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How to bridge the fiscal gap

Dipen Sheth offers a solution to tackling the ballooning fiscal deficit — the government should tap the nearly Rs 50 lakh crore of illegal money stashed abroad by Indians.

Dipen Sheth | Print Edition: July 23, 2009

Dipen Sheth

After the Budget, the Sensex tanked 850 points, spooked as much by fiscal fears as by the lack of any pathbreaking initiative by the finance minister. This was largely in line with the persistent pessimism that yours truly has been inflicting on the readers for the past few months. My view that the single biggest problem — the ballooning fiscal — cannot be wished away stands vindicated, but it is indeed painful as a citizen to see the complete lack of desire to look the problem in the eye.

As a result, the government is set to borrow over Rs 4 lakh crore in 2009-10, up from Rs 3.2 lakh crore in 2008-9. The key numbers in the budget are nothing short of scary. The interest outgo is now estimated at over Rs 2.25 lakh crore for 2009-10, nearly 37% of the revenue receipts. The total government debt is slated to cross 80% of the GDP. Add to this fiscal gap the corresponding gaps that will now emerge in state budgets and the offbalance sheet items that the government will conveniently add as the year progresses, and you know that the government is walking blindly into a debt trap.

Faced with a resource crunch, what could Pranab Mukherjee have done differently? How can the government raise resources that are required to fill the fiscal gap? And, do it in a way that does not crowd out private sector borrowing, does not raise interest rates and avoids inflation? In short, a saviour is desperately needed. Someone who would otherwise not be a willing lender or an investor in the country.

Did the Budget live up to expectations?
A fiscal deficit target of 6.8% of the GDP was expected, but there was no plan on how to raise the resources. There are tough times ahead as government borrowing is set to cross Rs 4 lakh crore. Total public debt can cross 80% of the GDP.
No clear road map for reforms such as disinvestment, FDI in insurance/banks/retail, infrastructure sector investment and transparent subsidy mechanisms for fuels and fertilisers.
Corporate tax unchanged, but MAT hiked to 15% from 10%. MAT credit extended from seven years to 10. A good move, considering India Inc’s effective tax rate is about 21%.
Personal income tax eased somewhat by removal of surcharge and FBT, and a mild increase in the tax slab limits.

Yes, there is one such source. This is the humongous amount of money illegally stashed away by the Indians abroad. During the recent elections, there was public speculation that this amounted to approximately a trillion dollars or Rs 50 lakh crore! So if we could find a way of attracting even a tenth of this amount, the government would not need to borrow from the markets.

Why would someone who has illegally earned this income and parked it in an opaque Swiss bank want to bring it back to India? Simple, right now this money is earning a ridiculously low interest (approximately 2% a year) and, worse, runs the risk of currency depreciation vis-à-vis the Indian rupee as the western world grapples with economic depression. What if it could avoid the negative on the currency front and earn a halfway decent interest rate?

So here’s my suggestion: allow some sort of an amnesty scheme to bring back this money. Penalise it by all means with a shadow tax of sorts. Offer zero interest bonds against this money with, say, a five-year lock-in. Fix an annual target on a first-come, first-served basis, perhaps $50 billion, to start with. That’s still just 5% of the total guesstimated amount that is stashed away.

What the government can do is raise this money on two accounts. One, on its own books, and another, for funding infrastructure requirements via infrastructure financing companies such as IDFC, IIFCL, PFC, REC or, even, SBI. This way, borrowing cost benefits would accrue to the government and capital-intensive (and long gestation) infrastructure space. Also, P-notes in the stock market (largely ‘Indian’ money finding its way back through opaque investments routed through foreign institutional investments) should be banned, while FII registration should be regularised and simplified to enable any decent foreign entity to invest in India.

I know many of you are thinking that this kind of amnesty scheme may involve a ‘moral hazard’? Won’t it amount to encouraging all those who siphoned money out of the country? Yes it will, but it does penalise them by not paying any interest and locking-in their money for five years at the minimum. How will it prevent people like you and I from diverting the current income outside the country and then using the bonds to bring it back?

Well, in the first place, you’d lose the liquidity that you get by immediately paying a 30% tax on this income when you retain it in India. Secondly, anyone caught illegally diverting money out of the country from now onwards can be suitably penalised (say, by taxing them at 100%, plus slapping criminal charges punishable with imprisonment). Also, any such money discovered after the expiry of the amnesty scheme could attract the same punishment that current diversions face. This way, any incremental diversion of incomes to Swiss banks would be discouraged, while the money already diverted could be lured back.

What could the consequences of such a scheme be? I suspect we would see a flood of money coming back in the country, driving up the rupee in the short term and availability of funds in the banking system. The government’s borrowing needs would be fulfilled for, perhaps, the rest of its tenure.

Sure, some P-note money would go out (the original idea to ban P-notes did not have a corresponding antidote, hence it evoked a knee-jerk crack in the markets in the face of their selling). However, the simplified and quick registration of new foreign entities would enable the legit money to come back. In fact, allowing a direct switch in status would result in a smooth transition without panic exits and frantic buying later. Of course, the government’s fiscal problems, interest-rate risks and infrastructure funding gaps would all be solved at one go. QED?

Dipen Sheth is Vice-President, Institutional Equities, BRICS Securities Ltd.

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