Demonetisation And Budgets: All In The Mind

Arun Jaitley will soon be presenting the 2017-18 budget and his well-laid plans may have to incorporate demonetisation-induced changes

It’s 690 seats this year; another 964 seats are up for grabs next year, with the general election to follow in 2019. This inescapable political imperative will weigh on finance minister Arun Jaitley’s mind when he drafts India’s economic policy. The battle for occupying popular mindspace over the past two months is now telescoping into a two-year battle. And if the vast majority of Indians feel confounded after Prime Minister Narendra Modi’s surgical excision of 86% of currency, they shouldn’t despair: They are in the distinguished company of Jaitley who, presumably, is equally disconcerted.

Jaitley will soon be presenting the 2017-18 budget and his well-laid plans may have to incorporate demonetisation-induced changes, over and above those included for introducing the goods and services tax (GST) system. What’s worse, with the GST start likely to be postponed, revenue projections may now have to be recast along traditional lines. Two huge changes in three months is more than just a rude disruption.

Two other elements add to the confusion. One, the railway budget will be merged with the Union budget this year in a meaningful break from a meaningless tradition. Also, the traditional expenditure reporting format under the broad heads of Plan and non-Plan expenditure will be jettisoned.

File photo of Finance Minister Arun Jaitley; Photo courtesy: Mint  

Standing for a moment in Jaitley’s shoes, what’s likely to be more worrying is how the economic slowdown affects revenue growth and how that shapes spending plans—especially committed social sector or infrastructure expenditure—that cannot be trimmed, leave alone eliminated. Jaitley has already promised higher government pump-priming to boost economic growth. Many new variables have cropped up in the meantime, further skewing the math. Modi contributed gamely during his 31 December speech with promises to increase social spending under both new and old schemes.

For example, new interest subventions on small housing loans and farm loans or increases in the number of rural houses built for the poor under the Pradhan Mantri Awas Yojana are some of the schemes which might expand both capital and revenue expenditure bills for 2017-18. It is clear that Jaitley has little option in slashing the outlay for social sector schemes, especially when demonetisation has eroded rural incomes and the ruling Bharatiya Janata Party is unable to dismount the election treadmill. Apart from state assembly elections for Uttar Pradesh, Punjab, Goa, Uttarakhand and Manipur in less than a month, next year will see elections in Tripura, Rajasthan, Madhya Pradesh, Karnataka, Chhattisgarh, Nagaland, Mizoram and Meghalaya.

With the political economy constraining deep spending cuts—at the most, outlays might be shuffled around under different schemes—revenue generation becomes imperative for meeting many of the grand spending plans. This is where rubber hits tarmac.

The demonetisation narrative focused on cornering tax evaders and, through legislative amendments, forcing assessees depositing unreported incomes to pay higher penal rates. This would require enhanced tax scrutiny and inevitably involve some element of persecution. But by stating that demonetisation was launched to punish currency hoarders, it subjected the majority to widespread suffering for the misdemeanours of a few. The messaging was subsequently imbued with nationalist overtones and repurposed to focus on moving India to a less cash economy.

Enter the good cop: News reports claimed that Jaitley had hinted at lower tax rates in a meeting with tax officers, citing how similar attempts earlier had met with success. News leaks from unidentified finance ministry sources also made similar claims.

Jaitley later seemed to deny his statement without actually denying it. There’s no text of Jaitley’s speech; only a summary is available, which has him stating there was an urgent need for a change of mindset: “India has to move towards a mindset of voluntary compliance…payment of legitimate taxes should be considered as part of the process and nobody should think that tax evasion is acceptable.”

This is where things get muddied up. By using the term “mindset”, Jaitley pivots seamlessly into the arcane world of behavioural economics. It is reassuring to note that Jaitley recognizes the importance of mindset in correcting tax compliance behaviour. But his public musings betray a contradiction. Initiating mindset change is a long-term project which involves altering social norms using a combination of psychological and social forces. The post-demonetisation regime instead uses a carrot-and-stick approach: simultaneously offering incentives (aka the Laffer curve) and disincentives (penalties).

