What to expect from Union Budget 2017-18

What might a government pounded for demonetisation, ridiculed for its shifting numbers and goalposts and damned by former RBI governors do with the upcoming budget to restore credibility and confidence? Given that consumption is down, small and medium enterprises are impacted by a shortage of cash in the economy and the GDP growth will slip, what should be the broad direction of the budget, which, incidentally also comes before the ensuing elections in key states like Uttar Pradesh and Punjab?

One way would be to offer more sops and populist schemes in the hope that those unfairly hurt by the move to withdraw 86% of the country’s currency see this as a government that is not unmindful of the hardships it has brought. This is the path that would build on the series of announcements already made by the Prime Minister on Dec. 31, and it means higher revenue expenditure (and revenue deficit). The other would be to get back to classical budget balancing, which recognises that fiscal profligacy will further aggravate the problem and make it that much more challenging to return to a higher growth trajectory.

The Union Budget 2017-18 will be presented to Parliament on February 1, 2017 as against the practice hitherto of presenting it on the last day of February. This departure as claimed by the government would enable the various departments to work on the budget proposals early enough in the coming fiscal year. There are other developments also which will have critical bearing on the budget. The 2017-18 budget will dispense with the traditional plan and non-plan break up of expenditure and will only focus on revenue and capital expenditure. Furthermore, the railway budget will be a part of the union budget. These developments broadly are cosmetic in nature and will not have any essential impact on the budget in terms of expenditure allocations. There are, however, the recommendations of two important committees; one is the expenditure committee headed by former governor of RBI Dr. Bimal Jalan and another, the FRBM committee under the Chairmanship of NK Singh. The recommendations of these two committees are not currently in the public domain.  It is expected that while presenting the budget, the finance minister will release these two reports.

The budget will be presented against the backdrop of a moderation of CPI inflation rate (3.41 per cent in December 2016 as compared with 5.61 per cent in December 2015) and slackening of growth (7.1 per cent in 2016-17 as compared with 7.6 per cent in 2015-16). The current account deficit (CAD) has moderated to around 1 per cent. More importantly, the withdrawal of bank notes of Rs.1,000 and Rs.500 denomination (the so-called Specified Bank Notes, or SBNs) has not only impacted the economy but also brought new challenges in monetary and liquidity management and also consumption.  Though the authorities are hopeful of the long term gains from demonetisation, many economists, including former governors of the RBI, have expressed their reservations in this regard.

In large part, the budget is an instrument through which the government operationalises its fiscal policy objectives of achieving a higher growth trajectory and maintaining economic stability. In a democracy such as India, there is a bias towards spending rather than a focus on tax and non-tax receipts and consequently the government tends to go in for borrowing/deficit. The government’s consumption (non-developmental) expenditure grows higher as the government has to spend for defence, interest payments, subsidies, wages and salaries. This results in a higher revenue deficit, leading to higher fiscal deficit and public debt and ultimately the government falls into the trap of a vicious cycle of deficit and debt. To break this vicious cycle, normally, rule-based fiscal policy is undertaken by the government, which specifies limits and norms for borrowing and spending.

The India experience was similar to the situation narrated above and the authorities with a broad political consensus introduced fiscal legislation in terms of the Fiscal Responsibility and Budget Management (FRBM) Act in 2003 and subsequently revised in 2012. It is a pity that 13 years of  fiscal legislation has not yielded any satisfactory results in terms of eliminating revenue deficit, which is still persisting at around 2.5 per cent of the GDP representing ‘dis-savings’ of the government, which is a growth inhibitor.

A higher revenue deficit necessarily results in higher borrowing and higher interest rates at the long end of the spectrum. The higher interest rate thus crowds out private investment. In aggregate thus, investment suffers.   The Union budget therefore, in the medium term should focus on raising tax revenue by the increasing tax base. In its own admission, the government claims that in India only 24 lakhs of people report income of Rs. 10 lakhs and above. If this number can rise dramatically, then it would be regarded as a huge achievement of the government. It is important that an increase in tax base not lead to harassment and inspector raj.

The prudent management of fiscal policy also critically hinges on budget integrity which is reflected in the best estimates of the receipt and expenditure under various heads. In other words, there should not be large deviations when the budget estimate will be translated to revised estimates and subsequently actuals/accounts.

To sum up, Union budget 2017-18 should keep high on its agenda revival of economic growth and strict adherence to fiscal consolidation as prescribed in the FRBM Act. To this end, it is important to bring back elimination of revenue deficit as the most critical factor of fiscal management without compromising transparency in budget accounting and integrity in budget estimates. Window dressing may look good on paper now but extracts a high price when the numbers come calling.

(R K Pattnaik is Professor, SPJIMR. Jagdish Rattanani is Editor, SPJIMR. Views are personal)