INDIA AND EURO ZONE CRISIS - THE WAY AHEAD

The monetary policy of the Reserve Bank of India has invited despairing reactions from a cross section of the industry, media and analysts. The issues staring the Indian economy are complex and cannot be addressed by tinkering with repo rates to slash the cost of funds to be made available to the industry. However, the need for a boost to the industry cannot be overstated. In this background an attempt is to be made to devise innovative methods to kickstart the economy and create a favourable atmosphere for the Central Bank to pitch in by slashing the repo rates.

Cost reduction to fuel demand:

The fuel prices have been spiralling and have impacted the prices of all manufactured products. There is a need to initiate a reform process in pricing of fuel products. These products being essential in nature should attract levies at a flat value rather than a percentage of the base price with varying bases. The Central and State Governments should agree to not levy more than 4% for every Rs 25/- of the company price. Further, to this if the retail value of the fuel is fixed across the country, it would ensure that all industries benefit equally. The initial value can be fixed at Rs 60/- wherein the State gets Rs 2/- and Centre Rs 2/- per litre or unit effectively slashing the value to Rs 54/-.

The subsidy factor of the fuel products could then be phased out in a period of three years while the amounts parked for subsidy can be shared in a ratio of 80:20 between States and Centre. 

The next step would be to reform indirect taxes by ensuring that at no point the levy exceeds 8% except in cases such as tobacco products etc. This would considerably reduce the prices of the manufactured products. The MODVAT system would ensure that the loss is effectively compensated to a larger extent though not fully. These steps would ensure that inflation could be controlled and and also fuel a demand from the supply side.

Consumer driver:

The consumer is now inhibiited by prohibitive pricing. He neither spends nor invests resulting in locking up of funds. Hedging against the inflationary tendencies, consumers are driven to purchase gold or save in fixed deposits. These deposits attract higher rates of interest while the industry does not borrow funds due to high interest costs. This would end up destabilising the banks in the longer run. The need of the hour is to hand a carrot to the consumer to either invest in the industrial or agricultural sector or spend rather than hoard gold. Lower cost of products would drive them towards purchase but this would impact the economy only in the medium term.

For the benefit of the short run, the direct tax reform is to be introduced. The deductions accorded favour the rich against the poor as they get higher relief of taxes. If the same were to be converted into rebates and categorised, the economy could benefit. Savings should attract a rebate of 10% of the amount saved from the tax liability. Expenses in the form of contributions to 100% tax free funds should attract a rebate of 20% of the amount contributed from the tax liability. Similarly, the investment in industrial and agricultural sector should attract a 30% rebate from tax liability. A ceiling of Rs 20000/-, Rs 40,000/ and Rs 60000 could be prescribed. This would encourage even the marginal class to invest as their tax liability could be extinguished faster. The rich are dissuaded from saving and motivated to spend or invest. 

Fiscal Management:

The reforms in the indirect and direct taxes would appear to diminish the revenues. This will not be the case. The lower the levies the wider the tax base and compliance. This fact is best established from the phenomenal growth in revenues since 1996. Lower costs stimulate greater demand resulting in larger production and therefore higher revenue. Similarly, the cost of investment and management is prudently addressed by ensuring that no interest costs are tagged nor is the banking sector taxed. In fact, it would also be a good measure to consider restoring the standard deduction for salaried class thereby ensuring that people do not drift to other heads of income and reduce tax liability artificially by  charging expenses. This would also increase compliance levels

The levy of tax on transaction in immovable properties at a flat rate is to be considered. If the definition of the term short term capital asset were to be amended to bring under its ambit immovable properties which are held for a period less than ten years and a levy of 5% is prescribed on them while in case of long term capital assets it is prescribed at 2.5%, the administrative mechanism of a capital gains scheme account or the tracking of the deductions and their claims would not be warranted. It would also minimise the scope for corruption on these  fronts. Such a flat levy which would neither be refundable nor taxed again would ensure that compliance levels on such transactions bring in larger revenues to compensate the loss even during the short term. This levy should however not exempt any class of immovable properties. Even if one were to consider agricultural properties for an exemption, the same should attract this levy at the time of conversion for non agricultural purposes. Similarly, the levy should stand attracted in the case of joint development agreements. This would deter channelising of black money through real estate transactions.

A levy of commodity transaction tax on bullion, silver on the lines of securities transaction tax could be considered to compensate the short term loss by the outlined direct tax reform measures. A levy of 0.01% on payments to e payment gateways irrespective of whether they belong to India or outside would also bring in substantial revenues especially in the light of the growth in ATMs, debit cards and credit cards.

The conferences such as G 20 and other summits could be established through video conferencing rather than travel of global heads. This would set a sterling example for minimising public expenditure. Public expenditure should be in the nature of development. Focus should be placed on education, health, transport etc. Construction of rain water harvesting cells on major roads and linking them to major tanks or construction of fresh tanks would also ensure provision of water for the future. 

Euro zone crisis and India

India must also focus on increasing its imports from countries hit by euro zone crisis as a measure to fund such nations. Parallely, it should encourage exports by looking East and to the African nations which are largely untapped. The African market is to be drawn into the global market by India. The Euro zone crisis should be viewed as an opportunity to strengthen the rupee. A vision to convert the rupee to a hard currency should lay a roadmap out of the present scenario.

These with other innovative ideas should be conceived to take us out of a crisis and not to look at the Central Bank to bail us out each time.

