Budget 2017 is poised to be an important event. On the one hand, the broad macroeconomic backdrop that India enjoys remains markedly better than most peers. On the other hand, the near-term momentum in economic recovery has been severely hurt of late—though likely only a transient phenomenon—following the ban on high-value currency notes. However, the economy can rebound beyond the first half of 2017, and India’s long-term growth prospects remain robust, buoyed by sound fundamentals and several supply-side reform initiatives. India enjoys a structurally strong domestic demand. Boosting its supply-side economics is the key to the long-term success of the economy. The primary challenge for Finance Minister (FM) Arun Jaitley is to reinvigorate momentum in economic growth without compromising materially on the government’s fiscal consolidation commitment.
On the key macro metrics—growth, inflation, current account and fiscal deficit—India has stepped up in the past two to three years. Since mid-2014, on average, real GDP has grown by approximately 7.5 percent, Consumer Price Index (CPI) inflation has slowed to below 6 percent, and current account deficit is down to approximately 1 percent of GDP. Beyond the ongoing phase of a sharp drop in momentum in economic activities since November, one expects India’s GDP to grow at 7-8 percent year-on-year over the coming years. In the next one or two years, CPI inflation will most likely hover around 5 percent. The twin deficits look set to stay in check. It seems that current account deficit as a proportion of GDP is unlikely to cross the 1 percent handle in the next couple of years. Adhering to its fiscal deficit target road map remains feasible for the government, while a conscious modest relaxation of the deficit targets to provide an additional boost to the economy cannot be ruled out. With better fiscal health in place, the government is also in a position to focus on structural reforms such as implementing the Goods and Services Tax (GST). The RBI’s monetary policy under Governor Urjit Patel and the monetary policy committee (MPC) will likely maintain an accommodative bias–I pencil in another 50 bps of repo rate cuts by mid-2017. Amid an otherwise bright macro backdrop, the two issues that have remained laggards for the Indian economy are the asset quality of the banking system and private capex momentum; there is no indication of any quick turnaround in these areas.
India enjoys a structurally strong domestic demand Image: Robert Nickelsberg / Getty Images
India’s fiscal arithmetic remains, by and large, on a comfortable footing. Barring any major adverse surprises, the central government is on track to meet its FY16-17 fiscal deficit target of 3.5 percent of GDP. The final milestone for fiscal deficit as per the Fiscal Responsibility and Budget Management (FRBM) Act is 3 percent of GDP, which remains achievable by FY18-19, in my view. Overall, the government remains committed to fiscal discipline, and the risk of any major fiscal slippage remains minimal. In fact, after ballooning earlier in the decade, India’s fiscal deficit has decreased significantly since FY12-13 on the back of disciplined spending, led by a sharp drop in energy subsidies, and windfall excise duty collections on petroleum products, as well as a modest uptick in other tax revenues. Such factors will likely remain relevant in the coming years as well. The overall government (central + states) debt-to-GDP, after declining from a high of about 83 percent in FY02-03, has also been stable over the past six years averaging at approximately 67 percent of GDP since FY10-11. It is expected to decline gradually in the coming years.
However, at the current juncture, the government faces an interesting choice—whether to relax the fiscal deficit targets moderately to boost the economy or be rigid with the FRBM road map. Although staying on the path of gradual fiscal consolidation remains feasible, one cannot rule out the making of a conscious choice of a modest relaxation of the deficit targets in the budget. The terminal target levels of a fiscal deficit of 3 percent of GDP and revenue deficit close to zero are unlikely to be altered. However, a near-term relaxation of the FRBM road map will offer greater headroom for fiscal policy to stay proactive and counter-cyclical. Also, the government’s efforts to implement reforms that improve the efficiency of expenditures (example, subsidy rationalisation, direct benefit transfer), as well as structural tax reforms to improve revenue collections (example, GST), are long-term positives for India’s fiscal health. While the focus on the indirect tax front is on the implementation of GST, the budget will remain important for any potential announcement on the direct tax front. For instance, the FM, in his 2015 budget announcement, had offered a guideline of gradual reduction in the corporate tax rates, along with simplifying the corporate tax structure (and even followed up on it, to an extent, in the 2016 budget).
The glass for policy initiatives appears more than half full.
While the upcoming budget is important for near-term policy, it is also crucial to closely track the broader picture as regards policy initiatives and reforms. Expectations for reforms in India were so high after the Narendra Modi government came to power that the reality was always likely to disappoint. However, looking back, reform progress has indeed been significant, even if the path has been uneven. The government has shown courage by introducing big and dramatic policy initiatives keeping in mind the long-term macroeconomic priorities of the country, even if some of these have proved disruptive in the short term.
Admittedly, progress has not been without setbacks and has been limited in some areas. For example, the government adopted an aggressive stance in terms of delivering legislation for streamlining the process of acquiring land for industrialisation, urbanisation and providing infrastructural facilities. However, considerable political opposition has forced the government to step back in these areas. Similarly, though some early progress was made on tweaking the country’s labour laws, typically at the state level in some of the states governed by the ruling BJP, progress on this front at the national level has not been significant. Nevertheless, we view the glass of long-term macroeconomic reforms as more than half full.