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Indian Fiscal Budget 1997-98: Analysis

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The Budget 1997-98: An Analysis
Kamal Mitra Chenoy, JNU

Finance Minister P. Chidambaram has performed a delicate balancing act in this Budget. He was under pressure from the Congress, the corporate sector, and the IMF-World Bank to continue with the economic reforms initiated by former FM Dr. Manmohan Singh. On the other hand, the Left wanted him to go slow on reforms and to take specific pro-poor steps. The FM has tried to do both. Business reactions have been positive, in some cases like that of the FICCI President, effusive. The Left, however, is likely to react strongly to the specific proposal to permit private sector companies in the insurance sector, including health insurance. The Communist parties have already threatened to move amendments to the Finance Bill to oppose such moves.

The FM will have earned goodwill from the foreign investors through the proposed reductions in taxes on foreign companies, the removal of FERA, the opening up of the insurance sector to the private sector despite Left opposition, the reductions in import and customs duties, the reduction in taxes on royalties, permission to FIIs to invest upto 30% in Indian companies (up from the earlier 24%) and the promises to dismantle Quantitative Restrictions (QRs) and to move towards capital account convertibility. Domestic companies will appreciate the amendments to MAT (Minimum Alternative Tax), the significant reduction in corporate taxes including the abolition of the corporate tax surcharge, the proposed entry of the private sector into health insurance, the dereservation of 14 items earlier reserved for the small scale sector, permission for companies to buyback shares, the abolition of taxes on dividends for shareholders, and the tax holiday for telecommunications projects. The promise to amend the Companies Act in the Monsoon session of Parliament meets a longstanding demand. The significant reductions in import and excise duties will also be welcomed.

The middle classes will welcome the reduction in income taxes, the increased contributions in provident funds, the removal of taxes on dividends for shareholders, the absence of any petroleum & related products price hike, and the reductions in import and customs duties which they hope will translate into lower prices for consumer goods.

In a macroeconomic perspective, the Budget, particularly in the light of previous international experience is problematic. Progressive taxation has been further diluted. The rich will be taxed less. Personal income tax rates and those for the corporate sector are virtually the same. The increase in social sector spending is not significant when adjusted for inflation. Public investment in employment generating schemes is also inadequate. In other countries which have undertaken such neo-liberal economic reforms, the decline in public investment has led to economic recession, increased unemployment and deindustrialization. With the Indian manufacturing sector in recession, despite the Economic Survey’s attempts to downplay this, this is likely to be a major problem in the medium and long run.

The reduction in direct taxes, import duties, customs duties, extension of tax holidays, reductions in taxes on royalties, and other such concessions purportedly directed at maximizing corporate investment and foreign direct investment, will serve to decrease potential revenues leading to an increase in the revenue deficit. The size of the revenue deficit is a more alarming indicator than the fiscal deficit, but the FM has not squarely addressed this problem.

Expectations of significantly increased Foreign Direct Investment (FDI) may also prove illusory. Despite all earlier concessions FDI last year was only $1.7 billion well under the goal of $10 billion. There is nothing from our past experience, or that of other countries of the South, to indicate that FDI flows will increase greatly. In any case, as the FM has admitted earlier FDI can only supplement domestic investment. And the main generator of domestic investment, which encourages or crowds in private investment, is public investment. But the Budget does little to encourage this crucial public investment. This will have major negative economic consequences. On the other hand, the replacement of FERA, the removal of QRs, and the move towards capital account convertibility are likely to significantly worsen India’s foreign exchange position.

In sum, the FM has promised much to all. To the tiny minority of the corporate elite, gains may well accrue. But the middle classes and the masses of the poor are likely to find the promises illusory, with inflation and unemployment rising.

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Kamal Mitra Chenoy is an Associate Professor at the School of International Studies JNU, New Delhi.


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