Budget '07-'08: PC's post-Budget interview

TAX-MAN: Finance Minister P Chidambaram says employee stock options are a fringe benefit and must be taxed.

        

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Just a day after the Budget, FM P Chidambaram spoke to TV18 network's Editor Raghav Bahl, where he clarified that discussions on the Rangarajan Panel will start.

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Keywords: Interview, Post-budget

Palaniappan Chidambaram, the Union Finance Minister, who is perhaps also the most prolific Finance Minister since India began its reforms in 1991, explains the finer nuances of the Union Budget 2007-08 in a special post-Budget interview to Raghav Bahl, MD of the Network 18.

Raghav Bahl: Sir, yesterday, people who saw you giving the Budget speech must have been rubbing their eyes in disbelief. Here was a man 10 years ago with a much worse macro-economic situation took bold leaps of faith. But yesterday he was a man sitting on a dream macro-economic situation being virtually status quoist?

P Chidambaram: Wrong. The dreams of 1997 and the dreams of 2007 are very different. I am lucky to be part of that dream and I am lucky to be part of this dream.

In 1997, what was the dream? India must join the rest of the world, India must take wings, India must accept her share of responsibility to become a key driver of economic growth in the world. Those were the dreams in 1997, and the engines that could have driven those dreams obviously were industry and services sector.

The dreams of 2007 are very different. The growth today is a given, it's not a cyclical shift. It is a structural shift. Given that the growth is a given and industry and services seem to be virtually on auto pilot, they are mature, confident enterprising, willing to take on the rest of the world; this is the time to dream other dreams, namely to make growth more inclusive.

Bahl: I will come to your assertion that growth is a given, which maybe a bit too facile and does not quite get reflected in your numbers. But your Budget that very morning was born under fear. You ban forward trading in wheat and rice.

Chidambaram: I didn't. Forward Markets Commission did it.

Bahl: But here is a government, a Prime Minister, a Finance Minister who believe in the efficiency of markets. And then, you get scared.

Chidambaram: I think you are drawing very facile conclusions. The economics division, which enjoys a large degree of autonomy, has got a section on forward markets in the Economic Survey, which justifies forward market as a price-discovery mechanism. But there is another view. There is another view that there is too much speculation, there is too much trading in "thin" commodities and I am no expert to say which view is right. Let me make that very clear, I am no expert to say which view is right.

Bahl: Sir, it's a problem of regulation.

Chidambaram: One month ago, the FMC restricted forward trading in tur and urad. Tur prices have declined. There maybe no cause-and-effect relation, but it has declined. We don't know, which view is right, which view is wrong in the given context. Therefore we have appointed an expert committee, for, I do not have to take a view now, I have to take a view only when the expert committee report comes to me.

Bahl: Sir you have just played safe.

Chidambaram: I have simply reported what the FMC did.

Bahl: Let me say why I believe it's a status quoist Budget. You had 20-30-35-40 per cent, unheard levels of growth in your tax revenues. And you wanted to control inflation.

Chidambaram: That was not because some kind God smiled on us. It is because our department worked hard.

Bahl: You managed the economy very efficiently. Absolutely. You had that much of flexibility before you and you wanted to rein in inflation. What then stopped you from bringing duties down to 7-8 per cent? In one fell swoop, you would have killed inflationary expectations in the economy?

Chidambaram: Not correct. I will tell you why. When an economy is firing at near-full speed, when actual outputs exceed potential output, cutting customs duties alone does not act as a price-restraining measure. Because the demand is so high, you can still sell your product at the price that you are able to command.

Bahl: That’s a strange argument I am hearing from you. You have always said consistently that this inflation is far more supply-induced than demand-driven?

Chidambaram: No, you talked about cutting further. I am answering that.

Bahl: You were giving me the reason for not cutting?

Chidambaram: No, I didn't say that. You said that I should have cut custom duty further, it will be disinflationary.

Bahl: It would have killed inflationary expectations?

Chidambaram: That is not correct. I will tell you why it’s not correct and that’s what I am trying to explain to you. You agree or disagree that’s a different matter.

I have been advised by my economic advisors. You have to cut a customs duty that is disinflationary. But the further step that you are suggesting - you cut it deeper, it is more disinflationary; we don't buy that argument.

That will apply only when there is industry working at less than full capacity. When industry is producing at full capacity, in fact, actual output is exceeding potential output and they have got pricing power; merely cutting customs duties more does not make it more disinflationary.

Bahl: That’s the sub-text of status quoism I am talking about?

Chidambaram: That is an economic advise I have received and I think it is sound advice.

Bahl: Let me give you another example. Last year and the year before that, we all applauded you for the kind of tax reforms and the convergence to the single rate that you talked about. Now, we were all expecting this year that you would cut excise, move service tax up — sort of converge to that single rate that you have been talking about. You didn’t touch it, nothing.

Chidambaram: How can I? I will tell you why. How can I do that? Only a few days before the Budget, we reached an agreement with the state governments. I have given an outline of that agreement. You don't know the details of that agreement.

