What’s In The Bag?

For all intents and purposes, the Budget is in the right direction. Except, it could use a plan to achieve its ambitious goals

From the moment finance minister Arun Jaitley began reading his career’s third Budget speech, all the way till the very end, the stock market’s bellwether index, the BSE Sensitive Index, oscillated wildly. Social media comments too reflected the mood in the bourses — swinging between complimentary and scathing, to downright snarky and fulsome praise. 

One tweet even claimed (without furnishing any proof) that though the Budget speech was read out by Jaitley, its key architect was Prime Minister Narendra Modi. Another, snidely claimed the Budget seemed to have UPA-III’s imprint, given its emphasis on rural and farm sectors. There were other similar tweets. While you can’t really expect a proper analysis in 140 characters, it’s true that the tenor and content of Budget 2016 has left experts confounded and desperate to find the one thread that ties up the whole package of measures.

Indeed, there are multiple strands to Budget 2016, each striving to provide a specific solution. The question is: do all these cohere to form a meaningful tapestry? Does it make sense? It might be worthwhile to examine some of the overarching themes in Budget 2016.

Let’s consider the first charge: Budget 2016 is a political document. To be fair, Jaitley had little choice. Economic policy-making cannot be conducted in a political vacuum. With key states (Assam, West Bengal and Tamil Nadu) going to polls this year, followed by Uttar Pradesh and Punjab next year, it might be naive to expect that Budget 2016 will be bereft of any political grandstanding. 

That might also explain this Budget’s exaggerated emphasis on playing Robin Hood: imposing a slew of additional taxes on the wealthy, under the heading “Additional resource mobilisation for agriculture, rural economy and clean environment”, without bothering to specify whether these taxes will indeed be sequestered for the specified objective, or even caring to explain what happened to taxes collected under similar heads over the years. Ironically, Jaitley has himself provided the counter-point: pensioners withdrawing life savings from pension funds will now have to pay tax on 60 per cent of the accumulated corpus, if it is not invested in an annuity. As a wag observed drily, Thomas Piketty’s whistle-stop tour through India has left economic administrators with fleeting notions of inequality.

Two other broad themes dominate Budget 2016: a stimulus package to spur rural consumption and enhanced outlay to speed up investment in infrastructure. As argued in these pages a few weeks ago (http://goo.gl/GvFnbP), Jaitley was faced with a binary choice: either ramp up public investment to derive economic growth, or stick to the fiscal straight-and-narrow. A spirited public debate ensued with growth adherents advocating a temporary slippage in fiscal deficit. Fiscal hardliners argued it would be foolhardy to relax vigil during these trying times of global turmoil; a downgrade by credit rating agencies would scupper even incipient growth impulses.

In the end, the minister has chosen both options. How he achieves both ends will have to be seen. While his public investment outlay is up 15.5 per cent over previous year’s estimates, he has also set aside large amounts for the rural and farm sectors. Jaitley stated capital expenditure on railways and roads will alone account for Rs 2,18,000 crore this year. Additional outlays have been announced for investment in power generation, ports and waterways. It is interesting to note that even in infrastructure investment, the emphasis is on the rural sector: investing in expanding the coverage of irrigation (to reduce Indian farmers’ vulnerability to fickle monsoons) and investing in rural roads and rural electrification. Connecting unconnected villages will help farmers get their produce to markets. 

In the midst of this enhanced spending, the FM has also promised to adhere to the fiscal deficit target: 3.5 per cent of gross domestic product. A lot will depend on the revenues he manages to raise — Rs 19,610 crore of additional tax revenue (some of it from soaking the rich) and a 25 per cent increase in non-tax revenues. One large chunk of non-tax revenues (Rs 98,995 crore, compared with last year’s Rs 56,034 crore) is expected to come from telecom spectrum auctions. The other source of non-tax revenue is a leap of faith: the government expects Rs 56,500 crore from disinvestments. In this fiscal year, the government managed only Rs 25,312 crore against a target of Rs 69,500 crore.

