As a nation, we are experiencing first-hand the effect of a high fiscal deficit over the years. As the fiscal deficit grew from two per cent a decade ago to 5.89 per cent in 2012, inflation tailgated the fiscal deficit, and became rather stubborn. This led the Reserve Bank of India (RBI) to tighten interest rates, leading to a circular problem of higher interest rates, lower savings, investments, growth and tax collections, and again, a higher fiscal deficit and interest rates.
Borrowings have gone towards subsidies on oil and food, so they have been consumed, not invested. To top it all, the government is paying more interest on borrowings (about 8 per cent), than it did in 2004/05 (when the rates were about 5 per cent). Borrowing to consume is not the kind of deficit we would like to create.
Providing more subsidies in the name of the poor will raise inflation and hurt the very poor that we trying to protect. If we really care for the poor, let's rein in inflation, protect the value of their savings, and give them more value for money. Lowering inflation starts with reducing the fiscal deficit, followed by policies that power growth.
The finance minister has made it clear that the budget will be a responsible one. The first step towards reducing the fiscal deficit is by streamlining subsidies. He could also increase excise to pre-economic crisis levels. India Inc., though initially disappointed, will get on fine with it. Interest rates, which were expected to reduce from here on, will be the counterbalancing factor for corporate profits.
The other part of fixing the fisc is to collect more taxes. Here, it is interesting to study the behaviour of small enterprises. They understand the benefit of showing capital on their balance sheet but hesitate to pay the taxes that go with it. Try arguing with an SME (small and medium enterprise) that 30 per cent is already low by global standards; in his mind he is paying much more through a cascading tax structure sans GST (Goods and Services Tax) and inefficiencies in the system, including corruption.
I would therefore strongly recommend that the peak tax rates for MSE (micro and small enterprises) be reduced to 20 per cent. We will kill two birds with one stone - on the one hand, we will encourage small enterprises, and on the other, many MSEs will pay their taxes and strengthen their balance sheets. We can argue that businesses may split themselves into micro enterprises, but they can get only that far with such an approach. Medium and large entities cannot walk this path as counter-cyclical benefits of scale kick in with size. For larger corporates, the existing tax structure can stay.
Additionally, we should eliminate a large number of clauses, caveats and covenants, prescribe a simple tax rate structure, reduce the income-tax manual to a fourth and yet be far more effective.
Finally, the need of the hour is to increase investments. Let us start by changing the positioning statement for India from "Incredible India!" to "Business Friendly India!" If there is a realistic chance of eliminating poverty, only business will make it happen. Slogans, however, well-meaning and heartfelt, won't.
V. Vaidyanathan is chairman and managing director of Capital First Limited.