Fiscal constraint prevents stimulus

The interim budget in February gave a substantial stimulus to the taxpayer. Almost three crore taxpayers moved out of the net, as the minimum threshold was raised. Further the cash transfer to farming households led to some consumption push, and not to forget electoral gains too. Against that backdrop there were expectations of further big bang stimulus announcements. The extra expectation was also because this was the first budget of a government which had come back with a thumping electoral win. It was in a honeymoon first year, with plenty of political capital to spend. It could announce bold and politically difficult reforms, short term pain for long term economic gain. But all that did not happen.

The budget was indeed historic as a first full time woman Finance Minister presented to Parliament a spending plan for 27 trillion rupees. Beyond that the looming reality was that of a tight fiscal constraint. Tax revenues grew slower than target last year. Goods and Services Tax collections also fell short. Indeed, the total financial savings of the households is barely 10 percent of the GDP, which is equal to the total borrowing requirement of the government and public sector. So that leaves very little room for funds for private investment. Since private sector competes with the public sector for savings, which are intermediated by banks, that puts upward pressure on interest rates. This is the crowding out effect.

Recognising this constraint, this Union Budget has reduced market borrowing, and supplemented it by going abroad. This is actually a risky proposition to depend on dollars to invest in government bonds. This would then expose the government liabilities to additional currency risk. Interest rate volatilty might increase. Hence it would be wise to reconsider this idea of issuing a sovereign dollar bond.

There is however a crowding in effect too. The huge investment in connectivity through road, water and rail ways, as well as a national gas and electricity grid, is the kind of public spending that complements rather than crowds out private investment. Of course, it has to be funded from the same fiscal resources.

The increase in the taxation of the super rich makes our direct tax system more progressive. But there is a limit to such socialist tendencies. One cannot overdo it, especially at a time when there are reports that millionaires are leaving India in big numbers. Income tax rates have to be optimal so that compliance is maximal, collection is buoyant and the tax net is as wide as possible. Almost 86 percent of GDP is taxable, representing the non-agriculture component. Are we taxing it all in a comprehensive way, and as fair as possible? India’s overall tax to GDP ratio is among the lowest in the world. The share of indirect taxes is slightly higher than direct taxes, which should change in the other direction.

The budget speech laid out a longer term vision for start-ups, agriculture based businesses and for small and medium enterprises. The currently illiquidity plagued non-bank finance companies too got some relief in terms of government guaranteed enhancement in credit. Importantly an infusion of 70,000 crore of fresh equity into public sector banks will surely increase the quantum of loanable funds.

But ultimately growth will pick up only when private sector investments pick up in a big way, which requires animal spirits and risk-taking confidence. In a world of slowing down economies, protectionism and tit-for-tat import tariffs, it is causing more anxiety and risk aversion. The government has much work left to do to take the economy to an 8 or 8.5 percent growth trajectory to take us to a 5 trillion economy.

(The writer is an economist and Senior Fellow, Takshashila Institution)