New Delhi: External shocks are the biggest risks the Indian economy faces in the medium term, and insurance against them has to come in the form of reforms to fiscal policy, the financial sector, energy policy and the investment climate, the Economic Survey 2009 said.
To reform fiscal policy, tax and expenditure norms need to be restructured to act as shock absorbers and enhance transparency, according to the section of the survey that identifies risks and challenges to the economy.
Potential hit: The New York Mercantile Exchange in the US. The recent rise in prices of commodities such as crude oil may stall a recovery in India’s economic growth, which has slowed in the wake of a global recession. Andrew Harrer / Bloomberg
Loose policies in the past “reduced the headroom for short-term counter-cyclical fiscal policy” when India was hit by the fallout from the implosion of global financial intermediaries last year, said the survey. Moreover, introduction of taxes on transactions and expenditure in the recent past, such as fringe benefit tax (FBT), reversed moves towards a simpler system.
“All our ills in the last two years are related to external shocks,” D.K. Joshi, principal economist and director, Crisil Ltd, said.
According to Joshi, the survey should have attempted to prioritize the sequence of reforms, even if it is a difficult task. Without prioritization, the government would spread itself too thin, he said.
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Industry lobby group Confederation of Indian Industry (CII) supported the survey’s stand on taxes. “Tax reforms such as the removal of inefficient taxes such as the FBT, CTT (commodities transaction tax) and STT (securities transaction tax) have also been proposed by CII. Removal of surcharges and cesses, and merging them with the direct tax rate, will also help simplify the process of filing taxes,” it said in a statement.
The finance ministry’s chief economic adviser, Arvind Virmani, in an interview to Mint said the reforms were essential as complacency could undo the benefits of fast-paced growth over the last few years.
The emphasis on reform is linked to possible external shocks that might stall a recovery in economic growth, which has slowed in the wake of a global recession.
The recent rise in the price of crude oil and other commodities may adversely affect recovery, the survey said.
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The pace of India’s growth recovery is also linked to the revival of the global economy, particularly the US.
According to the survey, if the US economy bottoms out by September, there is a good possibility of the Indian economy repeating its 2008-09 performance; that is, around 7% growth, assuming a normal monsoon.
The survey said the growth forecast was subject to a fluctuation of up to 0.75% either way, an indication, according to Virmani, of the extent of economic uncertainty.
In the wake of the rise in crude prices, reforms in energy policy was identified as a key policy challenge. The current method of largely insulating domestic consumers from an increase in international crude prices means a transfer of a form of tax abroad as long as consumption increases, the survey said. The subsidy for domestic consumption is borne by the government balance sheet and adds to below-the-line fiscal deficit.
The survey’s recommendations on energy reforms were not restricted to petroleum and its downstream products. Coal, which is the input for about 70% of the country’s power supply, was identified as a sector in need of reforms.
Financial sector reforms need to be a priority area for the government as the current fragmented nature of credit markets also has a negative impact on the effectiveness of monetary policy, the survey said. Domestic financial sector reforms are also likely to act as a cushion against external risks stemming from the crisis in developed markets’ financial sector.
Among the risks to the Indian economy that the survey identified were a reduction in the availability of risk (equity) capital for companies worldwide and a slowdown in medium- to long-term capital flows.
Among the financial sector reform measures suggested by the survey to counter the fallout of a global financial crisis are the introduction of exchange-traded credit derivatives, banking reforms, making the Securities and Exchange Board of India the sole entity overseeing financial market regulations and introducing a government guarantee mechanism to boost infrastructure lending.
Some of the reforms suggested in the survey have been proposed before, but were not implemented by the governments of the day. The United Progressive Alliance’s victory in the April-May general election with a bigger majority than it won in 2004 has sparked expectations that stalled reforms may finally be carried out.
“This time, there is a stable government and it has shown some resolve in the last month. This gives some confidence some reforms will get carried,” Crisil’s Joshi said.
Among the financial sector reforms suggested to improve the investment climate are legislation to give statutory status to the country’s New Pension System and its regulator, the Pension Fund and Regulatory Development Authority. Finance ministry officials had earlier told Mint that the pension legislation was going to be one of the legislative priorities for the government.
Insurance reforms, including the move to enhance the ceiling on foreign direct investment to 49%, were initiated by the last government, and the current government would have to continue with the process.
Another reform suggested is the establishment of a regulatory body for the transport sector, including railways, highways, ports and airports. Transport is one of the key components of India’s infrastructure, and an area where the government has tried to boost investment.
To complete the reforms package to enhance the investment environment, the survey has called, yet again, for a reform in bankruptcy laws to “ensure speedy and effective bankruptcy so as to save/preserve assets for alternative uses”.
Graphics by Sandeep Bhatnagar, Images by Stockxpert