Fiscal Reforms In India By Tarun Das

MEPP Lectures 13-14-15 Fiscal Policy Reforms In India since 1991

Presented by Dr. Tarun Das Professor, IILM Fiscal Policy Reforms

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1. Characteristics of Reforms •Gradual and Step by Step Approach not a Big Bang or Shock Therapy Approach •Democratic and political constraint •Strong emphasis on “human face” •Least sacrifice made by people •No write-off or rescheduling of external debt •Agency constraint and No backtracking •Nationality constraint •Ownership of reforms Fiscal Policy Reforms

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2.1 Motivation for Fiscal Reforms •

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Large fiscal deficits and automatic monetization of deficits leading to high inflation and high interest rates and crowding out private investment. High and irrational tax rates, high tariff walls led to industrial inefficiency, lack of competitiveness, high cost economy and non-optimal allocation of resources. Large variance and multiplicity of tax rates on the basis of end-uses led to complicated and weak tax administration and rent seeking. Fiscal Policy Reforms

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2.2 Motivation for Fiscal Reforms • Low buoyancy and elasticity of both direct and indirect taxes. • Complicated tax structure, legal laws, rules and procedures. • Low compliance rate, high degree of tax evasion, low administrative efficiency. • Narrow tax base and greater dependence on indirect taxes leading to inequity • Change in the role of the government from operator to regulator, supplier of Fiscal Policy Reforms goods and services to facilitator.

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2.3 Motivation for Fiscal Reforms

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Liberalization of trade, industry, investment Emphasis of social services and safety net in the context of so-called LPG (liberalization, privatization and globalization). Public sector enterprises reforms and disinvestment of government equity. Integration of monetary, exchange rate, regulatory and other policies. Globalization and Regionalization of economic activities. Impact of WTO, SAARC, BTAs and FTAs.

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2.4 Motivation for Fiscal Reforms

Demographic change (social security and health care for senior citizens and reforms in pensions, provident and insurance funds). Fiscal federalism, Centre-state relations, decentralization, grass root planning, Panchayati Raj. To tackle environment degradation through filth tax /environment tax. IMF/ World Bank/ ADB conditionalities for reforms and fiscal sustainability. Fiscal Policy Reforms

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3.1 Major Fiscal Reforms

• Reduction of fiscal deficit • Fiscal Responsibility and Budget Management Act 2003 • Simplifying rules and procedures • Strengthening tax administration • Widening tax base & enhancing buoyancy • Rationalisation and Reduction of both direct and indirect tax rates

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3.2 Fiscal Responsibility and Budget Management (FRBM) Act 2003

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FRBM Act 2003 and FRBM Rules 2004 came into force w.e.f. 5 July 2004. The Act mandates the Central govt to eliminate revenue deficit by March 2009 and to reduce fiscal deficit to 3% of GDP by March 2008. Under section 7 of the Act, the central govt is required to lay before both houses of Parliament Medium Term Fiscal Policy Statement, Fiscal Policy Strategy Statement and Macro Economic Framework Statement along with the Annual Financial Statement and Demand for Grants. Fiscal Policy Reforms

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3.3 FRBM Rules 2004 • Reduction of revenue deficit by 0.5% of GDP or more every year. • Reduction of gross fiscal deficit by 0.3% of GDP or more every year. • No assumption of additional debt exceeding 9% of GDP for 2004-05 and progressive reduction of this limit by at least one percentage point of GDP in each subsequent year.

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3.4 FRBM Rules 2004 • No guarantee in excess of 0.5% of GDP in any financial year. • Four fiscal indicators to be projected for the medium term. These include revenue deficit, fiscal deficit, tax revenue and total debt as % of GDP. • Greater transparency in the budgetary process, rules, accounting standards and policies having bearing on fiscal indicators. • Quarterly review of the fiscal situation.

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3.5 FRBM Rules 2004 • The rules mandate the Central Government to take appropriate collective action in the case of revenue and fiscal deficits exceeding 45% of the budget estimates, or total non-debt receipts falling short of 40% of the budget estimates at the end of half year of the financial year. • The rules also prescribe the formats for the mandatory statements.

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3.6 Macro-economic Background for Budget 2006-07 Major macro-economic variables

2005- 2006-07 06 Projected

1. Real GDP growth rate 2. WPI Inflation rate (%) 3. Fiscal deficit / GDP (%)

8.4 4.4 4.1

8.0 5.0 3.7

4. Revenue deficit/GDP (%) 5.Primary deficit/GDP (%)

2.6

2.1

0.5

0.2

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Items

3.7 Medium Term Fiscal Indicators

2005-06 2006- 2007- 2008RE 07 BE 08 Tar 09 Tar

1.Revenue Deficit as % of GDP

2.6

2.1

1.0

0.0

2.Fiscal Deficit as % of GDP

4.1

3.7

3.4

3.0

3.Gross tax rev. as % of GDP

10.5

11.2

11.5

11.8

4.Year-end debt stock (% of GDP)

65.7

65.7

64.4

63.1

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3.8 Recommendations of the Twelfth Finance Commission (1)  Fiscal deficit to GDP for the Centre and States be targeted at 3%.  Revenue deficit f the Centre and States be reduced to zero by 2008-09.  State’s recruitment policy must ensure that salary bill as % of revenue exp, net of interest payments, is within 35%.  Each State must enact Fiscal Responsibility bill to reduce fiscal deficit to SDP ratio to 3% and revenue deficit to zero by 2008-09. Fiscal Policy Reforms