Under that agreement, we have agreed to work together on a roadmap for GST. They have accepted in principle the GST, they have not yet agreed on a roadmap. At the end of that roadmap, we will have to agree on a rate on which all taxes will converge. We have not agreed on the convergence rate.

Bahl: You have indicated that 16 per cent CENVAT is something you would like to do. What is the Finance Ministry’s view on this?

Chidambaram: That is my view. There are 30 state governments, it requires a constitution amendment, state governments have to ratify that amendment. I can’t thrust an opinion down the throat of state governments.

The consultative process has not even begun, we have just reached an agreement to begin the consultative process. Once I know what the convergence rate will be, then I have to move the excise duty, service tax and they have to move the VAT towards that rate. At this stage, without knowing what the convergence rate is, how do I move the service tax and the excise duty rates?

Bahl: But that's something you had spoken about last year. You said 24 per cent and 32 per cent rates, and then you would start moving towards the convergence rates. Now the convergence rates would be 15, 16 or18?

Chidambaram: No. Kelkar has recommended 20, let me remind you. Therefore, there is no agreement yet on a convergence rate and without an agreement, we cannot move either service tax or excise duty. If I reach a convergence rate agreement this year, then next year we will make the movement.

Bahl: Surely you could not be thinking of 20 per cent?

Chidambaram: Kelkar has recommended 20.

Bahl: That is a recommendation of an academic committee?

Chidambaram: I have to consult everyone.

Bahl: Let me talk about one issue which may not be very large on your agenda, but where clearly the Finance Ministry seems to have got it completely wrong. And that is the Fringe Benefit Tax assessment of Employee Stock Ownership Plans, or ESOPs. ESOPs are a capital asset. They are a wealth-creating asset and you are taxing them like income. Which canon of economic thinking can ever justify that?

Chidambaram: Let me ask you a very simple question. Is ESOP a fringe benefit or not?

Bahl: Yes, okay conceded. It is a transfer of remuneration from the company via a capital asset.

Chidambaram: If it is a fringe benefit, it has to be taxed. I have not yet told you how we are going to calculate it, how we are going to tax it. All that will come in the rules. All that we have said is ESOP is a fringe benefit and I am extending FBT to it. You will have to wait to see how we determine the value of ESOP, how we tax it. All that has to be announced once we come up with the detail.

Bahl: Therefore, the media, which seems to be suggesting that 34 per cent is going to be the rate of taxation on the gains realised on the date of exercising of ESOPs has got it wrong? Is it categorical?

Chidambaram: I do not know whether it is wrong or right, all I know is that at the moment it is completely premature. Because I have not seen the detail calculations yet. So how could the media claim to know what it is?

Bahl: Therefore, it is not a given that they will be taxed at the income tax rate?

Chidambaram: It is a given that it will be taxed at the FBT rate; what the base will be, how the base will be calculated, how the tax will apply all that has to be worked out?

Bahl: Fine. I think that would come as a major relief because otherwise what seems to have been suggested and wasn’t denied strenuously yesterday by anybody is that you are actually going to tax capital assets at the rate of income tax.

Chidambaram: Who is in a position to deny it or affirm it except me? You didn’t put the question to me yesterday.

Bahl: But I am talking to you now?

Chidambaram: And I am telling you today. We have announced the policy that FBT will include ESOPs. Now what the ESOP should be, how it will be valued, how it will be taxed all that has to be worked out.

Bahl: That's fair enough. Because otherwise, this government was increasingly getting seen to be too anti-urban.

Chidambaram: No, not at all. Play what the three presidents of the three chambers said this morning back on your television channel.

Bahl: I think what you said yesterday in one of your appearances was that ESOPs are largely given to senior managers - that is not correct. ESOPs have led to an entrepreneurial upsurge in this country. And if you start taxing them at the maximum incomes rates ...

Chidambaram: Did you know that many developed countries are moving away from ESOPs?

Bahl: Well, that's for a variety of other reasons. The fact that ESOP is a wealth-creating measure. I do not think any country in the world taxes ESOPs at income tax rate?

Chidambaram: There are countries in the world, which tax ESOPs. And all that I have said is we will tax ESOPs. All the rest is your addition. Speculation.

Bahl: Let me ask you one question, which is strictly outside the Budget, but the country awaits an answer from you. There is a feeling that you, the Ministry of Finance and the Reserve Bank of India are working at cross-purposes as far as their understanding of how hard you must slam the breaks is.

Chidambaram: You see, the dharma of the Reserve Bank of India is price stability, monetary stability; the dharma of a government is to promote growth. As Prime Minister said yesterday, there is always a trade-off between growth and inflation. It's not that one has to yield to another.

So, when the RBI and the government consult each other — we consult them, they consult us — each one presents quite legitimately its side of the case. Until that your story is correct. The rest of your story is pure fiction that government and RBI are at loggerheads about dealing with the situation. We consult each other, we come to an understanding and then the RBI announces monetary policy changes and we check the fiscal measures.

Bahl: When you took over this government, the interest rate that the government was paying was nearly 4.9 per cent — it was in that region, maybe 5.2, but it could not be more than that. And corporates were paying 8-9 per cent. Today the government is picking up money at well over 8 per cent and the corporates today are having to borrow at about 13-14 per cent.