The World Bank’s World Development Report 2015—titled “Mind, Society And Behavior”—states clearly that penalties or incentives have failed to improve tax compliance across the world. The UK government’s behavioural insights team, also known as the “nudge unit”, claims to have used behavioural sciences successfully to improve tax compliance in the UK and other countries. Jaitley will do well to remember that like liquor prohibition failed to stem alcoholism and related social problems, a one-time demonetization (or a subsequent penal regime) might not be enough to raise tax revenue on a sustainable basis. While the impact of behavioural sciences in influencing policy outcomes is still imprecise, one thing is clear: lasting changes in social norms require long-term investments.

The above article was first published in Mint newspaper on January 11 and can also be read here

Key GST Lessons From The World

The long march to implement the long-awaited Good and Services Tax in India has just begun. It is instructive to understand how other countries introduced this tax and cherry-pick lessons from their experiences

As India gets ready to celebrate the 70th anniversary of its independence, it is also preparing for another important milestone. Great hopes have been pinned on the Goods and Services Tax (GST), which will liberate Indian citizens from the tyranny of multiple levies and tax rates. This tax will unite almost all state and central indirect taxes into one single category, thereby creating a true single market in the country.

The passage of the Constitution (122nd amendment) Bill on 3rd August in the Rajya Sabha marks the crossing of the first hurdle in implementing the transformational GST regime. However, there is still substantial legislative work to be done – apart from the amendment (which will now travel to the Lok Sabha, the President’s office and state assemblies for ratification), Parliament will have to vote in two further bills to make GST a reality.

Beyond the legislative workload, Indian administrators and businesses will need to do their homework before this reality sets in. There are approximately 140 countries in the world that have introduced GST (also called VAT, or Value Added Tax), and there are manifold lessons to be drawn from their respective implementations.

Malaysia was the most recent country to implement GST in 2015, having announced its intention to do so in 2009. Malaysia’s experience highlights how inadequate preparation can hamstring the tax’s speedy implementation from the outset.[i]Malaysian businesses and tax authorities had a harrowing time adjusting to the new system, which was riddled with uncertainties and teething problems. The Malaysian government had to contend with street protests by small businesses and traders who were confused by the new system—whether in calculating the correct value-added rates, or in seeking tax credit refunds. Unsurprisingly, opposition political parties found it opportune to fish in these troubled waters, adding to the government’s mounting operational woes.[ii]

There was another layer of complexity. Malaysia had a multiple GST rate structure, much like the one proposed in India. A 6% GST (among the lowest in the world) was introduced, with some essential goods exempted and some goods attracting a zero rate i.e they were not exempt and could be taxed later. India too has proposed a multi-tiered structure, which will be finalised by the GST Council whenever it is set up.

Two clear lessons emerge from the Malaysian experience. Under pressure to launch GST as soon as possible, the Indian government must resist temptations to truncate the implementation process, which will include the training of tax officers and business executives. A presentation by revenue secretary Hasmukh Adhia estimates that 60,000 tax officials in both central and state governments will need to be trained.[iii] GST is a tectonic shift in the indirect tax architecture: the point of taxation shifts from producers to consumers, requiring a significant reorientation in philosophy and perspective. This overhaul cannot be completed unless the technology backbone is in place and all the relevant economic agents are registered. That alone is a mammoth task. There should, therefore, be no compulsion to implement GST by April 2017 if either the system is not fully tested or all the pieces are not firmly in place.

A related issue almost tripped up Malaysia’s GST experiment: the timely payment of input tax credit refunds.[iv] Unless the necessary technology infrastructure is installed, it can take months to refund tax credits, thereby creating cash flow problems for all links in a supply chain. This can easily convert GST supporters into detractors. Delaying tax credit refunds leads to protracted litigation and provides perverse incentives for the supply chain to stay outside of the organised system.

