Budget 2011: Boosting the trust deficit
by M R Venkatesh on 02 Mar 2011 5 Comments

Budget 2011 merely reflects the drift in the Central Government. Perhaps never in the history of independent India, with the sole exception of the period during the Emergency, has a Central Government suffered from such a credibility crisis as the present one. Naturally, what matters is not the fiscal, revenue, current account, trade deficits or for that matter power, infrastructure or even manpower deficits, but trust deficit of India.  


When questioned on the state of drift by the electronic media a few weeks ago, the Hon’ble Prime Minister blamed it on coalition compulsions. If it is corruption, it is the ally from South India. Blame the ally from the West for inflation. Blame the ally from the East for Maoism, and the ally from Kashmir for the problems there. Yet the Hon’ble PM asserts that this is not a lame duck government and “assures us” that he will complete his term, little realising some analysts in the interregnum have hyphenated India with Egypt, Tunisia and Libya.


Given this state of affairs, Budget 2011 was an opportunity for the Central Government to address this trust deficit. Instead, Budget 2011 turned out to be an entirely vacuous one, an accountant’s delight, interlaced with the “grand vision” of a gram panchayat leader. On corruption, inflation and unemployment – the three major challenges to the nation – Budget 2011 maintained an inexplicable and eloquent silence. The disconnect of the Central Government to the mood of the nation seems complete.


Short shrift to Manufacturing


Budget 2011 seeks to enhance the share of the manufacturing sector to the national GDP from the present 16 percent to about 25 percent in the next ten yeas. While the intention is indeed welcome, Budget 2011 has nothing specific to offer to effectuate the same. It may be noted that several developing countries, particularly Asian ones including China, have realised that the road to economic nirvana is only by developing their manufacturing sector.


India, on the contrary, has attempted to have a unique grammar of development – where services and not manufacture remains the engine of growth. While this is acceptable in the short run, the fact of the matter is that India’s road to economic prosperity from now on shall impinge on our manufacturing sector. This is simply because empirical evidence worldwide demonstrates that the growth of manufacturing sector ensures broader based social development than say, the services sector.


Successive Central Governments have realised that this is easier said than done as the manufacturing sector, in contrast to the services sector, is reforms sensitive. For manufacturing to contribute one-fourth to the national GDP, governments need to carry out intensive reforms. This includes labour law reforms, improved infrastructure, besides tax reforms and administrative reforms – all of which combine to wreak havoc on India’s manufacturing competitiveness.  


There is more to this. In March 2009, the Rupee was traded approximately Rs 52 to a US Dollar. Since then it has appreciated fifteen percent. It may be noted that this appreciation comes on top of significant levels of inflation experienced by India in these two years. That roughly translates into an implicit appreciation of the Rupee by more than thirty-five percent in the past two years.


This explicit and implicit appreciation of the Rupee is having a debilitating impact on the national manufacturing sector while simultaneously eroding our competitiveness. Some of India’s peers have neither experienced such significant bouts of inflation in this period nor have they allowed their currency to appreciate. The net result is that we are running gargantuan trade deficits (caused to some extent by higher oil prices) – close to USD 10 billions per month. That in effect means we are importing jobs into a country that is having huge unemployment in the first place!


Naturally the obvious question follows: Why is the government preventing the depreciation of the Rupee to reflect our economic fundamentals? The answer for that is not far to seek. Economic text books suggest that a stronger currency is an antidote for inflation. By keeping the Rupee stronger, economic managers are hoping to address the issue of inflation, little realising that it is hurting the manufacturing sector, which incidentally is never in the radar of the national policy framers.


It may also be noted that several Asian countries have modelled their growth pattern on the back of a weak currency while maintaining lower import tariffs. In short, given the extent of undervaluation of these currencies, import tariffs are irrelevant. But in our anxiety to match with Asian rates, we seem to have forgotten the whole matrix.


