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The Budget 2001 Special/Shailendra Bhandari

Five steps to boom: how Sinha can energise MFs

It is customary for every interest group to have a wish-list before the Union Budget. Not all wishes are granted, since the finance minister has only so much leeway in a tight fiscal situation. But that has not stopped anybody from asking. The Indian mutual funds industry, for its part, would like to look at its Budget wish-list from a different perspective.

Over the last few years, the industry has come of age with the entry of several international players, many of them through joint ventures with Indian partners. With assets under management hovering around Rs 1 trillion, it is clear that an inflection point has been reached; the industry will continue to grow on its own steam as long as the economy is on the right trajectory.

Prudential-ICICI believes that the interests of the mutual funds industry would be best served if the Budget, therefore, addresses itself to removing the bottlenecks to growth and speeds up macro-economic reforms.

There are five major areas where concerted action is required. They are:

1. The government has to control its unproductive expenditure. If the government can eliminate its revenue deficit, and then bring its fiscal deficit down to manageable levels of 3 to 4 per cent over the next three years, its borrowing requirements will reduce. The government is already into a mild debt-trap. According to the Budget 2000-01 documents, 28 per cent of the government's resources are raised by borrowings; and 26 per cent of its expenditure is on interest payments.

This means the government essentially borrows to pay interest. Any substantial reduction in the government's borrowing requirements will automatically improve the fiscal situation and make more resources available for the private sector, bring down interest rates, and promote more savings through the equity route.

2. A critical area of government action is reduction of subsidies. Subsidies currently chew up around six per cent of the Union Budget, and this may really be an underestimate because of the implicit subsidies involved in many other government pricing decisions (eg: the kerosene and LPG subsidies that are financed from the oil pool account). While there can be a valid case for subsidising the really poor, in all other cases subsidies must pass the test of means -- testing the recipient.

Subsidies must also become more transparent and explicit and they must be frequently reviewed. Eliminating subsidies for the non-poor holds the key to reducing the subsidy burden on the Budget.

3. On the revenue side, the key to fiscal stability is privatisation. Unless the government is willing to part with control of non-strategic public sector enterprises, the future of these enterprises will be in doubt. This has two implications: the loss-makers will continue to be a drain on the public exchequer, and the profit-earners will steadily lose marketshare to new players in sectors that have been opened up (oil, telecom, etc). This, again, forecloses the government's options by reducing its ability to raise resources by aggressive privatisation.

4. Ultimately, economic growth depends on sound infrastructure. The country cannot achieve the prime minister's stated objective of nine per cent annual gross domestic product or GDP growth unless it can attract huge investments in power, telecommunications, ports and roads. If these arteries of commerce remain unclogged, the economy will continue to face bottlenecks to growth. Once again, the only way to achieve this is through appropriate fiscal incentives for investment, privatisation, restructuring and downsizing, whether it is banks, electricity boards, port trusts, or telecom companies.

5. A lot of the infrastructure cannot be financed unless long-term funds can be made available to them. A start in this direction was made with the opening up of the life insurance sector. It should be carried further by opening up the pension sector. The country badly needs something like the US 401K pension vehicle to channel private savings into long- term investment for providing superannuation benefits.

This can be done if the government quickly opens up the pension funds industry with effective regulation. The Association of Mutual Funds in India has made suggestions in this regard, including a facility to allow savers to choose their level of risk while investing in pension funds.

Depending on the appetite for risk, a pension fund investor can choose the percentage of assets which his pension fund manager can invest in equity. It is a well-known fact that equity investments offer better returns over the long-term. This reform needs to be backed up with a tax-deferment plan, under which the investor will get the benefit of a tax-deferment as long as he does not withdraw money from his pension fund before he retires.

Withdrawals should be allowed only after retirement. Otherwise, the investor would have to pay tax. The Indian mutual fund industry will go from strength to strength if some of these points find a place in the Union Budget 2001, to be presented on February 28.

Shailendra Bhandari is managing director, Prudential-ICICI Asset Management Company.

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