A second set of lessons can be drawn from Singapore. The city-state introduced GST in 1994 but witnessed a sharp rise in inflation soon after its introduction, mirroring the experience of many other countries.[v] Although inflation rates tend to moderate after a couple of years, the Indian government must be prepared for an initial surge because of India’s unique supply-side pressures, which tend to firmly embed inflationary expectations in households and businesses. India can consider what many countries did: initiate anti-profiteering measures at the retail level to protect consumers from price gouging.

Subsequently, the Singapore government faced other predicaments, like t the need to increase GST rates without stoking inflationary pressures. Eventually Singapore did increase GST rates (from 3% in 1994 to 7% currently), but simultaneously cut income tax rates (both at the individual and corporate levels) and accelerated the delivery of welfare benefits to lower income sections.[vi] While GST is efficient, it can also be regressive, especially for low income workers or pensioners. The Indian government therefore needs to be cognisant of this, and act cautiously.

The final set of lessons come from Canada, which introduced GST in 1991 amidst great internal conflict and disagreement. In fact, at the tax’s introduction, three provinces–Alberta, Ontario and British Columbia–even sued the federal government for violating constitutional agreements and limits. But over the years, Canada has pioneered a unique system that allows for three different models to co-exist.[vii] [viii]For example, Quebec is permitted to administer its own value-added tax alongside a federal GST. Quebec is responsible for all tax administration in the state, independently determining its tax base, independently fixing the state VAT rate, and even remitting federal GST collected in the state to the central government for a fee.

Compared to Canada, India has been able to forge a broad consensus among most states through a process of negotiation and compromises. The only point of disagreement remains the GST rate, which has been entrusted to the GST Council. This may lead to intense political manoeuvring with demands for special status or special rates. Tamil Nadu has already expressed its dissatisfaction with GST.

These examples clearly illustrate that the GST battle has barely begun: there are many mountains to climb, and multiple fires to extinguish along the way. The process of bipartisan consultation and consensus-building with states and various stakeholders must continue to make GST a cornerstone of successful and sustainable fiscal federalism.

This feature was exclusively written for Gateway House: Indian Council on Global Relations. You can also read it here.

References

[i] Pachisia, Vivek; Lessons from countries that have implemented goods and services tax; Financial Express; July 28, 2016;http://www.financialexpress.com/economy/gst-lessons-from-countries-that-have-implemented-the-goods-and-services-tax/331289/

[ii] Dey, Sudipto; Some Lessons From Malaysia That India Can Use; Business Standard; New Delhi; June 13, 2015; http://www.business-standard.com/article/economy-policy/gst-some-lessons-from-malaysia-that-india-can-use-115061300748_1.html

[iii] Adhia, Hasmukh; Goods and Services Tax: Next Steps; Department of Revenue, Ministry of Finance, Government of India; New Delhi; August 4, 2016;http://finmin.nic.in/press_room/2016/GST_nextstep_04082016.pdf

[iv] Beh, Yvonne & Tan Yi Lin; GST In Malaysia: One Year On; Wong and Partners; April 2016;http://www.wongpartners.com/files/Uploads/Documents/Type%202/WP/al_kulalumpur_gstmalaysia_apr16.pdf

[v] Ilias, Suhaimi with Zamros Dzulkafli, Ramesh Lankanathan and William Poh; Malaysia: GST- Early Impact Assessment; Maybank KimEng; April 2015;http://info.maybank2u.com.sg/pdf/investment-insurance/misc/misc-15-04-15-3.pdf

[vi] Singapore Government; How Is the Government Helping to Mitigate Inflation in Singapore; December 14, 2012; https://www.gov.sg/factually/content/how-is-the-government-helping-to-mitigate-inflation-in-singapore

[vii] Kumar, Sanjay with ML Sukhpal, Sandeep Rawal, Ashok Kr Pandey, Samar Nanda; Policy Paper on Role of Central Board of Excise and Customs in GST; National Academy of Customs, Excise and Narcotics;http://nacen.gov.in/inspire/uploads/downloads/569887ea212d1.pdf

[viii] Sharma, Radheshyam with JK Simte, MK Sarangi, KGVN Surya Teja, Sydney D’Silva and Manish Thapliyal; How to achieve administrative harmony between centre and states in the GST regime; National Academy of Customs, Excise and Narcotics; January 6, 2016;http://nacen.gov.in/inspire/uploads/downloads/56989a961d524.pdf

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.

