Budget: It's Only A Part Of Economic Policy

Expect a reasonably good budget but not big-bang reforms. This annual ritual of presenting a document of expenditure and earning is not the place where the finance minister or government gives the country a pathbreaker

Most market commentators still do not realise that the bulk of government economic policy ‘action’ no longer happens in the Union Budget — or, if they do realise it, they still insist on trying to create an ‘event’ — but a low key Budget is how it should be. The Budget should state income and expenses, expectations of where the Central government expects to get its revenues from and where it will spend it on, and maybe make some tweaks to the overall tax rate. The big ticket policy items — the new Direct Tax Code, GST, GAAR, ease of doing business reforms, removal of antiquated laws, and consolidation of subsidies — are all separate pieces of legislation or government activities.

Market participants and news pundits expecting a P Chidambaram-style ‘dream budget’ will be solely disappointed. Chidambaram could do so much back in the 1990s primarily because of the high base of taxation that he was starting from. Currently, the taxation structure, both direct and indirect, is far more modest and the recent economic slowdown has cut any flexibility for incumbent Arun Jaitley. The only saving grace for the finance minister is the decline in oil prices, which would make his job of achieving a fiscal deficit target of 3.6 per cent easier in theory; he does not have to either raise taxes or cut food and other subsidies significantly for the financial year 2016.

So what would I expect to see from this budget? In Section A, which deals with all the budgetary plans and targeted expenditure, I would expect to see new outlays for the Swachh Bharat Abhiyan and other such assorted schemes, while I would not expect either the food or fertiliser subsidies to be cut. Since the oil subsidy has naturally reduced and the government has cannily not passed on all the gains from the reduced oil prices to customers, there is breathing space for Jaitley to be expansive in this section while not busting through the 3.6 per cent fiscal deficit target. He may even come up with a lower 3.3-3.5 per cent number to show the progress that the government has been making on the fiscal front. This is the single key deliverable, in theory, for India’s future economic growth — this number impinges upon prospective inflation, interest rates, the rupee and general confidence in the Indian economy. If the government can get its spending under control, show a primary surplus and reduced marginal borrowing, then those would be positive indicators for a rebound in private investment in the economy.

I would expect to see a significant increase in the outlay for defence expenditure given the pending procurement programs for aircrafts, artillery, naval ships, etc and the raising of new brigades and allied facilities in Arunachal Pradesh. We already spend about 25 per cent of the Union Budget on Defence explicitly; whether this rises closer to 30 per cent or not remains to be seen. Essentially, this is a trade off between the gains from lower oil prices, stable subsidies and increased defence expenditure.

The other area that requires urgent attention, although this may not figure in the Budget, is the state of the public sector banks. Their aggregate balance sheets have been under severe stress due the increase in the non-performing assets over the previous three years, and they are going to need re-capitalisation in the near future. Here again, reducing the fiscal deficit and lowering inflation expectations would allow the Reserve Bank to lower rates more aggressively in the future, easing the stress on the banks’ balance sheets but this is only a partial solution. At the policy level, the government would have to decide whether to give up its majority stakes in public sector banks or infuse tax payers’ monies in the form of equity or other Tier-1 capital. The Finance Minister may consider taking recourse to the concept of the “golden share”.

In Section B, which deals with direct and indirect taxation, I believe that market focus is largely on three areas: retrospective taxation, GAAR and GST. The market was disappointed last time due to the absence of any mention of no retrospective taxation, but recent government action in not appealing tax cases it lost in High Courts has been a positive indicator. If the finance minister were to declare that the government plans no retrospective legislation in the future, it would go a long way in burnishing India’s credentials as a country with rule of law and a stable tax regime. This is one of the most important factors for future investment plans of both domestic and foreign investors.

On GAAR and GST, I would only expect statements of intent and maybe projected timelines but there is very little the finance minister can do in the Union Budget. While there have been sustained demands for rollback of GAAR, if not outright scrapping, this is extremely unlikely to happen given India’s tax treaty considerations and the aggressive stance taken by Revenue department on transfer pricing and related matters.

Similarly, for the new Direct Tax Code, I would expect Jaitley to lay out a timeline for implementation.

On rates, I would expect minor calibration of rates on excise duties – mainly for the automobile and the chemicals sectors. On Income Tax, expect some minor calibration in slabs, with the lowest slab possibly being raised 10 per cent and possibly the standard deduction exemption making a comeback for higher income slabs. What is more likely is that some designated investment schemes (mainly government infrastructure related) would get additional tax exempt status. The reason I do not expect much changes here is because the finance minister has very little wiggle room on taxes, until tax collection picks up substantially. And, that will not happen until the economy starts growing more robustly, on a sustained basis and jobs start to pick up. It would not have slipped the minister’s notice that traditional high growth sectors like information technology and media have been laying off people recently, and in large numbers.

There could be some increases in foreign investment limits for specified sectors, although insurance remains mired in the Rajya Sabha and the big-ticket announcement for Defence was already made earlier.

Finally, I would expect some announcements and possibly clarity on certain onerous clauses in the new Companies Act as part of the Union Budget, but again actual changes would be part of a separate legislative activity.

So, for a budget being presented nine months after the swearing in of a new government with an absolute majority, do not expect a wonder child – just your normal neighbourhood kid!