Undoubtedly, the agricultural sector needs additional resources: it is not only hobbled by numerous structural deficiencies but poor monsoons over the past two years have caused deep distress in the sector. The Budget wants to double farmer incomes by 2022, by facilitating easier access to markets for inputs and finished products, higher credit allocation and better infrastructure. But, the text lacks details of how this will be achieved; there is no mention of a roadmap.

A massive allotment of Rs 2.87 lakh crore — in the form of grant-in-aid — has been made to village panchayats and municipal bodies. Again, there is lack of clarity about the end-objective of this fund flow. Will it be used for local infrastructure? How will the money be spent — in one year or five years?

The FM’s intentions seem honourable and generally aimed in the right direction. The economy needs higher public investment in the absence of private sector capital expenditure; there are deep structural flaws in the farm and rural sector that need urgent corrective action; fiscal discipline is non-negotiable. What’s lacking is clarity, or the nuts and bolts of how the FM intends to achieve these objectives. There are some other unanswered questions in the Budget:

Monetary Policy and Monetary Policy Committee have now acquired a statutory basis. Details on the committee’s composition are absent. While it has been clarified that there will be equal representation from both the government and the central bank (with RBI governor getting the casting vote), it is not known whether the original plan of appointing a senior bureaucrat on the committee as an ex-officio member still exists. The bureaucrat’s status as an observer is to report to the ministry on the voting pattern of the committee members. I am sure you get the picture.

There is an overall increase in the incidence of cesses and surcharges. One example is the Krishi Kalyan Cess, which will levy an additional 0.5 per cent on all taxable services. When combined with a consumption upsurge, due to Pay Commission arrears and a fillip to rural demand, the after-effects are most likely to be felt on the price line. What happens to inflation targeting then?

PM Narendra Modi’s ambitious Make In India programme suffers from domestic industry’s negative propensity to invest. Industry, in turn, complains that bank credit is not forthcoming. Banks, on the other hand, carp that their ability to lend is seriously impaired by mounting bad loans. In short, banks need fresh capital to start the lending process once again. Against this background, Jaitley’s allocation of only Rs 25,000 crore towards bank recapitalisation is underwhelming. FM Jaitley also mentioned consolidation; is he proposing public sector bank mergers as a way of reducing the drain on the Central exchequer?

The fiscal deficit target for 2016-17 — 3.5 per cent of GDP — is premised on GDP growing at 11 per cent. Given the global headwinds, and exports contracting for 14 months consecutively, slippage in the 11 per cent target will not be very surprising. Hopefully, the government’s resource transfers will keep the growth trajectory along expected lines.

A lot of Jaitley’s wishes are riding on revenue estimates delivering. He collected an additional Rs 54,334 crore of indirect taxes over the budgeted estimate during 2015-16 by increasing taxes on petro products, at a time when oil prices were crashing globally. Gross tax revenues are expected to grow by 11.73 per cent during 2016-17, at the same rate as India’s GDP. He is expecting tax on luxury consumption and a plethora of cesses and surcharges to fill the gap. It might be a bit of a tall ask.

There are too many imponderables in this well-intentioned Budget. Hopefully, some clarity will emerge in the coming weeks.

This article was published as cover story in Businessworld magazine (issue dated 'March 21, 2016) as part of the publication's special Budget package, titled 'Budget 2016 Split Verdict'.

The story can be found here.

GDP Blues: April-June (2012-13) Data Sums Up Economy's Woes

The year has begun according to expectations. GDP growth figures for the April-June quarter of 2012-13 – at 5.5%, measured on a year-on-year basis -- reveals that the slow growth trend thrown up by the final quarter of 2011-12 (at 5.3%) continues.