Budget: It’s Now Or Never

The 2016 Budget could be the last chance for the government to redeem itself and find a way back into the common man’s heart.

It is that time of the year again. Newspapers, business channels, Internet sites are all full of ideas, suggestions and even advice for Finance Minister Arun Jaitley. The minister’s appointment diary is brimming with meetings scheduled with representatives from industry, trade unions and agriculturalists. They all come armed with wish-lists, hoping to influence the final design of this year’s Budget exercise. 

Jaitley is on track to present his third budget (for 2016-17) and, while patiently sticking to the routine of meeting various lobbies and representatives, he is aware of the criticism he faced for his first two Budgets and the challenges that lie ahead. It’s now or never; this might be his last opportunity to introduce bold reforms and sow the seeds of future growth. Next year might be too late; assembly elections for Uttar Pradesh and Punjab among other states are scheduled for 2017 and expedient politics traditionally triumphs sensible, hard-nosed economic measures in poll-bound years; the year also marks the beginning of the countdown to 2019 general elections.

To be fair, the FM does seem trapped in a cleft stick. Look at the hand he has been dealt: the global economy is struggling to emerge from a prolonged slowdown, leading to lower demand for Indian goods and services, and shrinking exports; China’s economic recalibration is spooking global capital flows and skewing the pitch for foreign direct investment (FDI) into India; indiscriminate past lending by banks (largely public sector banks) has impaired their ability to finance new projects, especially infrastructure projects; power generation and supply — essential for manufacturing activity — is stuck in a tangle of issues relating to fuel supplies, pricing, past regulatory infractions; agricultural output remains depressed due to sub-par monsoons, in addition to legacy issues of low productivity, inadequate credit and input supplies; this has dampened rural demand, thereby impacting a wide range of industries. 

In addition, the pre-election promises of fortifying the country’s manufacturing base, resulting in additional employment, fanned unrealistic expectations; when these did not materialise (as they were not expected to in such a short period), they spawned widespread disappointment with the regime’s economic managers.

It might be instructive to review the FM’s first two Budgets to decipher the tenor and direction of this government’s economic policy-making. In his debut (Budget 2014-15) innings, presented 45 days after taking office, the focus seemed to be on long-term, structural reforms: FDI up to 49 per cent in defence and insurance, guarantees of a stable and predictable tax regime, real estate and infrastructure investment trusts, incentives for foreign institutional investors (FIIs) and fillip to debt markets. The second outing continued policy thrust in the same direction: greater decentralisation and balanced regional growth through higher devolution to states, commitment to increased public expenditure to kick-start investment in the economy and a host of institutional reforms to attract fresh domestic and foreign investment.

But, expectations built up in the pre-poll season cannot be wished away easily and stakeholders have started voicing their disappointment. In short, Jaitley has to find ways to prod the economy into a higher growth trajectory immediately, without over-playing his hand or pushing the economy down a fiscal slope. On the other hand, the government is committed to certain expenditure — social sector allocations (especially in a year of agricultural distress and depressed rural incomes), a higher outgo because of Seventh Pay Commission recommendations and One Rank One Pension settlement (both are expected to result in combined outflows of about Rs 100,000 crore), interest burden on past government loans, capital infusion for state-owned banks and other PSU companies, plus a host of other obligations.

The Good News

Fortunately, revenue growth has been good. Data from the Controller General of Accounts shows net tax revenue for the first eight months (April-November) at Rs 4,64,864 crore, a growth of 12.5 per cent over the corresponding period last year. Non-tax revenues rose 35 per cent, helped primarily by spectrum auction proceeds and transfer of profits from public sector companies. There are three reasons behind tax revenue growth — higher duties on petroleum goods, the new service tax rates and the enhanced cess.

