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Chidambaram’s Challenges: Budget 2005

Omkar Goswami

Finance Minister P. Chidambaram knows better than most the challenges that face the economy and the exchequer. The first challenge is that of managing expectations. When he presented the UPA government’s first Budget in July 2004, Chidambaram said that it was a hasty exercise, which was fashioned in less than 40 days of assuming office. At that point, he made it quite clear that real fiscal reforms will be in his second budget. Since that Chidambaram is equated with ‘dream budgets’, each financial newspaper and chamber of commerce has started publishing its grand laundry list. The problem is that the numbers just don’t add up. If all wishes were to be granted, the exchequer would be broke beyond redemption. The faster people realise this, the better will it be for their expectations.

Other than managing sky-high expectations, what are the Finance Minister’s fiscal  challenges? To my mind, there are five. 

• How to use fiscal instruments to kick start physical infrastructure, without which the country will find it impossible to maintain a long term annual growth rate of 7 per cent.

• How to curtail non-plan expenditure, especially when many of the populist coalition partners are interested only on greater spending.

• How to increase plan expenditure, especially where these build the country’s capital stock for future growth.

• How to clean up the tax regime, so that we have greater transparency, more incentive compatibility, greater competitiveness and significantly lesser number of exemptions — and to do so without unduly alienating the existing beneficiaries.

• How to raise revenues without increasing tax rates in an environment where revenues are falling short of targets, and where the Left opposes any form of significant divestment.

Today, I will focus on infrastructure. According to a study that we are doing, the investments needed for road, power, telecom, railways, ports and airports up to 2010-11 amount to Rs.1,914,300 crore. Against this, the most optimistic estimate government financing is Rs.1,360,100 crore. Thus, there will be a minimum financing gap of Rs.550,000 crore (or around $126 billion at today’s exchange rate) which has to be met through private sector and other non-governmental financing. What could the FM do to facilitate such funding?

First, long term growth of infrastructure requires a wide and deep market for 15- and 20-year bonds. Therefore, the FM might consider giving 100 per cent tax exemption to those who invest in 15- or 20-year infrastructure paper, which could be issued by infrastructure companies or financial institutions such as IDBI, ICICI Bank, IDFC, and the like. If necessary, there can be a cap — for instance, no individual can invest more than Rs.10 lakh per year.

Second, section 80IA of the Income Tax Act states that for specified infrastructure projects, profits for the first 10 years is tax free, and for the next five the tax liability is 50 per cent of what it would have normally been. There are two problems with this. Most infrastructure projects don’t make profits in the first 10 years; so the fiscal benefits are really not worth anything. Moreover, the Minimum Alternate Tax (MAT) of 7.5 per cent of book profit overrides this provision, which takes away whatever little benefit that remains. The FM should seriously consider scrapping MAT for infrastructure companies — at least for the first 15 or 20 years of any infrastructure project. Moreover, it might make sense to replace 80IA by indefinite carry-forward of accumulated losses (as suggested by the Vijay Kelkar Committee), which would give more substantive fiscal impetus for infrastructure.

Third, the FM might consider introducing some ring-fenced cesses like the Rs.1.50 cess per litre on diesel and petrol which goes to the Central Road Fund. This will prevent the levies from disappearing in the Consolidated Fund of India, and will also create quasi-equity for authorities like airports and ports to leverage long term debt. 

Fiscal incentives for infrastructure are necessary, not sufficient, for kick starting the sector. But they would help. The cost to the exchequer won’t be that great; in any event, it ought to be greatly outweighed by the benefits to the economy. In the next issue, I will focus on expenditure.    

Published: Business world, February  2005

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