Chidambaram: But why? You know the answer.

Bahl: Sir, that is the reality.

Chidambaram: That is not correct, the corporates do not say that. I do not know about your company but corporates do not say that. The point is it is true that when this government took over, the top corporates were able to borrow at sub-PLR. Today they are perhaps borrowing at PLR.

Bahl: PLRs have become 12.5, 13 per cent.

Chidambaram: The reason is interest rates have indeed moved up, but please remember, in 2000-2001, home loan rates were 14 per cent.

Bahl: Are we, therefore, going back to that?

Chidambaram: No, we are not going back. This is not going back or going forward. These are interest rates, which are determined by the Reserve Bank of India by deciding the policy rates, reflecting the requirement of the economy. If today inflation is 6.5 per cent, it requires a response.

Bahl: But inflation was 4.5 per cent when interest rates were 8-9 per cent. PLR is 12-12.5 per cent on several times.

Chidambaram: The policy rate has moved up, the CRR has been increased four times.

Bahl: So is the Ministry of Finance in consonance with such a conservative policy?

Chidambaram: I have always supported the RBI's monetary management.

Bahl: Surely sir, you couldn't have supported a policy which 24 hours later hikes the CRR when 24 hour before you were telling the banks don't raise home loan rates.

Chidambaram: Please, you have got your sequence wrong. I told the banks that RBI has increased a risk weight on four assets, not including housing. It was increased on four assets, not including housing. And the RBI statement underlined the fact that housing was not included. So I told the banks — because the meeting had been scheduled earlier — that the RBI had increased the risk weight for four assets only, housing is not included, so please do not tweak the rates for housing. What is wrong with that?

Bahl: What is widely perceived to be the situation is that you believe, or it is the assessment of the Ministry of Finance, that in the RBI, we have a situation where it is an over-dependence on monetary policy when the problem is actually in the supply side?

Chidambaram: Please, RBI has only got monetary policy.

Bahl: But it's over depending on that instrument?

Chidambaram: I do not agree. RBI, I think, has a duty to be ahead of the curve. RBI has to anticipate the inflationary situation and take measures. RBI, in fact, has adjusted the repo rate four times and CRR four times in order to contain inflation. Despite that, inflation has moved up to 6.5. The reason is supply side, which RBI has no control over.

Bahl: And the 13-14 per cent interest rates could hurt economic growth?

Chidambaram: If they persist for a long period, they could hurt economic growth. That is why every effort is being made to moderate inflation in the medium term, so that these high interest rates do not persist.

Bahl: We are 4 per cent points away from that era of 18 per cent interest rate and 3 per cent GDP growth; we are not very far away?

Chidambaram: You are exaggerating. In 2000-2001, not in the distant past, 48 out of 52 weeks, inflation was over 6 per cent. In 22 of those weeks, it was over 7 per cent, in 12 of those weeks, it was over 8 per cent.

Bahl: But see what the economic growth rate then was as well?

Chidambaram: Economic growth rate that time was 4.5 per cent. Therefore, they had low growth and high inflation and I wonder what question you put to them at that time.

Bahl: That is in the past, but I am saying you could be seriously headed towards that situation again. Because you have got high interest rates, you have got high inflation only high growth and that comes down, the equation is the same?

Chidambaram: Why do you assume that it will come down? I believe there is a structural shift in the growth cycle. It is not a cyclical shift. So does Raghuram Raja, so does Steven Roche, who met me.

We believe there has been a structural shift, thanks to the engines of industry and services firing in all cylinders. We have a situation of high inflation today, not as high as it was in 2000-01. Still much lower than 2000-01. We are, therefore, taking steps in the fiscal, monetary and supply side to moderate that inflation. If we succeed in moderating the inflation, interest rates will decline.

Bahl: That was my question, how hard are you going to slam the breaks?

Chidambaram: I can only answer in the language of Prime Minister. We need to moderate inflation without hurting growth. It is a fine balancing act, but I am sure we can manage it.

Bahl: And you are saying the RBI is doing that fine balancing act?

Chidambaram: RBI is consulting the government before taking any steps and it will be untruthful to me to say RBI does not consult the government. RBI is consulting the government fully and comprehensively.

Bahl: And you are comfortable with the policy stance that RBI has adopted?

Chidambaram: The final policy stance adopted by RBI has the full support of the government; let me make that very clear to our viewers.

Bahl: And you will see a moderation in interest rates - that is the expectation and assessment of Finance Minister.

Chidambaram: Once inflation moderates, interest rates also will moderate.

Bahl: Down to what level?

Chidambaram: That depends on how quickly and to what level inflation moderates.

Bahl: You must be having some assessment?

Chidambaram: If inflation goes back to 4-5, interest rates also will go back to where they were.

Bahl: To about 8-9, prime lending rates?

Chidambaram: It should go back to at least between nine and 10.

Bahl: Sir, on that very hopeful note, thank you very much for joining us.

Chidambaram: Thank you.