There are other encouraging signs as well. Bursts of public expenditure during June, July and September have taken the government’s total planned capital expenditure to Rs 97,788 crore during the first eight months of 2015-16, a 57 per cent jump over what was spent during the corresponding period last year. For example, funds allocated during 2015-16 to states and Union Territories for development of national highways, according to a PIB press release, is significantly higher than previous year: Rs 81,006.99 crore against Rs 31,495.20 crore in 2014-15, a jump of over 157 per cent. It remains to be seen how much of that allocation is actually spent. The National Highways Authority of India has so far awarded 43 projects in the current financial year for a total length of 2,624 kms.

The individual ministry-wise data provides greater insight. The ministries of road transport and highways, and rural development are among heavy-hitting ministries, with both having exhausted 74 per cent and 80 per cent of their budgeted plan expenditure for 2015-16 in eight months. Even the ministries of agriculture, health and family welfare and human resource development have spent a higher proportion of their budgeted plan expenditure than last year. More pointedly, among the large spenders seem to be ministries charged with key social sectors — such as, rural development and health. 

Clearly, the government is betting on higher public expenditure to shake the economy out of its torpor. This is classic text-book stuff. It is also in keeping with the FM’s undertaking in last year’s Budget speech to increase public investment outlay: “The total additional public investment over and above the RE (revised estimate) is planned to be Rs 1.25 lakh crore, of which Rs 70,000 crore would be capital expenditure from budgetary outlays.”

Clear & Present Dilemmas

The proverbial monkey-wrench is lack of revenue to finance public projects. While revenue generation has so far held up, largely on back of indirect taxes, there are multiple pressure points building up.

One, industrial activity as represented by the Index of Industrial Production shows 3.9 per cent growth during April-November 2015 over the same period last year, helped in large measure by festival shopping during October. Three among the top five items which contributed to October growth corroborates this — gems and jewellery, telephone instruments (including mobile phones) and passenger cars. On the flip side, what is worrying is stagnation in consumer non-durable items, which shrank by 0.5 per cent during April-November. In fact, consumer non-durable items stayed in negative zone in five of the eight months. In addition, the Nikkei Purchasing Managers’ Index also indicates manufacturing shrinking in December, affected partly by the Chennai floods. 

Two, the continuing fall in exports — close to 20 per cent by November — and its impact on overall manufacturing activity, is likely to dampen revenue generation in the coming fiscal. Worryingly, commerce secretary Rita Teotia was widely reported informing chambers of commerce that 2015-16 will end with $270-billion exports, markedly lower than $311 billion in 2014-15. The government and Reserve Bank of India (RBI) have allowed the rupee to depreciate, probably to keep exports competitive. This becomes especially critical when viewed against the Chinese central bank’s repeated devaluation of the yuan — in August 2015 and again on January 7, 2016.

This then, in short, is the FM’s dilemma. How does he meet the various expenditure demands — commitment to social sector schemes; need to keep investing in public investment to rekindle economic growth; allocations to agricultural sector to forestall distress; increase in salaries, wages and pension of government employees (including the armed forces); and, finally (but most importantly), increased allocation to states from the divisible central tax pool under the Fourteenth Finance Commission award. Worse, Jaitley has to fork out increased sums of money while staring down a diminishing exchequer.

The government seems to have reached the crossroads and needs to select a path that will help it emerge from this impasse. A few ineluctable options present themselves.

Feeling Fiscy

First, will the government be willing to take the fight to fiscal conservatives? In short, will it be willing to let the fiscal deficit slip just that wee bit to fire up animal spirits in the economy? 

