Many of the challenges that the Budget will seek to address tomorrow come from a need to increase public spending as well as present a credible fiscal consolidation plan
What will be the underlying assumptions of the NDA’s third budget? The Economic Survey clearly reflects the general mood of nervousness that persists about the prospects of growth in the domestic economy this year. Chief Economic Advisor Arvind Subramanian was upfront in stating this. The weakness in global growth might persist given that most large economies are slowing sharply. China, which contributes to 40% of incremental global growth, is yet to stabilise and there is no knowing when and where it will bottom out.
If the Chinese growth rate goes down to as low as 4 to 5%, the world could be staring at a recession in 2016. The IMF technically defines global recession as GDP growth of under 2%. In this context, where China bottoms out will remain the key factor in 2016. If China slows down further and decides to devalue its currency, India’s private investment revival will get further delayed. In the face of these global realities, finance minister Arun Jaitley’s budget exercise has very limited room to do anything that will counter global trends. This is why Arvind Subramanian plays it very safe by giving an unusually wide range( 7-7.75%)of GDP growth estimate for 2016-17. He says the range is so wide precisely because of the sheer uncertainty deriving from the global headwinds. Put in another way, the GDP growth estimates remain in the range of 5 – 5.75% going by the old GDP series!
If low to moderate growth is the primary assumption, then the question arises as to how the government will garner resources to meet its much publicised commitment to bring relief to distressed farmers and the rural poor, whose wage growth is now in the negative by some estimates. The NDA has been very callous in ignoring the deepening farm distress throughout 2015. Agriculture GDP growth during the two years of NDA is close to zero. This forced Modi to address farmers recently with the promise of a comprehensive insurance scheme. The budget will have higher allocation for future crop insurance but what about compensation for the massive crop losses suffered so far due to unseasonal rains and drought last year. This is what has depressed rural demand on an unprecedented scale.
Arun Jaitley recently admitted that reviving rural demand is the biggest challenge for him in the budget. Here the government is caught in a deep contradiction. Higher support for the farm sector and rural poor will necessarily entail what Subramanian describes as a “less aggressive” path towards fiscal consolidation. In short, the Chief Economic Advisor is advocating that in the current environment more public spending could be pursued to counter global conditions. The finance minister had committed to lower fiscal deficit to 3.5 % of GDP in 2016-2017, down from 3.9 % of GDP in 2015-16. What the CEA is arguing is the government could go down to a deficit 3.5 % of GDP over two to three years rather than in one shot.
Making it credible
Foreign finance capital wants a strict adherence to the fiscal road map and has made it a credibility issue. The global rating agencies too support this.
Arun Jaitley may stick to the aggressive fiscal consolidation plan to meet the expectations of foreign capital and credit rating agencies. He could choose to relax the target marginally at a later stage if the growth impulses prove very sluggish.
However, the domestic constituencies — the farmers, the self employed and over 15 million government employees waiting for the pay commission award — want more public spending to mitigate their income stagnation. Indeed, managing this contradiction is the the biggest political challenge for the NDA.
Jaitley is under tremendous pressure because he has already appropriated over the past year an additional Rs.1 lakh crore by raising fresh indirect taxes on petroleum products. In other words he has not passed on to the consumer about 65 % of the dramatic oil price fall through 2015. This has caused some anger amongst consumers because they have not fully accepted the government’s explanation that the extra money raised by not passing on the benefits of the steep oil price fall is being used for public sector driven infrastructure development. Typically, the consumer does not see the immediate benefit of roads or airports under construction. Even if the government had passed on about 55 to 60% of the oil price fall to the consumers, it might have given them immediate relief.
Another risk the government faces is it has become too dependant on the oil sector for revenues simply by raising duties to high levels. The extra Rs. 1 lakh crore garnered by hiking oil taxes will accrue in 2016-17 too. However, the big danger is if oil prices recover even moderately to about $50 to $55 per barrel — which can happen due to production cuts by Saudi and Russia — then Jaitley will have to raise oil prices from current levels by 40 % to 50 % , which will be politically disastrous. The other option will be to cut oil taxes just as he had raised it last year. This will impact revenue collection. So too much dependence on oil for revenues is a kind of trap.
The government has caused some nervousness in the market by suggesting that it could bring back the regime of long term capital gains tax on stocks ,which was done away with many years ago. The UPA had removed the long term capital gains tax and had brought the Securities Transaction Tax in lieu of that. There has been some talk of bringing back long term capital gains tax or extending the period for the levy of tax on short term capital gains from one year to three years. There is tremendous nervousness in the stock market on this count. However, it is possible the government may have floated this trial balloon to lower expectations from market players. Now there will be relief if Jaitley refrains from altering the capital gains tax regime. Not much change is expected on the personal income tax front except that the income tax slabs could be tinkered with and exemptions limits for savings could be raised to factor in the high price inflation of the past few years.
The finance minister also promises to announce substantive measures to rescue public sector bank balance sheets which are awash in red ink. There is a recognition that business-as-usual quick fixes will not work and a deep surgery is in order. A massive recapitalisation of banks could be announced to revive confidence in the economy.
Overall, the budget will seek to create the optics of being welfare oriented as the NDA has detected that the mood of the people at large is turning negative because of the failure in reviving growth and jobs. As argued earlier, much of this is also a function of how the global economic situation plays out. The NDA clearly squandered the first 12 months of its tenure when things seemed better globally and India was a darling of the global investing community. Now that situation has passed and India will have to do a lot more to attract capital. The depressed stock market is but an indicator of that.