And that is the crux of the issue. India is caught in a catch-22 situation – if it allows Rupee to depreciate, there could probably be higher inflation and should it not allow the Rupee to depreciate, it could hurt the Indian manufacturing, employment and of course our ability to eradicate poverty. The moot point is do we realise this? Forget providing a course correction, Budget 2011 does not even seem to cognise this difficult situation. The net result: increasingly government is seen as irrelevant.


But who is the beneficiary of all this?


Nevertheless, with mounting trade deficits, India is compelled to look at capital flows to bridge the current account deficits. Else we could have a repeat of 1991. That in turn compels the RBI to keep the Rupee stable and, if possible, strong.


A stable Rupee, it may be noted, virtually mitigates all currency risks as these are absorbed by our central bank. Naturally, a stronger and stable Rupee favours the financial sector, especially the FIIs, and positively discriminates against our domestic manufacturing sector. And in a country obsessed with Sensex and the stock markets, FIIs wield disproportionate influence on the national psyche and policy.


The reason for the same is not far to seek. It is generally believed that FII route, thanks to the large regulatory gap in our capital markets that a herd of elephants could walk through, allows enormous amount of money to be first laundered away from India and brought back through the FII route, more specifically through the Mauritius route.


The reason for Mauritius is compelling – according to the Indo-Mauritius Double Taxation Avoidance Agreement, capital gains arising out of investment from Mauritius is not taxed in India and shall be taxed in only in Mauritius where the tax rate is zero. No wonder, in the past decade or so, 50 percent of foreign investment into India has originated from Mauritius. FII in the Indian context represents Foreign Indirect Investment!


Naturally, vested interests in the establishment are rooting for this arrangement to continue. And successive Budgets have taken care to ensure that this arrangement not only continues, but also is continuously “liberalised.”


Budget 2011 is no different. Accordingly, it states, “to liberalise the portfolio investment route, it has been decided to permit SEBI registered Mutual Funds to accept subscriptions from foreign investors who meet the KYC requirements for equity schemes. This would enable Indian Mutual Funds to have direct access to foreign investors and widen the class of foreign investors in Indian equity market.”


But there is a serious catch here – SEBI has not prescribed the KYC norms or Know Your Customer norms for FII investment. And in case it inadvertently prescribes – do not worry – route it through the Participatory Notes (PNs). PNs as readers may note, are peculiar instruments in the Indian market that allows multi-layering, leading to anonymity for the “foreign” investors.  


So all these allow (why even encourages) one and sundry to first launder money from India and bring it back through the Mutual Fund route. Who said the Budget has not done anything to bring back unaccounted wealth of Indians parked in Tax Havens into India? Sure it does, with an amnesty and at zero rate of tax!


It may be noted that during the course of his Budget speech, the Hon’ble Finance Minister dealt extensively on black money in six paragraphs where he was philosophical at best and vacuous at worst in his approach to fight the menace of corruption and the resultant illicit wealth. The five point agenda to fight black money seems empty rhetoric with no concrete promise to take action on anyone.


Interestingly, the obsession of the Hon’ble FM to the Settlement Commission (SC - also referred to as settlement through commission) – a relic of the pre-liberalisation era, continues. This year the Income-Tax Act has been further liberalised to include search cases provided that the additional income-tax payable on the income disclosed exceeds fifty lacs rupees. Well that is what we call a NALCO amendment! So much for our commitment to fight corruption!


Naturally the stock markets reacted positively to the Budget. So has the corporate sector. Little do we realise that the corporate sector contributes less than 10 percent to the national GDP. And of this, the contribution of the listed corporates is less than 07 percent. As my teacher put it tongue in cheek – an item number at best. Yet the Budget is strangely benchmarked on how the corporate and stock markets react to the Budget.


La affair Niira Radia had exposed these corporates and their functioning. Surely, like Munni badnaam, corporate India has lost its credibility. So has the UPA government. In this scenario, it is puerile to believe that government can constructively address the structural issues facing the Indian economy. In the process, the government, too, is reduced to an item number.


This may well be the weakest government since independence. But are we not also witnessing the weakest Opposition since independence - one that allows this government to function instead of pulling it down?


The author is a Chennai-based chartered accountant; his email is mrv@mrv.net.in

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