education, health services and targeted subsidies, improving tax collection through improved compliance and imposition of VAT, attracting foreign investments to meet the domestic resource gap and allowing profitable and large PSUs to function with autonomy. This is quite a list. Good intentions have to be followed up with good implementation.

The advantage that this Government has is that the system is flush with liquidity; hence funds are not a constraint. Also, in the modern globalised world, accessing technology is not a constraint any more. The macro-economic situation is generally good, except for the fiscal deficit position. To reiterate, the litmus test will be good governance.

Abhijit Roy

Investment analyst

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