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Reforms march ahead-I - Views on News from Equitymaster
 
 
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  • Aug 26, 2003

    Reforms march ahead-I

    Yesterday was yet another day when terror reared its ugly head in the financial capital of the country i.e. Mumbai. The bomb blasts that occurred yesterday have once again reminded us that we are still fighting a war against terror within the country as much as the US is across the globe. The blast that occurred yesterday had a telling impact on the stock markets. Investors were shaken up and the Sensex and the Nifty fell 3.0% and 3.3% respectively.

    While it may be difficult for a while to divert one's attention from this blatant and unjustifiable act of terror, the government on its part continues to carry on economic reforms, which would benefit the economy in the long run. We are referring to the union cabinet's decision to reform the central government pension system in the country. Earlier, contribution to the employee's pension scheme was solely made by the central government. The new pension scheme defined by the cabinet is contributory in nature and involves the employees contributing 10% of their salary amount towards their pension. The new scheme also entails the setting up of a pension scheme regulator like the IRDA for insurance sector and SEBI for the capital markets.

    While we are not exactly going into the modalities of the new scheme, we are trying to look in to the long-term implications of the same. The RBI, in its Currency and Finance Report 2001-2002, has indicated that the main reason for the fiscal deterioration has been the wage bill. The wage bill includes salaries and pensions of state and central government employees. The eleventh finance commission goes a step further and indicates that the spending on wages was the primary reason for the abnormal rise in revenue expenditure in the 1990s. An indication of the poor state of affairs is the fact that the wage bill as a percentage of GDP has risen from under 2% in FY81 to nearly 2.2% in FY02. The fifth pay commission has been the main culprit for the deteriorating situation in the late 1990s.

    What this indicates is that the contributory nature of the new pension scheme, is likely to go a long way in reducing the revenue expenditure burden of the central government currently and the state governments at a later stage (because they may have no choice but to follow suit). The reduction in revenue expenditure will also lead to improvement of the fiscal health of both the central and state governments, also helping keep fiscal deficit under control. With these measures, the government will also be able to allay the fears of the IMF and the World Bank regarding the deteriorating fiscal state of the central and governments.

    Apart from the apparent effect on the fiscal health of the central and state governments, it will also have a positive long-term impact on the stock market, which have been time and again starved for lack of breadth. When pension monies come in to the stock market (the new pension scheme envisages investment of part of the corpus in the stock markets), it will infuse a larger quantum of capital into the same as well as more long-term capital. It will also increase the breadth of the stock markets, leading to greater maturity in the same.

    One needs to understand that reforms being carried out by the central government are fundamental in nature and will have long-term implications on the economy.

     

     

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