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3.9 Recommendations of the Twelfth Finance Commission (2)  States’ share in net proceeds of shareable central taxes be increased from 29.5% to 30.5%.  Indicative amount of overall transfers to States be fixed at 38% of the Centre’s gross revenue receipts.  A grant of Rs.20,000 crore for Panchayati Raj Institutions and Rs.5,000 crore for urban local bodies to be given to States for the period 2005-2010. Fiscal Policy Reforms

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4.1 Progress of Fiscal Reforms

Status in June 1991 (a)Budget support to PSEs: 1.5% of GDP (b) Price and purchase preference for PSEs (c )Preferential treatment for bank credits (d) No hard budget constraints for PSEs (e) No disinvestment (f)SICA does not include sick PSUs

Status in January 2007 (a) Support reduced to 0.5% of GDP (b)No price preference, but purchase preference exists (c )No preferential treatment for bank credits (d) MOUs strengthened (e) Divestment allowed (f)SICA applicable for PSUs

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4.2 Fiscal Deficit (as % of GDP) Status in 2005-06

Status in 1990-91 Central Govt Fiscal Deficit 6.6% Revenue deficit 3.3% Primary deficit 2.8% State governments Fiscal Deficit 3.3% Revenue deficit 0.9% Primary deficit 1.8%

Central Govt Fiscal Deficit 4.1% Revenue deficit 2.6% Primary deficit 0.5% State governments Fiscal Deficit 3.3% Revenue deficit 0.5% Primary deficit 0.7%

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4.3 Fiscal Deficit as % of GDP Status in 1990-91 General government Fiscal Deficit 9.4% Revenue deficit 3.3% Primary deficit 2.8% • Monetization of budget deficit • Control on interest rate on government securities

Status in 2005-06 General government Fiscal Deficit 7.3% Revenue deficit 3.1% Primary deficit 1.2% • No automatic monetization • Govt securities are auctioned and sold at market prices

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4.4 Progress of Fiscal Reforms Status in June 1991 • Public debt as percentage of GDP (a) Central govt 61% - Internal 50% - External 12% (b) States 19% - Internal 19% (c )General govt 68% - Internal 56% - External 12%

Status in March 2006 • Public debt as percentage of GDP (a) Central govt 66% - Internal 60% - External 6% (b) States 33% - Internal 33% (c )General govt 99% - Internal 93% - External 6%

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4.5 Progress of Fiscal Reforms Status in January 2007

Status in June 1991 Fiscal Deficit was financed by: (a) RBI Ad Hoc TBs at 4.6% interest (b) Banks through SLR holdings at 38.5% and CRR 25% (c ) Market borrowings (d) Public funds (e) External debt

(a) Ad hocs replaced by WMAs at market rate (b) SLR reduced to 25% and CRR 5% (c)Govt. securities are sold at market rates (d) Reduction of interest rates for public funds (e) Less dependence on External debt

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4.6 Progress of Fiscal Reforms Status in January 2007

Status in June 1991 High duty & tax rates Maximum rates Excise duty 110% Import duty 400% Income tax 54% Corporate taxes: Domestic COs. 49% and 54% Foreign COs. 65%

Duties & taxes reduced Maximum rates Excise duty 16% Cenvat + 16% SED Import duty 12.5% Income tax 30%

Corporate taxes: Domestic COs. 30% + 10% surcharge Foreign COs. 40%+2.5% surcharge Fiscal Policy Reforms

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4.7 Progress of Fiscal Reforms Status in January 2007 Status in June 1991 • No service tax • No MinAlternativeTax • No transactions tax No tariff value • Dividend tax on both • individuals & Cos. • Existence of gift tax • • Limited cases of tax- • holidays • • No fringe benefit tax (FBT)

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Service tax @12% MAT introduced Trans. tax @0.02%+25% increase in 2006-07 Tariff value introduced Dividend tax on only companies Gift tax abolished Tax holidays widened to many infrastructure FBT imposed

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4.8 Progress of Fiscal Reforms Status in January 2007

Status in June 1991 • No MRP linked excise duties

• No estimated income scheme for retail traders • No presumptive tax

• Concept of MRP introduced for consumer goods • Estimated income scheme introduced for retail traders. • Presumptive income tax scheme introduced • State level VAT introduced wef April 05

• No state level VAT

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4.9 Related Financial Reforms

Status in June 1991 • CRR 25% • SLR 38.5% • Bank Rate 12% • PLR above 21% • Deposit and interest rates are controlled • Capital issues and prices determined by the CCI in MOF

Status in January 2007 • CRR 5% • SLR 25% • Bank rate 6% • PLR 11% to 11.5% • Deposit and interest rates are liberalised • The office of CCI abolished and SEBI established

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4.10 Related Financial Reforms Status in January 2007

Status in June 1991 • • Indian firms not allowed to raise funds from foreign stock exchanges • • Portfolio investment by foreign investors in Indian companies not allowed • • Foreigners not allowed to buy G-secs

Indian firms allowed to raise foreign funds by GDR, ADR, FCCBs & offshore funds FIIs, NRIs and OCBs allowed to buy stocks in Indian markets s.t. overall limit of 49% FIIs/ NRIs/ OCBs allowed to buy G-secs

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5.1 Second Generation Fiscal Reforms

 Coordinating state level reforms  Accelerated privatisation  Development of debt and bond markets  Reforms in Insurance, Provident and Pension funds  Thrust on state provision of basic needs  Rationalisation of user charges for public utilities  Rationalisation of subsidies

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6. Concluding Remarks  Transparency and accountability of budget formulation  Multi-year budget and macro-economic forecast  Adequacy and sustainability of policies  Willingness to pay by stakeholders  Strengthening institutional set up

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Thank you Have a Good Day

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