This is not entirely unexpected. In fact, many analysts had predicted the growth number close to the final number. For instance, Bloomberg and Reuters had predicted the growth number at 5.2% and 5.3% respectively. Rating agency ICRA had estimated 5.1% while Moody’s assessment clocked in at 5.2%. Some analysts have tweeted that at 5.5% Q1 GDP growth is actually better than expected.

However, there are a couple of issues that must be noted immediately. One, at this growth rate, India is no longer the second-fastest growing economy in the region. It now lags behind Indonesia and The Philippines, with Malaysia nipping at its heels. Niranjan Rajadhyaksha has a nice short piece on it in Mint (read here).

There are is another source of anxiety. Manufacturing growth during the quarter, measured on a year-on-year basis, comes in at a dismal 0.2%, continuing the trend from the previous quarters. So what really saved the economy seems to be a 10.9% growth in construction and 10.8% growth in the segment titled as “financing, insurance, real estate and business services”. This seems to be a bit of an anomaly: if construction grew by over 10%, then it must have consumed cement and steel. Yet, this does not reflect in the manufacturing numbers -- unless, of course, the construction industry was running down its accumulated inventory of raw materials. Also, steel and cement combined have a decent weight in the index for industrial production.

The pathetic manufacturing data pretty much reflects the slowdown tightening its grip on the economy. Given that 0.2% growth also means people consumed almost exactly as much as they consumed during April-June 2011, does it also reflect slowing down demand? Could be true, given that private consumption expenditure grew by only 4.7%. This is lower than the growth registered by consumption expenditure in the past few quarters, particularly 6.% in the immediately preceding quarter. After all, wasn't it the boast of policy wonks that the consumption story had kept the India story vibrant during the global slowdown? That engine of growth seems to be sputtering now.

The other engine of growth -- investment -- also throws up a depressing picture. Investment growth during Q1FY13 came in at a measly 0.7%. The Indian economy at this point seems like an aircraft with both its engines seizing up.

So, where is this 5.5% impetus coming from? Consumption of services? Perhaps, especially because of money distributed by the government in the form of social sector hand-outs. The segment “community, social and personal services”, which captures these payouts (or considered an euphemism for all kinds of social sector hand-outs), grew by almost 8%. The government’s own expenditure – under the head “government final consumption expenditure” – has also grown 9%.

This pretty much sums up the problem facing the economy: largesse distributed by the government is distorting income levels, creating a spike in aggregate demand without an accompanying boost in investment activity (or creation of sustainable assets). This, in turn, is leading to a situation of low growth and high inflation.

Rating agency Crisil has come up with two interesting reports, one of which states that rural consumption now out-strips urban consumption. This outcome is primarily a consequence of money doled out in the rural areas by the government, described by some economists as money thrown from a helicopter.

But, that still leaves many unanswered questions in this puzzle -- for instance, if the rural consumption story is really so strong, and growing apace, why isn't manufacturing responding by increasing capacity? Is it being discouraged by the current policy paralysis? Or, are expectations playing a major role: that this rural story may not be a secular trend and might peter out soon? Or, expectations that interest rates might not soften in the near future? Methinks it's a combination of all the three expectations.

Right Fuel For Economic Growth

The government should have devoted a good part of its spending in building infrastructure. This would not only have alleviated pressures on the price line but would have also boosted investment growth

IT IS time that the government steps up to the plate. With the global economy slowing down perceptibly and policy advisers in the government trying to figure out how the ripple-effects will impact India, there is a need for the government to act now, in a meaningful economic manner that provides the right fuel for the economy’s tank. This is not to suggest a return to the old ways of command and control but to provide the right growth impetus to economy. The urgency has got somewhat heightened by the latest inflationary figures.

The government has so far relied on the central bank to sort out some of the large and pressing economic problems, but it’s now time to shoulder some of that responsibility too. Many commentators have been speculating about the action expected from the Reserve Bank on April 29, when it announces its annual monetary and credit policy for 2008-09, and some have even gone to the extent of suggesting what the central bank should be doing. But the onus for squelching inflationary expectations cannot lie with the central bank alone. The reason for that lies in the nature of the problem and the prolonged frailty of the structural deficiencies.

