Budget 2016 - Prudent And Thoughtful But That May Not Be Enough

Few days ago, Swaminathan (Anklesaria) Aiyar had penned an article for Financial Times. The title was a provocative one: ‘Infighting at the top puts the Indian economy at risk’. Usually, authors do not get the title they prefer. So, it could all be the doing of the newspaper. The substance of the article was that in the budget for 2016-17, the Government was better off agreeing with the Governor of the Reserve Bank of India and stick to its fiscal consolidation path rather than pursue some fiscal stimulus for the economy.

Usually, central banks around the world advocate fiscal prudence while democratic governments are, from time to time, tempted to open the spigots to improve the economy and secure their political future. It is not new. It hardly suggests any infighting. In any case, both the author and the newspaper got their answer on 29 February. The budget that the Indian Finance Minister presented ticked all the boxes on fiscal consolidation.

Growth-unfriendly fiscal stance

The budget delivered rather well on fiscal, revenue and primary deficit parameters. It has done better on the revenue deficit target (2.5% vs. 2.8%) and effective revenue deficit target (1.5% vs. 2.0%). Not only that, it projects an accelerated decline in the effective revenue deficit, reaching 0.0% by 2018-19. The revised estimate of the primary deficit at 0.7% of GDP is the same as the original budget estimate. But, it too is projected to drop sharply to 0.3% next year. So far, so good.

At the same time, the fiscal deficit is coming down more slowly only to 3.0% of GDP. In other words, the medium-term fiscal policy statement envisages a drastic rebalancing of expenditure towards capital from revenue items. That is optimistic. For example, for the year ending 2015-16, the government expected revenue expenditure to go up by 5.0%. In the revised estimates, it is projected to rise by 6.0%. Capital expenditure is expected to go up by 14.2%. But, it is now expected to rise only by 12.9%. The achievement is still a good one but it only highlights the difficulty of achieving an effective revenue deficit of 0% by 2018-19.

This government inherited a bad fiscal situation. The true budget deficit was more than 6.0% of GDP when it took office. Hence, to achieve a deficit ratio of 3.5% in the current fiscal year is no mean achievement. But, it has paid a price for it. It has achieved a pro-cyclical fiscal consolidation in the face of faltering global growth and two failed monsoons. When the Central Statistical Organisation (CSO) told us few weeks ago that the nominal Gross Domestic Product (GDP) growth would be 8.6% for the year ending March 2016, it also revealed that the nominal growth in net indirect taxes (indirect taxes less subsidies) would be close to 30.0%. That gave us an inkling that the government would not fall too short of its deficit target of 3.9%. In the end, it didn’t.

We can see that in the Excise Duty collections. Against the actual excise duty receipt of 1,88,128 crores of Rupees in 2014-15, the government now expects to collect 2,83,353 crores in 2015-16. It is now projected to increase to 3,17,860 crores of Rupees in the coming financial year. The government’s revised estimate for Basic and Special Excise Duties excluding Cess on Motor Spirit and High-Speed Diesel Oil is 1,57,710 crores of Rupees against the budget estimate of 128,087 crores. Additional Excise Duty on Motor Spirit and High Speed Diesel Oil is now expected to fetch 73,000 crores of rupees against a budget estimate of Rupees 43,100 crores.

Now, clearly this is a dampener for economic activity. The government did not pass on the oil price windfall to Indian consumers but kept most of it to itself by raising duties on petroleum products. It is no bad thing from an environmental perspective but the price had been paid in terms of economic growth. That is one of the reasons why the nominal GDP growth target 11.5% assumed in the budget for 2015-16 had turned out to be too high. Indeed, the government has announced tax changes that raise more revenue for it by way of indirect taxes than direct taxes. Two new Cess are being introduced even as 13 ‘poorly performing’ ones are being withdrawn. Another cess is being renamed and the amount increased. Hence, its fiscal policy continues to remain more restrictive than even the headline numbers would indicate. Further, cesses are an annoying way of raising revenue and militates against the desire to ease business conditions in the country. They are growth inhibitors.

The government now has assumed GDP at current prices to grow at the rate of 11% for 2016-17, rising to 12% in 2017-18 and then to 13% in 2018-19. In the current global environment, these are stretch targets. There is a statistical challenge too. The CSO will have to invest time, effort and money in developing a reliable GDP deflator price index for India that reflects the dominance of the Services sector instead of using mostly Wholesale Price index proxies that might be understating nominal GDP growth and, conversely, overstating real GDP growth.