PETROL PINNACLE AND FINANCIALS

The last few days have witnessed a bizarre spectacle of persons affiliated with different ideologies sharing the platform for protesting the price hike in petroleum. The stranger aspect of this episode was that the States wished to hold on to its revenues while the Centre wished to hold deregulation of petrol prices the culprit. In the bargain, the common man of R.K. Laxman's fame was left in tatters with a placard in hand while his pockets were being emptied into the coffers of the State, Centre and the oil companies. Adding fuel to fire, a hike of Rs 7.50 per litre was compensated by a bandh which impacted the economy already in shambles followed by a cruel joke of a reduction by Rs 1.68 per litre. The whole charade went ahead as per the script without even making an attempt to identify and address the root causes of the issue on hand. Therefore, yours truly is making an attempt to look into the issue on hand dispassionately to the extent possible.

It cannot be gainsaid that the States look for their own share of tax revenues while the Centre also looks for its share in tax revenues. The land of Arthashastra should instil the economic sense of not having a percentage based taxation for a basic product such as fuel which triggers inflationary tendencies. Considering the fact that the Centre and States anticipate only a said amount of taxes, the freezing of the tax on petroleum products at a specific value per litre irrespective of the sale price would ensure that the Governments of the day got their share while the oil companies do not bear the brunt of the fluctuations in oil prices.

However, the arguments that would arise is that the Governments also would incur the additional expenditure on account of rising costs which needs to be factored in. this aspect cannot be denied but revenues from non taxation sources which would have no inflationary tendencies could be utilised to form a contingent fund for this purpose. The next question that comes up for consideration is what could be such source of revenue. The Government uses a large fleet of vehicles and also owns prime space with infrastructure. These vehicles and space could be utilised to generate income on the lean days and holidays by providing these locations and vehicles on rent. The use of vehicles for personal purposes on such days needs to be strictly on rental basis as provided in the existing rules. This would by itself generate substantial income. Further, the Government could facilitate training of personnel of different organisations for a fee in matters relating to compliance. This would also generate income for the Government. The share of revenue in Government private partnerships also provide a source of revenue without expenses being incurred. Provision of auditorium space for cultural events would bring rental income and also provide the recreation for the Government personnel. There is no dearth for innovation when the objective is clear.

The subsidy is another factor that bothers economists. The subsidies could be cut if levies are cut. If the states and Centre agree to tax only at the rate of Re 1/- for every Rs 25 of the price, the differential as on date would ensure that the subsidy is cut. Therefore, even by freezing the price at the average of the lowest and highest price across the country, a substantial portion of the subsidy can be removed since the levies would get restricted to maximum of Rs 4/-. This would mean that if the retail price of petrol rose to Rs 100/- the levy would only be Rs 8/- with the State and Centre sharing Rs 4/ each. This also is on par with the optimal rate of 8% levy of indirect taxes. This scheme of indirect taxation on the basic fuel would leave more money in the hands of the people.

This would also mean that a sum of at least Rs 10/- would be foregone by the Centre and the State which if the prices are frozen at the average of the highest and lowest prices say at Rs 70 would mean removal of subsidy to a differential extent. The next hike in the price can be deferred and the States and Centre would have the carrot of taking another Re 1/- each on the barometer crossing Rs 75/-. which would require another Rs 9/- ( Rs 75-(Rs 70-Rs4)). Effectively, removal of subsidies could be a reality while the Government also contributes to removal of inflationary tendencies.

The concern would then be to channelise such money into the development of the economy. To this objective, the tool of direct taxation needs a reform. It should provide for a tax rebate on the lines enunciated by the late Prof Madhu Dandavate instead of the present deductions. Savings should entitle a person for a rebate of 10% while certain expenses such as charity and medical expenses should attract a rebate of 20% followed by an investment rebate of 30% of the amount so invested. A ceiling of Rs 20000/- Rs 40,000 and Rs 60,000 respectively would ensure that the persons who are richer do not get a hefty deduction as in the present case. This would enable the Reserve Bank to channelise the surplus funds towards development. 

Another source of revenue would be to streamline the reality sector. The Central Government could levy a nominal tax at the time of transaction of immovable properties and commodities transactions. The capital gains tax if any on these fronts should be removed to nullify administrative issues. This would go a long way in ensuring the tax revenues go up on this front. The taxes so generated should be shared with the States to offset the loss on account of the reduced taxation of petroleum products.

The other principal factor has been the fall in the rupee value. The reason for the fall in rupee value has been the demand for the dollar has been rising in the absence of a strong alternative in the form of the European market. The rupee could be insulated by promoting it as a hard currency in the international market. Iran has already agreed to a rupee payment mechanism and the Russians would not be averse to it. Roping in the middle east and the African nations could trigger the European nations to look at the Indian Rupee as an alternative to the dollar or the British pound. Mere interventions in the form of release of dollars in the market would be a short term measure while the long term strategy should be to hard sell the Indian currency. Indians per se have a gold reserve which could still back the rupee and once this amenable atmosphere is created the Indian exporters and importers would be willing to let go the dollar which would have a free falling impact considering that India is one of the largest markets. Initially the dollars in the EEFC accounts could be absorbed to the extent of 50% to meet the country's needs while the Indian community abroad could be used as instruments to promote the rupee into a hard currency.

Some brainstorming and thinking out of the box could save the country from bandhs which accentuate the losses as well as provide the much needed succour to the common man. Anyone listening? 

With due apologies to Shri R.K. Laxman and Jim's Jokes and Cartoons.