Reforms, growth boost and a tightrope walk

The macro backdrop to the Union Budget was as follows. An economy which was slowing partly due to global factors, and partly as an immediate impact of demonetisation.  A resurgent and strong dollar globally, and higher interest rates in the US caused by the Trump Presidency. This in turn is also increasing the risk of capital outflows out of developing economies like India. There is also an Increasing global turn towards protectionism causing a doubt about export and jobs growth. And finally increasing prices of oil and other commodities, along with anticipated tax rate hikes in GST causing inflationary pressures buliding up within the economy. In fact there is some apprehension about food inflation as well.

On growth stimulus, it has come via lower income tax to the middle class and hence a boost to consumer spending. It has also come via a record spending of Rs 3.9 trillion on infrastructure. That includes roads, rail, ports, airports and irrigation schemes. All that will surely lead to increase in demand for materials like steel and cement, and also increase in employment. 

Thus in his fourth appearance as Finance Minister, Mr. Arun Jaitley had the classic challenge of providing a strong growth impulse, of increasing spending and purchasing power of citizens, and yet at the same time remaining within prudent fiscal limits.  On all these three fronts the FM has delivered admirably well. One could say that in its third year, the FM and his government could have been bolder. But no reform can be bolder and more disruptive than demonetisation. So it’s not as if the government has not demonstrated its capability for big bang reform, but the macro context presents multiple constraints.  On the growth stimulus, it has come via lower income tax to the middle class and hence a boost to consumer spending. It has also come via a record spending of Rs 3.9 trillion on infrastructure. That includes roads, rail, ports, airports and irrigation schemes. All that will surely lead to increase in demand for materials like steel and cement, and also increase in employment. 

On the fiscal prudence front, the budget has targeted a fiscal deficit of only 3.2% of GDP, much below market expectations. This brought good cheer to bond markets, since this means that borrowing pressure from the government would be lesser than anticipated.  This also means that bond yields would go down, bringing profits to bank treasuries. These profits in turn can help banks tackle their bad loans (called Non Performing Assets), and also help them make new loans. As such the surge in deposits post-demonetisation has also helped banks.  The deficit is low and the national debt is manageable. It is never going away, but so long as it is sustainable and funding productive assets and public goods (like roads) it is a good thing.  To the extent that this extra debt goes to finance creation of new infrastructure which will help future unborn generations, it is  good quality spending. 

Overall the size of budget is higher by around 6 percent although national income will go up by around 12 percent (in nominal rupee terms). In that sense there is sensible spending restraint.  The direct tax revenues are expected to rise by 15% even though tax rates have actually been reduced. How is that possible? This is because of greater tax compliance. In his speech the FM said that “India is largely a tax non-compliant economy”. What he meant is that we have one of the lowest tax to GDP ratios, and which is further made worse because the share of direct taxes compared to indirect taxes is even lower. The direct tax net can be widened thanks to new information coming from bank deposits which surged post demonetisation. Preliminary investigation has revealed some 18 lakh individuals whose huge bank deposits do not tally with their known sources of income. So at some stage they will all enter the tax net. Of course there may be lot of complicated litigation before that happens, but that’s a different story. At least a start has been made.

This year’s Economic Survey also points out that for every 100 voters there are only 7 who pay direct taxes. Whereas in a country like Norway, there are 100 taxpayers for every 100 voters. How to reconcile the political constituency (which votes for governments) and the taxpayer constituency (which helps fund and run the government)? There’s no point on relying excessively on indirect taxes, because they are unfair. Indeed the coming GST is basically an indirect tax. 

The Budget also proposes to spend Rs 1.9 trillion towards farm and rural sectors.  This is highly commendable. India cannot make a significant dent on poverty without increasing farmers’ incomes, which the government aims to double in five years. The government also proposes to bring a model law on contract farming that will help enable flow of credit to tenant farmers. Tenancy  farming is more than 30 percent of all farming. The ambitious target of Rs 10 trillion credit flow to agriculture is timely and not too soon. Presumably a large chunk of this will go to tenant farmers, who otherwise have no access to institutional credit.

Finally this is the first budget to have mentioned the issue of transparency in political funding.  In its fight against black money the government cannot ignore the issue of unaccounted money in politics. Hopefully this sunshine will eventually mean that political parties will also come under the ambit of RTI.

(Dr. Ajit Ranade is a senior economist based in Mumbai)