Too much faith on monetary stimulus

The seeming deference of the Government to the preferences of the Governor of the Reserve Bank of India (RBI) could be its note of thanks to the contribution that RBI made to its good fiscal performance. The central bank has also helped the government in a big way in meeting the fiscal deficit. For the financial year 2014-15, RBI transferred a surplus of around 65800 crores to the Government. Since the funds were transferred only during the current financial year, it would have formed part of the government’s non-tax receipt for 2015-16. Government budget is not on accrual but on cash basis. It forms the lion’s share of the revised estimate of 73, 905.55 crores of Rupees under the head, ‘Dividend/Surplus of Reserve Bank of India, Nationalised Banks & Financial Institutions’ under non-tax receipts. The government has been prudent in pencilling in an estimated receipt of ‘only’ 70,000 crores of Rupees on this account for 2016-17.

While on the subject of non-tax receipts, let us note, for the record, that the biggest item that the government is betting on is fee income from the auctioning of spectrum to telecom companies. The amount is almost 100,000 crores of Rupees. It is also betting on more than 56,000 crores of Rupees from sale of public sector assets including strategic sale. If it did not materialise like it did not in 2015-16, the government would be hoping that the Tax Amnesty Scheme it announced brings in additional tax revenues. Or, it might mobilise even more through indirect taxes. That would be a negative for economic growth. Further, such a backstop requires global crude oil price to stay low. If they did not, all bets are off on growth and fiscal consolidation. India’s margin for error is too low on both.

Let us return to the looming presence of RBI in the budget numbers. The government has striven to deliver responsible fiscal parameters such that the Reserve Bank of India could cut rates more aggressively. Will the RBI oblige? For the most part, I think RBI would be pleased. In that sense, the budget does pave the way for some reduction in the policy rate in the months ahead, if inflation rates remain stable and contained. Indeed, one gets the impression that the government has more faith in the ability of lower interest rates to deliver economic growth than on its own prowess. It has also kept an eye on the bond market. Its positive surprises on the revenue and effective revenue deficit and its projection of market borrowing that is less than the revised market borrowing estimate for 2015-16 which, in turn, was less than the original budget estimate all point to a bet on interest rate stimulus for growth. That is reasonable but might turn out to be a bet on the wrong horse.

Missing urgency on Indian banking

India’s growth problem is now not so much a problem of higher interest rate. Its corporations are still digesting their previous borrowing binge. Its public-sector dominated banking system is capital deficient and unable to lend. On that score, the budget disappoints with its allocation of a meagre 25,000 crores of Rupees for recapitalising banks. That works out to around USD3.66bn when the total stressed assets (including unrecognised stressed assets) could be close to USD200.0bn. To be sure, not all of them would turn bad and ultimately irrecoverable. But, the difference in magnitude is too stark to be tackled by a capital infusion of such a modest magnitude. At the minimum, the government should have been bolder and provided for 68,000 crores of rupees (USD10.0bn). The lack of courage and boldness, reflected in the allocation for recapitalisation of banks, is a big risk for the government’s growth assumption and all the revenue calculations that flow from it.

Along with sufficient funds for recapitalisation, one expected to see additional measures for the disposal of stressed assets, improvement in governance and accountability for the crisis. They were not forthcoming. It has announced the formation of the Banks Board Bureau. The government also announced liberalisation of rules on foreign investment in asset reconstruction companies. They fall short. Asset reconstruction companies and their security receipts have barely scratched the surface of the bad debt problem in banks. In practice, securitisation receipts have been another variant of ‘extend and pretend’ – similar to restructuring non-performing loans to make them seem like performing assets.

The Urbanomics blog stated that the banking crisis remains an as-yet-unrecognised crisis. He is right. Unfortunately, the budget is a missed opportunity to change that view.

Evidence of timidity in other areas

Another disappointment is that the government has made a very tentative beginning in removing corporate tax exemptions and lowering the tax rate. The measures announced are too tentative, split hairs too much and reflect revenue-consciousness than growth consciousness.

The same lack of courage and boldness that has characterised the bank recapitalisation effort and corporate tax reform effort is evident in other areas too. In the area of higher education, the country can do with a complete break from the past by allowing foreign universities to open campuses independently or in collaboration. A thorough overhaul of Indian higher education is overdue and the middle class – the government’s support base in 2014 – would have only been grateful for it. An opportunity has been missed again. Instead, what we have is a diluted quarter-hearted (not even half-hearted) opening of the window:

“An enabling regulatory architecture will be provided to ten public and ten private institutions to emerge as world-class Teaching and Research Institutions.”

