A day before the announcement of the Union Budget for 2004-05, the Economic Survey called for "overhauling" the tax exemption regime saying low Tax:GDP ratio was a prime concern and it was coming in the way of improving government finances.

Economic Survey 2003-2004: Complete Coverage

In tandem, the government should evolve innovative tax procedures and simple laws with "strict penal mechanism" to check tax evasion, the Survey, tabled in Parliament by Finance Minister P Chidambaram, said.

"In the process of fiscal consolidation with a low Tax-GDP ratio, revenue augmentation should be the prime concern," it said.

Strongly recommending phasing out of tax exemptions, the Survey said, "There is a clear need to overhaul the regime of exemptions, reduce the number of notifications, simplify procedures and move towards a paperless and transparent administration anchored on trust."

"It is equally important to establish a rigorous penal and enforcement mechanism that takes care of those who violate the trust imposed, as is the practice in countries with low rates, simple tax laws and procedures," it said.

Referring to Kelkar panel's proposals on re-engineering business processes, the Survey said, "A number of measures have been taken and a lot more remains to be done."

The crux of business process re-engineering lies in moving from the present officer-based assessment to a system of self-assessment, random validation and enforcement, it said, adding, "This process is likely to be hindered by the presence of large-scale evasion-prone cash transactions."

Noting that monetary policy formulation has become more complex, particularly in view of changing magnitude and composition of capital flows to developing countries, the Survey said RBI's policy of sterilising the capital flows was only a "temporary" phenomenon.

It said the sterilisation, through the open sale of government securities, involved "quasi-fiscal costs" in terms of difference between the domestic interest rates and return on foreign exchange reserves.

"Sterilisation, if it exerts upward pressure on interest rates, could result in attracting more foreign currency inflows, thus necessitating more intervention by the monetary authority," it warned.

In this context, the Survey stressed on the need for long-term policy initiatives for "improving the country's absorptive capacity" of such inflows.

It noted that private capital flows, which have increased "significantly", formed the bulk of the long-term capital flows.

In 2003-04, forex assets of RBI rose by Rs 1,41,428 crore (Rs 1414.28 billion) compared to Rs 82,090 crore (Rs 820.9 billion) in 2002-03, resulting in excess liquidity.

Under sterilisation, effective from April this year, the government issued Treasury Bills or dated-securities under the market stabilisation scheme besides the normal borrowing requirements to absorb excess liquidity, it said, adding these "indistinguishable" instruments were eligible for the purposes of SLR and repo.

These securities, under the scheme, were matched by an equivalent cash balance held by the government, offsetting the monetary impact of accretion to the RBI's net foreign assets.