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'We should not seek special instruments for avoiding income tax'

Savio G Pinto & Tamal Bandyopadhyay

Finance Minister Yashwant Sinha sees signs of a revival in the last quarter of 2001-02.

Though growth in the manufacturing sector is still lagging behind at 2.8 per cent, the gross domestic product has soared to 6.3 per cent in the third quarter, riding on a 7.1 per cent growth in agriculture. But the picture is likely to be different in the last quarter with the impact of last year's good monsoon reflecting in higher consumer demand.

In an exclusive interview with Business Standard on Sunday, Sinha said there was room for a further softening of interest rates and that the low interest rate regime was here to stay.

He also said the freeing of administered rates was only the beginning and the government was determined to usher in far-reaching tax and pension reforms. Extracts:

There is a lot of liquidity in the system, interest rates are low and yet corporates are not making fresh investments. What, in your opinion, can make corporates take the plunge?

I think your statement understates the true extent of investment demand in the country. Let me try a simple back-of-the-envelope calculation.

Private capital formation is India is roughly 17 per cent of the GDP. In 2001-02, the GDP is expected to be around Rs 22.2 trillion. Thus, private capital formation would work out to roughly Rs 3,800 billion. This number is inconsistent with the generalisation "corporates are not making fresh investments".

With the rate of inflation so low, is there a case for a further softening of interest rates?

The core interest rates of the country are determined on the secondary market for government bonds. This is a market outcome and not a policy variable.

Our primary focus has been on removing tax distortions in interest rates and anomalous rates which are administratively determined.

Given our inflation rates of around 1 or 2 per cent, and the international thumb-rule about the real interest rate on long-dated government paper, it does appear that there is room for further softening of interest rates.

How long do you think the soft interest regime will continue?

You are asking me to guess what will come of an active market! Obviously, nobody can tell what will happen in the future on a financial market. If your question is: will we be able to consistently stay with real interest rates which are away from the implausible values which were seen some time ago, my answer is in the affirmative.

You have already rolled back prices of LPG as it was hurting the middle class. Is there any plan to roll back kerosene prices, or for that matter any other measures?

The Budget process involves intensive consultation with Parliament. On some questions, we do attenuate our proposals in response to the feedbacks. I see these as calibrations of our basic trajectory, not qualitative departures from this trajectory.

Your Budget seems to be particularly harsh on the salaried, tax-paying middle class. Please comment.

First, for a matter of detail. I just do not think that a person earning over Rs 500,000 a year belongs to the "salaried middle class". I don't think that "salaried middle class" people purchase Rs 200,000 worth of RBI bonds a year.

So if you look closer at our proposals they do involve higher tax rates for the rich, but you can hardly call them "middle class."

At a more conceptual level, we started the reforms process in India with high tax rates, which were attenuated by a pervasive system of tax breaks and exemptions. In this world, people had perverse incentives to distort behaviour in seeking to avoid tax.

It also wasted millions of man-hours across the country, where taxpayers and their advisors set about devising contorted tax-efficient mechanisms. Now we are in 2002 with an income tax rate that is low by world standards. This is a big change.

Then, along with it, it is fair and it makes sense that this system of exemptions does not continue. We will get more economic growth when the tax-induced distortions are eliminated and when these millions of man-hours are put to more productive uses.

You have selectively used the Y V Reddy Committee recommendations on small savings and freed administered rates taking away tax benefits, but the committee was also in favour of continuing the tax benefits on long-term investments. What is your plan?

I think there is a larger process which is underway. We have not done everything that the Reddy Committee suggested but we are moving in that direction.

We should seek simplicity in the tax code, where people measure their income and then directly go on to compute their taxes. We have to move away from this culture of having myriad different mechanisms for dodging taxes.

Now long-term investment is an area where there is some merit in having a different tax treatment, but we need to think hard about where we would like to go.

A long dated government bond is not a long-term investment. Investments in the pension system are -- and contributions to the provided fund system continue to be tax-privileged.

We will make progress on implementing the Project Oasis system, the innovative and new approach to unorganised sector pensions which was created under the aegis of the ministry for social justice and empowerment. There we expect to have tax advantage for pension investment but under Project Oasis, pension assets are locked away until the person retires. This is unlike the present practice of using PPF as a mechanism to do short-term, tax-exempt savings.

Further, the international norm is that while pension contributions and accumulations are tax-free, pension benefits are taxed as normal income.

We have to simply get out of the culture of expecting to have special financial instruments for avoiding income tax. It is the duty of citizens to pay income tax, and after it is paid, households should form portfolios based on risk and return (and not tax considerations).

Another committee on insurance reforms was against the imposition of service tax. But the Budget did exactly the opposite. Why?

Much controversy has been raised on this issue. The risk part of the premium is already taxed in service tax in general insurance. We propose to extend this concept of the risk insurance to life insurance also.

The third quarter estimates of GDP by the Central Statistical Organisation have shown that agricultural growth has surged but the manufacturing sector is still lagging behind. When do you see a revival?

The impact of the monsoon is seen on the kharif crop and then on the rabi crop. This shows up with a lag in demand for consumer goods. Hence the impact of last year's good monsoon is likely to be seen in the fourth quarter.

A month has passed since you presented the Budget. You have given the revised estimate of the fiscal deficit for 2001-02. Could you tell us what the final figure will be?

I would not like to make a guess at this stage. The final figure will be out soon.

A host of economic legislation, including the Fiscal Responsibility Bill, is pending before Parliament. When do you see these bills getting passed and becoming Acts?

We are very aware of the enormous economic ramifications of our steady progress in solving legal impediments in the economy. We are anxiously working with Parliament on steering a host of economic legislation through. I hope some of this will go through in this session.

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