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Indian Budget 2010-11: Strapped And Shackled By The Past

By Dr Subramanian Swamy

26 February, 2010

The Finance Minister Pranab Mukherjee is no imposter like his precedessor. But he, without soft options today, shackled by the recent past of Finance Ministry stewardship, has proposed a Budget 2010-11 which has failed to address the core issues of reducing public debt, curb the dangerously high fiscal deficit[ even the claimed target for 2010-11 of 5.5 per cent is too high, and will represent a huge diversion of funds with public sector banks away from private sector investment], and introduce innovation into the ailing industries such as Textiles, Food Processing, Power Generation and Distribution. Hence, despite his heroic effort to put together a promising Budget, he has at best produced a damp squib for financial reforms..

The global financial crisis not a valid excuse for such an escapist Budget. China had got affected because its economic boom was export—led, enabling that country its huge trade surplus with US and EU, and consequently rising foreign exchange reserves. But why did Indian economy, which was not export-led like China, get affected ? Unlike China, India’s exports to US and EU as a ratio of GDP is still small.

Also, in the US, sub-prime loans were possible because of weak oversight of banks. But the Indian banks are strictly regulated by the Reserve Bank of India, and banks are forced to hold reserves in the name of SLR and CRR, and to purchase of government treasury bonds. In fact except for HFDC, due to their own foolishness, no bank in India collapsed or even made losses during this period. Then why did India suffer?

Indian economy had a set-back not because of financial contagion spreading from US, or because of the interdependent global trade system, but because of our own perfidious financial derivative called Participatory Notes [PNs] compounded by an anti-national agreement with Mauritius to permit even $ 1 paid-up companies incorporated in that country to invest in Indian stock markets and not be subject to capital gains tax. This was a “gift” from previous Finance Ministers, Yashwant Sinha and P. Chidambaram.

The Finance Ministry’s PN is unprecedented in world financial history. It is a piece of paper issued by designated financial institutions abroad such as Fidelity Investments and Morgan Stanley, which paper does not carry any detail except the money worth, and can be purchased by anyone with cash even without disclosing to any regulatory authority his or her name and the source of the funds! That piece of paper was acceptable for transactions in the Indian stock market for buying and selling shares as also short selling.

By a special order, the Finance Ministry under Chidambaram exempted the PNs from the purview of SEBI, RBI, Enforcement Directorate and CBI ! The SEBI headed then by Damodaran protested and repeatedly wrote to the Ministry to permit it as in any other stock market transactions to require reporting of the buyer and the seller as also the source of funds. The Tarapore Committee on Financial Reforms strongly condemned PNs and wanted it scrapped. The RBI Governor Reddy kept warning of dangers from PNs. All were ignored. Damodaran and Reddy were denied usual extensions of tenure. Their successors have fallen in line. Hence the perfidy continues without any accountability.

Thus, billions of dollars of “hot”money entered into the Mumbai stock exchange, that was used for buying and selling shares with PNs almost like cash, in fact better because cash transactions of over Rs.10,000 have to be reported with details to the Income Tax Department. Moreover if it came via Mauritius, it did not have to pay capital gains tax. By September 2008, PNs accounted for 60 percent of the FII funds in the stock market.

When the financial crisis was officially acknowledged in the US following the collapse of Fannie Mae and Freddie Mac, two government owned loan providers, followed by Lehman Brothers in September 2008, a liquidity crunch developed in US and later in Europe. Interest rates rose. Liquidity froze and funds were in demand. The PNs, which were “hot money” or Portfolio funds, just shipped out of India without any hindrance to the tune $60 billion in October 2008-January 2009 causing a stock market crash symbolized by the steep fall in the Sensex index. It is this that caused the financial crisis in India and not the US sub-prime loan defaults.

Why was Mauritius Tax Treaty and PNs invented by the then Finance Ministers of India ? Because it was to assist corrupt politicians and business persons to earn on their loot parked in Swiss Banks, Isle of Man, Cayman Island, Macao etc.. Till PNs came into existence this loot was just stashed away in secret accounts and they were paying service charges to the banks for keeping it secretly ! Now these bandits and pirates could earn easily on their ill-gotten money by playing anonymously on the stock market, and through consequent capital gains without having to pay taxes that honest citizens have, thanks to the Mauritius Treaty.

In fact so large PNs have become in value, that the movement of the stock market, bulls and bears, can be manipulated by the free entry and exit of this derivative. Today thus, our stock market has become rigged. It can be made to rise and fall at will of PN holders’ cartel of corrupt politicians and businesspersons. The sufferers are middle class who hang on to shares to improve on the yield of their pensions and provident funds but then who cares for them in India? Even the media has been muffled or compromised to remain silent on PNs by this cartel.