Another example of the failure to seize the higher ground is on mandatory wage deductions. Paragraphs 67 and 68 of the budget speech deal with the matter of mandatory deduction costs. They are too high. The Government of India will pay the Employee Pension Scheme contribution of 8.33% for all new employees enrolling in EPFO for the first three years of their employment. The scheme will be applicable to those with salary up to 15,000 Rupees per month. The Employment Generation incentive will now be extended to all assessees who are subject to statutory audit under the Income Tax Act. Earlier, it was only allowed for assessees who were involved in the manufacture of goods. However, no deduction will be admissible in respect of employees whose monthly emoluments exceed 25,000 Rupees.

These are thoughtful measures. Hitherto, tax incentives were allowed for capital investment via accelerated depreciation, etc. It makes sense to provide incentives for employment generation when labour is the more abundant factor of production in the country. But, why be squeamish with the salary levels up to which such deductions and government support are allowed? The numerical values are too low to be of much consequence to many enterprises. Good thinking thwarted by bad execution caused by lack of courage.

Attention to agriculture – is it enough?

Initiatives in the areas of agriculture are not populist one-off reliefs but are directed towards increasing irrigation coverage, soil health and rural roads. Together with the agricultural marketing e-platform to be launched in April and the crop insurance scheme announced earlier in the year, the government has made up some lost ground in attending to the concerns of the farmers. All that being said, farming is unremunerative for small and marginal farmers who own the bulk of the farming land. They have to seek to develop their fortunes outside agriculture and, to do that, they have to start by being able to dispose of their land. The government has gone silent on making land disposal and acquisition easier after its hyperactivity in the initial months of its term in office.

It is good to see the announcements on the name change for the Department of Disinvestment to Investment and Public Asset Management and the abolition of Plan and Non-Plan distinction from next year.

Friendlier tax administration

Clearly, much thought has gone into making the tax administration more responsive and friendlier. Several measures have been announced. Tax departments would be less litigious going forward. In particular, it is good to see checks being brought into discourage and eliminate tax adventurism. I had recommended it in a blog post, published on 20 February. There was one more coincidence. In another blog post published on the same day, I had suggested that every government policy should have an explicit sunset and a statement of expected outcomes with costs and benefits. The Finance Minister said in the speech that every new scheme being sanctioned by Government would have a sunset date and outcome review (Paragraph 110).

Does it all add up?

Couple of days ago, I had posted an article in my blog as to how I would evaluate the Indian budget and the budget delivered by the Finance Minister today, in particular. As I went through the budget speech document (much longer compared to last year’s) and all the related documents, I found that the budget ticked most of the boxes on fiscal prudence and on specific initiatives that I would have liked to see in the budget. Yet, I could not avoid the impression that the budget had failed to provide a vital spark that might have kindled animal spirits in the country. I asked myself why. This is what I came up with.

Few weeks ago, I had written that being an efficient UPA was not the answer for India. However, the government appears to think that offering the same policy mix as the previous UPA government did but in a more efficient (see paragraph 100 of the Budget Speech, for example) and less corrupt manner combined with fiscal responsibility is the right approach for it politically and for the economy too. Redistribution is not a bad thing in an economy with millions in or on the borderline of poverty with a large number in abject poverty too. As for growth, the government believes that lower interest rates and easier business conditions would do it. Undoubtedly, this is an incremental improvement over the previous government. But, is that enough?

In normal and benign times, this would be sound, sensible and adequate. These are not normal times. In the socio-political context, R. Jagannathan alluded to it in his piece on India being on the verge of million mutinies. He wrote that the Indian society was in churn, and that it needed leadership of the highest order at every level. It is as true and valid for the economy too.

India is trying to grow out of its low-income status. But, the global environment is far less favourable to it than it was for other countries at a similar stage of development. They had friendlier global environment - whether it was trade, economics or climate. Unfortunately, India does not. Consequently, other factors have to step up to the plate. When tangible factors turn unfavourable, the burden on intangible factors raises. Leadership is one of them. Indian leadership is being called up on to be sober, strategic, smart, supple and supine – all at the same time! The budget does not give the impression that the government has grasped this message.

All that being said, it is hard to be harsh on them. After all, the government has delivered a prudent and thoughtful budget in many ways. Unfortunately, it may not be enough to lead to favourable economic outcomes within the time-frame that matters to them or the country. They deserve better for the hard work they have put in and so does the country. Say a prayer for a better monsoon this year and continued low oil price for the next two years.

I began the piece with Swaminathan Aiyar. I will end with him. He wrote somewhat theatrically that if the Finance Minister ignored the RBI Governor’s message on fiscal prudence, it would amount to asking the governor to leave. Now that the Government has scrupulously followed his advice, does it mean that the Governor will serve another term as the head of RBI?