The superior quality of economic growth in the Indian economy for the past 48 months or so has been fired largely by investment in industry. Prior to that, it was consumption that was driving the Indian economy. It is now being increasingly felt that fresh investment by Corporate India into new capacities may slow down, thereby imperilling the very foundation of the sound growth experienced over the past few years. Real investment has grown at an annual average rate of 17% since 2002-03. Or, in other words, investment has been contributing to over 35% of GDP every year. While consumption was earlier the main driver for growth, the contribution of investment to growth over the past four years has been outstripping that made by consumption. However, recent data on investment growth does show some softening from the previous growth levels.

For instance, bank credit to the commercial sector, as reported every fortnight by the Reserve Bank, has been showing a declining trend. Bank credit to the commercial sector (food plus non-food credit) as on June 22, 2007, over March 30 was down 1.7% compared to a growth of 0.9% in the same period in 2006. At the end of the second quarter, bank credit in the first six months was up 5% compared to 10.2% in the first six months of 2006. For the first nine months, bank credit grew only 11.3% compared to 17.2% in 2006. And, finally, bank credit on March 14, 2008, was up 17.8% in 12 months, but far lower than the 24% recorded in the 12 months of 2006-07. It also seems that there is some tapering off of the volume of investments announced as well as the volume of investments implemented.

The government seems to have anticipated this trend. In the budget, the finance minister cut personal income taxes in the hope that some of the resulting increase in disposable income would find its way into additional consumption. Also, the sixth Pay Commission’s recommendations are expected to kick in from the third quarter — the government also seems to be banking heavily on the resulting consumption surge to work some wonders for the economy. Add the additional push from the states, and some economists expect the consumption party to continue till March 2010.

BUT that still does not take care of the deeper problems that are simultaneously plaguing growth as well as stoking the inflationary fires. One of the core issues is the supply-side afflictions. True, part of the push to the WPI has emanated from global food prices. But then the contribution of domestic supply-side problems has neither diminished nor can it be wished away summarily. And, it is here that the government seems to be failing in its role.

Take a look at the capital expenditure (plan plus non-plan) budgeted for 2008-09. Total capital expenditure during 2007-08 amounted to Rs 1,20,787 crore (revised estimates). If the one-time expenditure of Rs 35,531 crore incurred on acquiring the RBI’s stake in State Bank of India is deducted, the comparable figure works out to Rs 85,256 crore. When compared with the actual capital expenditure of Rs 68,778 crore for 2006-07, this is a good 24% higher. But, against the Rs 92,765 crore budgeted for 2008-09, the growth under this head is only about 9% this year.

That is a sharp drop in government’s spending for building assets. One would have expected that in times like these, the government would have devoted a good part of its spending in building infrastructure — such as roads, bridges or power distribution networks in rural areas — to sort out some of the supply-side bottlenecks. This would have then taken care of not only alleviating some of the pressures on the price line but would have also continued to provide the required impulse to investment growth. Two issues arise hereon.

• Prima facie it seems corporate investments into fresh capacities do not seem to be strategic about business cycles. Fresh research might be needed on whether companies wait for sufficient internal accruals before embarking on capacity-creation, primarily because the trust on external sources — particularly the bond markets — could be low. That threatens to then impinge on another acknowledged source of GDP growth — overall productivity growth in the economy.

• Given that the government’s expansionary fiscal measures could be feeding the demand-supply gap for some more time to come, the RBI’s task in managing the price line becomes that much more difficult. The question that arises then is: will the next policy, therefore, follow the predictable path of demand suppression or selectively ease funding of fresh capacities to step up supplies, especially to the rural and SME sectors?

Admittedly, walking the fine line between growth and inflation is becoming increasingly perilous.

Published as an Op-Ed in The Economic Times (April 11, 2008)