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FM Arun Jaitley astutely released funds for infrastructure spending while staying on the path of fiscal consolidation
Image: Udit Kulshrestha / Bloomberg via Getty Images
The Reserve Bank of India (RBI) under Governor Urjit Patel has made it a practice to surprise the market with its monetary policy pronouncements. In October 2016, when not many had anticipated a rate cut, the RBI delivered a 25 basis point reduction in the repo rate. It maintained status quo in the December policy meeting even though a 25 basis point cut was deemed certain. Again in February 2017, it went against the general expectation of a 25 basis point cut by holding the repo rate at 6.25 percent. Patel blamed the uncertain conditions for the abundant caution that the Monetary Policy Committee (MPC) adopted to keep the rate on hold. The MPC wanted to assess the transitory effects of demonetisation on inflation and the output gap. And now that it has changed its policy stance from ‘accommodative’ to ‘neutral’, the likelihood of further rate cuts this year is uncertain.
This policy move by the RBI should disappoint the central government. It comes against the backdrop of Budget 2017 through which the government struck a fine balance between the need for growth and fiscal prudence.
Finance Minister (FM) Arun Jaitley’s fourth budget had to inevitably address the need for a stronger impetus to growth. Demonetisation and the indifferently executed remonetisation had hit consumption, a key driver of growth, in a big way. With exports and private investment already languishing, growth began to slide despite the government’s attempts to pump-prime the economy through a large dose of public investment: The Economic Survey expects growth to be anywhere between 6.5 percent and 6.75 percent of GDP in 2016-17; this is against 7.6 percent in 2015-16.
To kick-start consumption, Jaitley judiciously chose to leave more money in the hands of the people. He could have embraced Universal Basic Income (UBI)—giving money directly to the people, a concept that was gaining traction in the run-up to the budget. It would have been a political masterstroke, but the government held back as UBI could not coexist with the various subsidies and the move needed to be well thought through. Instead he chose to cut income tax rates and made the highest ever allocation towards the rural job guarantee scheme (MNREGA). This, he hopes, will drive consumption which is critical to absorb the excess capacity that the industry is grappling with. The private sector will not begin to invest unless this capacity is absorbed, and without private sector investment kicking in, economic growth will not accelerate.
The FM also continued with the thrust on public investment by increasing allocation to infrastructure—roads, railways, airports and telecom. Affordable housing was given infrastructure status. He also increased rural spend by 24 percent. These measures should help in creating jobs which, in turn, will drive up consumption.
Another interesting aspect of the budget is the quality of the expenditure. “The total expenditure growth projected in FY18 was quite moderate at 7 percent year-on-year and skewed more towards capital spend than revenue spend… this skew reflects that the government refrained from turning overtly populist in this budget despite the upcoming assembly elections,” said Citi in its report. In fact, as a percentage of GDP, overall expenditure has declined by 0.7 percent.
Jaitley has also ensured that he stayed on the path of fiscal consolidation. While he is set to achieve the fiscal deficit target of 3.5 percent in FY17, he chose to slow down on his journey to 3 percent in a bid to boost public spending. By setting fiscal deficit targets of 3.2 percent of GDP in 2017-18 and 3 percent in 2018-19, he has astutely released funds for infrastructure spending. What makes this effort even more credible are the revenue assumptions. “Overall, revenue targets look largely credible to us. We think any downside risk to the disinvestment target could be met by somewhat higher tax revenue growth arising from a potential widening of the tax net following demonetisation,” said Goldman Sachs in its latest report on Budget 2017.
The government has also done its bit to soften interest rates by limiting its market borrowing to fund fiscal deficit. According to Citi, in 2016-17, the government resorted to market borrowing to fund 68 percent of the deficit against the budgeted 82 percent. In FY18, this will be even lower at 64 percent. Simply put, this would mean lower interest rates in the market for corporates.
Post-demonetisation, the government has used the budget to continue with its move to expand the formal economy. It has capped cash transactions and brought in measures to streamline political funding. These attempts plus the imminent roll-out of the Goods and Services Tax (GST) should expand the formal economy, bringing in more revenue to the government and, in the long run, leading to lower tax rates.
The shortcomings that experts point to in Budget 2017 include the lack of adequate thrust to solve the banking sector’s non-performing assets (NPAs) problem and the slower pace of recapitalising public sector banks. Jaitley could have tried out the ‘bad banks’ option to tackle the NPA issue, as suggested by the Economic Survey. By transferring their NPAs to a ‘bad bank’, the banks—after adequate recapitalisation—would be free to continue their operations. After all, one of the reasons why private sector investment is sluggish is due to poor lending support from the banks. Experts also say that the budget could have done more to create jobs. The FM’s notion of spending on infrastructure and reducing the corporate tax rate for medium and small enterprises by 5 percentage points on the assumption that this will create jobs is just not enough, they say.
However, the negatives are very few and it is not surprising that the budget has been well received. “This was a very good growth-oriented budget. The measures announced by the finance minister, including the lowering of income tax, will help boost consumption. With remonetisation working well and GST on the anvil, private sector investment should also revive shortly,” Adi Godrej, chairman, Godrej Group, told Forbes India after the budget.
Jaitley, of course, would have been happier if the RBI had cut the repo rate in February. Then the economy would have been better primed for faster growth. But he can hardly complain. Like how he chose prudence over profligacy while drafting the budget, the central bank has chosen caution over aggression. Higher inflation, after all, negates the benefits of a faster pace of economic growth.