Contrary to the widespread media speculation, India’s budget presented by its suave Finance Minister Arun Jaitely on Feb 1 is far from being populist. The budget sticks more or less to the Modi government’s fiscal road map and has kept fiscal deficit at 3.2% of the GDP. However, on closer looks, it seems like a missed opportunity to push difficult reforms before the government gets into an election mode in the run up to the next general election in 2019.
Low deficit translates into lower borrowings which together with low inflation will help keep the interest rates low. That in turn should boost investment and consumption, and keep the growth momentum going. So, sticking to fiscal road map makes sense.
Investment as measured by gross fixed capital formation has fallen by 1.9%, 3.1% and 5.6% respectively in the last three quarters. That remains the top downside risk. India can’t continue to grow at 7% unless investment especially from private sector picks up. Demonetization has badly affected the sales of Indian firms. Sluggish export demand is further adding to the piling up of inventories, and firms are forced to operate well below their capacities. As a result, private sector firms – big or small - are sitting on their capex plans and may need strong incentives to add new capacities.
Jaitely in his last budget promised to cut corporate tax rate to 25% to bring it at par with Asian neighbours from the current rate of 30% - which is a major drag on India’s relative attractiveness as an investment destination despite its high growth and cheap labour advantages. With President Trump promising to cut corporate tax to 15-20%, any reduction in India’s corporate tax would have been a big sentimental boost for Indian corporates.
Jaitley did reduce it to 25% but has kept the benefit restricted to the firms with annual sales turnover of 500 million rupees or below thereby excluding many large private sector firms. In the long term, that (along with tougher labour regulations for large firms) would encourage smaller firms to remain small and miss the benefits of economies of scale. That will also limit the number of good jobs which mostly large firms in the organized sector create.
India is adding 1 million youths to its workforce every month that makes 12 million a year new job seekers. However, jobs are increasingly being difficult to come by. Eight key sectors of the economy that include manufacturing, construction, trade, transport, hospitality, information technology, education and health added just 135000 jobs in 2015 compared to 421000 in 2014 and 419000 in 2013. Even in 2016, things are not good on jobs front as shown below.
Despite the hype about Skill India campaign aimed at improving the employability of youths, it could skill only 1.72 million youths in its first year against an ambitious target of 400 million in seven years. While corporates are facing difficulty in hiring suitably skilled personnel and many positions remain unfilled.
Small reform measures such as addressing the problem of inverted duties (higher duties on raw materials and intermediates, and lower duties on finished products) in sectors such as chemicals, electronics and textiles can encourage value added production and create many more new jobs. Yet, like his previous budgets, the current budget fails to address this critical issue.
The abolition of Foreign Investment Promotion Board (FIPB) and announcement that government will continue to further liberalize its FDI regime are good moves. However, the major concern of foreign investors is the scrapping of 57 investment treaties. As a result, there’s no protection available to the new foreigner investors.
The new model investment treaty that India is trying to push is far from satisfactory as it excludes tax matters and mandates that foreign investors must first exhaust all domestic legal remedies i.e. first deal with impartial but snail's pace Indian judiciary. Only then, they can request for speedier international arbitration.
It’s worth mentioning here that though India received $43 billion worth of FDI in April-Nov 2016, it also witnessed an outflow of $16.4 in this period that makes net FDI inflows (in this period) at $26.6 billion. Unless the major concerns of the foreign investors are addressed, net FDI inflows may go down further and threaten the stability of rupee when commodity prices have started to harden.
Jaitely also fails to address the issues related to the quality of government expenditure. Given the high multiplier effect of capital expenditure (e.g. roads and airports) at 2.5 compared to less than 1 for revenue expenditure (e.g. salaries and allowances of government officials, subsidies on fuels and interest payments), any increase in the share of capital expenditure in total budgeted expenditure would have been helpful for pushing economic growth. However, the share of capital expenditure has gone up only 0.5% in the new budget and stands at 14.4% despite an increase of 11% in the outlay.
The budget raises rural spending by a whopping 24%. Increased allocations for irrigation and crop insurance are praiseworthy. However, the quality of their implementation will be an open question. Moreover, with global energy prices still low, the finance minister should have considered bringing urea under nutrient based subsidy regime. That would reduce the relative price gap between urea and non-urea fertilizers, promote balanced use of fertilizers and ensure better return on per unit of subsidy in addition to checking soil degradation.
With GST substantially diluted and doubts still remaining about its implementation from July 1, it now seems that direct tax reforms have been shelved too. Jaitely reduces income tax rates for lower middle class tax payers by increasing them for upper middle class tax payers in the form of new surcharge. This is nothing but kind of cross subsidization that reduces the incentive to pay taxes honestly. Obviously that runs counter to the objective of improving tax compliance.
Instead he should have attempted to widen the direct tax net (only 1.5% of Indians pay any income tax; 76 million have declared an income of more than half million rupees in a country of 1.3 billion people in 2015) by deciding to tax rich farmers who also appropriate most of the subsidized farm inputs, electricity and benefits of assured government procurement, but he didn’t. That shows the unwillingness of the Modi government to introduce tough reforms measures. The budget measures to clean electoral funding too appear to be inadequate and devoid of any deep thinking given the economics of electoral politics in India. Worse, the idea of electoral bonds is being criticized for intruding into RBI’s turf.
Similarly, the budget doesn’t do much (except providing for 100 billion rupees or $1.5 billion for bank recapitalization when bad loans have crossed $120 billion mark and increase in the tax break for bad loan provisioning from 7.5% to 8.5%) to deal with the menace of non-performing loans and an ever-increasing number of wilful defaulters leading to large scale loan write offs year after year. Rising NPAs will reduce the ability and willingness of banks to lend at a time when credit growth is an all-time low. That will have implications for economic growth going forward.
Budget in India is meant to be an expression of long term economic policy and not a statement of account aimed at balancing revenue and expenditure. But Jaitely’s budget mostly does that. It skips providing a clear road map to push crucial reforms agenda further and remain silent on many critical issues such as jobless growth and how to address that which is threatening to turn India’s demographic dividend into demographic disaster.
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A modified version of this post (co-authored with Prerna Sharma) catering to International readership has been published in Nikkei Asian Review from Nikkei-Financial Times Group here.