This question goes to the heart of the Bharatiya Janata Party’s (BJP’s) economic philosophy, which has been morphing from its avowed “swarajya” policy in the 1970s and 1980s to pro-globalisation and support for foreign investment in the 1990s. Among the many consanguineous economic ideologies that exist within mainstream BJP, its affiliates and allies (such as Shiv Sena, Vishwa Hindu Parishad) and its mother organisation Rashtriya Swayamsevak Sangh, the umbrella right wing also includes economists of variegated hues — right-wing economists trained in Western universities (who find enlarged fiscal deficits and higher government debts anathema to the conservative notion of smaller government, low tax rates, and laissez faire economics) sitting cheek-by-jowl with free-market votaries who do not mind tweaking rules to protect domestic interests from competition (the lopsided FDI policy on foreign retail is a good example) or to suit local conditions. A lot will depend on who gets to monopolise airwaves in coming weeks.

There are other external pressures: credit rating agencies (especially the Big Two) are also wedded to fiscal orthodoxy and any deviation invites a rap on the knuckles or a downgrade, depending on the severity of the slippage. Interestingly, when the US allowed its fiscal deficit to expand to $1-trillion-plus between 2009 and 2012 — as it accelerated spending to stave off after-effects of the 2008 global financial crisis and the consequent economic slowdown — it did elicit censure from a section of Republicans in Congress, but that was pretty much it. It’s only in 2015, as the US economy continues to recover, that the deficit narrowed to $439 billion, the lowest since 2008.

Interestingly, while fiscal conservatism is considered an essential ingredient of the Republican ideological toolkit, even the Bill Clinton presidency adhered to large parts of this credo, attracting the new moniker “Liberal Democrats”. In a recent, cogent essay in The Atlantic Why America Is Moving Left, political scientist Peter Beinart, argues that President Barack Obama has pushed US economic policy dramatically to the left and it is likely to stay that way for some time to come. But, in India, conservative orthodoxy has slowly and insidiously sunk roots across ideological divides, thereby making fiscal deficits a dirty and contemptible term, even when sought to be used as a one-off, emergency measure. 

There are reasons to be wary of rising fiscal deficits; the reckless borrowing and spending of the 1980s brought India close to bankruptcy in 1990. Higher fiscal deficits and swollen debt levels could jeopardise the long battle that’s been waged to achieve fiscal stability, especially when the government’s inability to control wasteful spending or to execute expenditure rationalisation is well known. Relaxing vigil on the fiscal front is like a slippery slope: reining it back requires enormous political courage. 

If Jaitley, therefore, chooses to expand the fiscal gap a bit to finance all manners of expenditure (which increasingly look unavoidable now), he should expect commentators to look askance. To that extent, the FM seems to have already laid the foundation in his FY2016 Budget speech: “…insisting on, a pre-set time-table for fiscal consolidation pro-cyclically would, in my opinion, not be pro-growth…I will complete the journey to a fiscal deficit of 3 per cent in 3 years, rather than the two years envisaged previously…The additional fiscal space will go towards funding infrastructure investment.” But, between a paragraph in the budget speech and facing up to the risk lies a a wide chasm — and lots of criticism to boot.

Show Me The Money

The second tough call is raising revenue. As described above, higher tax revenues in the current economic environment increasingly seems difficult. There is no likelihood of an immediate increase in the number of tax payers which can compensate for the dip in revenues from existing tax payers. It will also be suicidal to increase tax or duty rates.

Part of the solution might lie in focusing on non-tax revenues, specifically non-debt capital receipts. The target for government disinvestment was Rs 69,500 crore and the achievement has been a paltry 18.5 per cent — Rs 12,852.90 crore. Evidently, the government’s policy of second-guessing the market has not paid off. It is also true that selling government assets in a falling market could invite Parliamentary condemnation, and the government may not wish to add this to its current list of woes. But, desperate times call for desperate measures. Jaitley might have to force the issue on this one. He does have some political capital in Delhi and he might have to expend chunks of it to push for disinvestment, regardless of how the Sensex behaves. 

