How budget can beat the blues

As we bid goodbye to 2016, we cannot deny that the economic outlook is not as bright as we would have wished. The reasons are many.

Firstly, the great currency swap has created a cash shortage in the economy, which is not being replenished at the desired pace. Hence some of the consumption and investment expenditure is being postponed, held up, or worse, being cancelled. This is a temporary phenomenon, and hopefully we will see a V-shaped recovery in the following quarters.  The data shows that rabi sowing has been in full swing, taking advantage of the plentiful pre-Diwali monsoon, and the moisture content in the soil. Emergency arrangements enabling farmers to buy seeds, fertilisers and other inputs despite cash shortage seem to have worked.

The second reason for a cloudy outlook is global dollar strengthening.  If the exchange rate drops by even one rupee, India’s gross oil import bill goes up by more than Rs.15,000 crore. Many other imports also become expensive. Oil prices have also started inching up internationally. So inflationary forces are already at play. This means that interest rates do not have enough room to be cut down. As it is, the dollar interest rates have started moving up. In this international scenario, India can’t be cutting rates, when US rates are actually going up.

The third reason is that private investment sentiment is still tepid. Gross fixed capital formation, that part of GDP that measures new capacity creation for future growth, has been stagnant or negative. It can be revived with public spending now, but sooner or later we need the private sector animal spirits to become active again.

The fourth reason for concern is the continuing problem of non-performing assets i.e. bad loans in the banking sector. Much of this is a legacy problem, and is confined to projects in infrastructure, electricity and steel.  The most recent bankruptcy and insolvency legislation will go a long way in providing a speedy resolution of the NPA problem, or at least bringing it within manageable limits. 

The fifth reason for concern is foreign investors’ sentiment, and inflows into India. Last fiscal year, India saw record dollar inflows in FDI, overtaking even China. But this fiscal there have been heavy outflows from the stock and bond markets, caused mainly by the strong dollar, and rising interest rates in the USA. It will be a challenge to attract foreign inflows at the same pace as in fiscal year 2015-16. 

Lastly, and perhaps most importantly, the big looming challenge is that of job creation and livelihood support. The pace of job creation has distinctly slowed down, where recently even one of India’s biggest engineering firms announced a layoff of 14,000 personnel. And new avenues are not opening up at the pace needed to encash India’s promised demographic dividend.

The Union Budget for fiscal year 207-18 will be presented one month earlier, which is a significant break from tradition. It will also be the first time that no separate budget will be presented for the Railways. This is also a year when mid-stream a new tax regime will be unfurled, namely the Goods and Services Tax (GST). Since the GST monies are distributed by a pre-determined formula, the Union Budget will have to make assumptions about when exactly is the rollout date for GST.  Given that some issues still remain unresolved in the GST council, this represents a challenge to the finance minister (FM).

However, here are a few steps that could usher in some positive sentiment. Firstly, the step toward a fiscal stimulus.  Even though oil prices are inching up, they are still far below the days of 100 dollars a barrel. The direct benefit transfer has trimmed the subsidy leakage. The seventh pay commission burden is largely behind us. The response to demonetisation, or rather the cash swap scheme, has led to significant fiscal benefits to local municipal governments, stamp duty collection, clearing of dues to discoms and MTNL. It is possible that some benefits may go to the central government as well. Hence there is enough fiscal room for a tax cut. The FM had promised that corporate income tax rate would go down to 25 percent. So this is the year to start that downward trend. It may be a good idea to give some relief on personal income taxes as well, but in a way that does not significantly deplete the tax net. So a lower rate for all, but a wider tax net for the country. 

The much needed recapitalisation of banks should be done with a combination of fiscal resources, tapping the capital markets and letting Life Insurance Corporation and Pension Fund Organization take a big chunk of equity. It will reduce the NPA problem, and restore credit growth. This also preserves the public sector nature of banks, which is one the government’s stated objectives. Bank consolidation must also be pushed.

A slew of financial sector measures can be announced, which will lead to the deepening of the sector. Gold imports are down 31 per cent this year, which is a healthy sign. The government can push its gold demat scheme more aggressively, thus saving foreign exchange. The corporate bond market needs some tweaking to give parity with the offshore masala bonds. The unfinished reform of long-term capital gains taxation, which began with the amendment to the Mauritius Treaty, is needed. It can give a fillip to the stock and bond markets.

Finally, some fiscal resources should go toward some form of universal basic income.  This can be done by combining several anti-poverty measures, removing overlaps, and using the infrastructure of Jan Dhan Accounts. It can also include health insurance for catastrophic health episodes. These are only some examples, and space constraint prevents us from expounding further. But clearly the Budget has many levers to drive away the temporary blues. We can yet usher in a prosperous and peaceful 2017!

(The writer is a senior economist based in Mumbai)