The National Security Adviser M K Narayanan made bold to warn the country that terrorists too were earning on the Indian stock market (obviously via the anonymous PNs) to finance killing of Indians, but he was silenced. Now he is away as Governor of West Bengal.

But thanks to the durability of our manufacturing and software IT sectors, we have however survived the induced financial crisis, despite the agriculture sector—poorly performing for reasons other than the global financial crisis.

In fact agriculture has been poorly performing since 2003 due to investment starvation and lack of adequate purchase price. Indian manufacturing sector unlike the Chinese’ is domestic demand driven. IT software giants were skillful in finding new markets and cheaper labour from tier II and II cities in India. All, no thanks to government.

But there is no time to breathe easier today. An another financial crisis awaits us which too will be of our making. But when it arrives, we cannot overcome it so easily. This coming crisis will be due the developing Union Budgetary bankruptcy and an exploding public debt. Can we prevent it? Of course we can, but we will not because it requires major economic and financial reforms which the present dispensation in power is incapable of implementing. Budget 2010-11 reflects this impotence.

We had a financial crisis in 1990-91 due to the reckless drain of the Treasury by the V P Singh government compounded by the Gulf War I and the collapse of our crony “patron” economy—the USSR. As Union Commerce Minister in the successor Chandrashekhar government, I had prepared the blueprints for sweeping reform and to get rid of Soviet socialism. Chandrashekhar’s government was succeeded in June 1991 by Narasimha Rao’s government. Rao invited me to join his government as Chairman of the “GATT” Commission with Cabinet rank to help implement the Reform package.

Rao had the necessary guile, if not the courage, to get implemented what he wanted, so he was able to get the Reform package implemented in the teeth of his party’s opposition.

But Manmohan Singh as Finance Minister has been surprisingly given credit for the Reforms by the media, but if he is so capable, how is it that during the last six years and half years as Prime Minister he has failed to implement a single major economic or financial reform? How has he allowed PNs to flourish when anyone can see it is a perfidious corrupting anti-national derivative that will ultimately ruin the Indian economy by a killer blow of fleeing the country at short notice in a crisis?

The Budgetary crisis looming in the horizon is that the allocations for major heads of expenditure, which cannot be reduced without creating a crisis such as government employees salaries, pensions, police, defence, subsidies, interests to be paid for past loans taken by the government, etc., now cover 98 per cent of the current and capital account revenues accruing to government. These allocations are revenue expenditures, and hence not asset building or investments for development projects.

Moreover, in the revenue budget, these expenditure far exceed the revenue. Thus the revenue budget is in a huge deficit which is covered by taking more loans from public sector banks, and regrettably for economic growth by creating a surplus in the capital account. In a financially healthy economy, it should be the other way around—surplus on the revenue account and a deficit in the capital account.

This present situation however cannot continue for long because the loans from the public sector banks to government have to be paid back. But here the government faces a developing debt-trap, i.e., we are heading for a situation when the past loan repayments will exceed the new loans the government would take. At present government pays back 96 paisa for ever rupee for new loans. Public debt is now over 90% of GDP and on an exploding trajectory.

My projection is that by 2013 this amortization will be more than a rupee to be paid back against a rupee of new loan. Then we are in the debt trap. If the government tries to get out of it by printing new notes in the Mint, it will generate unbearable inflation. Already the stimulus has accelerated money supply growth, and pumped money into the economy excessively. Unscrupulous persons with political clout have got hold of most the stimulus funds and are using to engage in forward trading and plain hoarding to cause an artificial shortage and thus galloping inflation today.

Fiscal Deficit, which measures this excess money in the system, is already at a dangerous level of 13 per cent of GDP when according to the Fiscal Management Act it should be statutorily near zero. Thus the government is violating a law which it ought to be complying with! Such is the irresponsibility, or desperate situation the government is already in today.

India is of course resurgent today in vitality and spirit of our people, but no thanks to current government policy; instead inspite of it. India is resurgent because of the economic reforms set into motion in 1991-95. No government has dared to reverse it, but no government so for since has dared to take it structurally forward. We have still three years to rectify matters with new financial reforms but with the present corrupt dispensation, it is not possible. As in the past, a crisis, this time a budgetary bankruptcy, will be again turn out to be a blessing in disguise for the country and enable the necessary reforms.

Dr Subramanian Swamy is former Union Commerce Minister and President of Janata Party. Dr Swamy can be contacted at swamy39@gmail.com