Another partial solution exists in the balance sheet of numerous public sector units. The government is believed to have advised profitable PSUs to pay out higher dividend this year — 30 per cent of post-tax profits or of the government’s equity, whichever is higher. There must be some number-crunching behind this. Budget FY16 estimates Rs 36,174.14 crore inflows from PSU dividends. It is to be seen if the 30 per cent dividend diktat precipitates revenue inflows higher than budgeted. There is also a likelihood that the 30 per cent decree has been necessitated by a shortfall expected in dividends budgeted from RBI, nationalised banks and financial institutions — Rs 64,477 crore. Whatever might be the reason, the government’s revenue projections for the year-end, and the anticipated resource crunch in the next year, might have necessitated the 30 per cent order.

An alternative to leveraging PSU balance sheets also exists. At last count, PSUs were sitting on a cash chest of over Rs 2,00,000 crore. Some of this has already been committed to their expansion projects. But a large part is lying idle, invested in low-yielding assets, like bank fixed deposits. The FM has to marshal these funds for a part of his public investment exercise. 

A distinction might be necessary here. The PSU investible corpus should be used exclusively for creating productive assets closely aligned with the specific company’s business opportunities. Therefore, an engineering company’s cash reserves should be utilised for not only expanding existing manufacturing capacity but also creating new production capacity in the engineering industry. For example, this might be a good time to revisit India’s installed capacity for manufacturing turbines, boilers and generators. This is important because it is linked to another facet of Jaitley’s to-do list: energising Make In India. His boss, Prime Minister Narendra Modi, has been busy collecting air-miles over the past 20 months, soliciting foreign investment from various governments and corporations. The trips seem to have paid off with only a slight uptick in FDI — $16.631 billion during the first half of 2015-16, a 14 per cent increase over $14.691 billion in the same period of 2014-15 — and not the deluge expected.

One reason could be the continuing stress in the developing economies, thereby inhibiting capital flows. But, importantly, the trickle of FDI could also be related to India Inc’s lackadaisical investment propensity. Many large Indian corporations have not been entirely successful in shedding investment inertia acquired during the calamitous 2009-14 UPA-II regime. Domestic industry’s unconcealed lack of confidence invariably has a demonstration effect on potential foreign investors. This needs to be corrected and a beginning could be made by asking PSUs to invest in expansion and fresh capacity, which can crowd-in fresh private sector investment.

When In Doubt, Fly

With FDI continuing to remain important for India, PM Modi is expected to retain, if not increase, his itinerant routine. Apart from crafting a fresh foreign policy doctrine for India, which seeks to project the country as a new power (or, as foreign secretary S. Jaishankar calls it, “a leading power”), PM Modi is also actively trying to drum up investments for India. He sees economic diplomacy as the centre-piece of India’s foreign policy. 

But investments are only a part of economic diplomacy. Truth be told, economic diplomacy, which has a vital role in India’s desire to emerge as a “Leading” power, has twin responsibilities — opening up markets for Indian goods, services and capital (human and financial), as well as attracting foreign inward investments. In this task, he will need the unstinted support of the external affairs ministry. 

The Budget, shorn of inner party rivalry, can provide the necessary strategic impetus. One of the ways in which this can be achieved is through higher allocations to successful tools of development diplomacy (such as, the highly successful Indian Technical and Economic Cooperation Programme, under which 10,000 participants from 161 partner countries visit India to attend various capacity building courses). But, more can be achieved. With economic growth showing green shoots in the US but staying tentative in Japan and Europe, India needs to find new markets for its goods and services. After the 2008 global financial crisis, India was compelled to seek out the Latin American and African markets for increasing exports. But, performance has been desultory at best. The Budget should try to correct that.

At the end of the day, the Budget is a economic policy document and not just a statement of accounts. Or, a list of tax changes. It is expected to spell out a roadmap that indicates the direction of economic policy-making and galvanises the pace of economic growth. Too many opportunities have been lost in the past with policy architects focusing on minutiae; FM Arun Jaitley has the opportunity to make enduring course corrections. 

This article was published as cover story in Businessworld magazine, issue dated January 25, 2016, as part of a pre-Budget cover package titled 'A Make Or Break Budget'.

It can also be read here.