Mister Jaitley’s Mid-Course Correction

It should now be clear that when it comes to economic policy, there is no major difference between Modi and his predecessors

Finance minister Arun Jaitley and MoS Jayant Sinha en route to parliament house with the budget speech. Credit: Shome Basu

Choosing between two fiscal decisions: Finance minister Arun Jaitley and MoS Jayant Sinha en route to parliament house with the budget speech. Credit: Shome Basu

Imagine if finance minister Arun Jaitley’s budget speech of February 2016 had been read out in July 2014. Large parts of the speech could have been stated then. Apart from the nine pillars of development, the foundational pillar of fiscal management – if defined two years ago the way it has been done now – would have given the finance minister greater leeway in managing the persistent drag on the investment front.

There could have been several reasons why Jaitley took two years to arrive at where he is now. First, there was an under-estimation by the Narendra Modi government of the magnitude of the ‘investment strike’ – the weak ‘animal spirits’ of private enterprise – that had contributed to a slowdown in India’s investment rate in 2012-14. There was also an under-estimation of the fiscal capacity of the Central government. Equally, there was an over-estimation of the likely impact on the economy of a political change at the Centre. There was also an under-estimation of the negative impact on the Indian economy of global headwinds and uncertainty.

Jaitley was wrongly advised in 2014-15 to remain committed to the path of fiscal consolidation while at the same time taking on the burden of implementation of the recommendations of the Fourteenth Finance Commission, the Seventh Pay Commission and the adoption of the principle of one-rank-one-pension for the armed forces. On top of these fiscal commitments, the government has been forced to increase social development expenditure as well as funding schemes for the welfare of farmers and weaker sections.

The Fourteenth Finance Commission increased the quantum of devolution from the Union to the states from 39% of gross revenues to 42%. Had this been based only on the transfer of Central plan schemes to the states, there would have been no difficulty. But, the commission went further and made its own determination of which of the subjects, that fall within the concurrent list of the constitution, would continue to be the joint responsibility of the Centre and the states and which, it considered, would be better dealt with by the states. It transferred the Central revenues for the latter to the states.

Anticipating the fiscal problem this would pose to the central government, one member of the commission (Abhijit Sen) appended a minute of dissent to the report in which he recommended: The share of tax devolution be set at 38% of the divisible pool in the first year of the award period and maintained at that level unless there is agreement in the new institutional mechanism to revert to the 42% share of tax devolutions.

The government should have accepted the report of the commission subject to this minute of dissent. There is a precedent for this in the case of the Third Finance Commission, where the note of dissent was accepted by the government of the day.

It was against this background that some in government initiated a debate on fiscal deficit management. Opinion became divided between fiscal and monetary conservatives, who urged the government to stay the course defined by the Fiscal Responsibility and Budget Management (FRBM) Act, and fiscal liberals who emphasised the importance of public investment in stimulating demand and growth.

Jaitley had three options before him: to be fiscally responsible and stick to the path defined by the FRBM Act (which is what he said he would do in last year’s budget speech); to be fiscally accommodative and seek a dilution of that commitment; or, to seek a change in the FRBM Act itself.

The finance minister was even advised to announce the appointment of the Fifteenth Finance Commission so as to secure a rollback of the Fourteenth Commission’s excessive award, as some saw it. There is a precedent for this too, going back to 1969. But he has resisted that temptation.

It appears Jaitley has tried to walk on two legs by reaffirming his commitment to the FRBM Act and, at the same time, seeking a dilution of that Act. His decision to constitute a committee that will examine the idea of moving from a fixed number to a range, for the fiscal deficit, suggests that he has opened a window after closing the door. This will come in handy when the government moves closer to election year.

This was the big fiscal issue in this year’s budget and it has been directly addressed. On the reform front, the finance minister has taken several important steps but the initial impact of his bold and creative decisions was lost in a poorly drafted budget speech.

The nine pillars of macroeconomic policy and development priorities are all well considered. They do not miss out on anything. In the end, what impact this budget will have on the economy will depend on the government’s fiscal capacity, the speed of improvement of the ease of doing business and of investment in infrastructure.

Taken together the policy announcements relating to investment in infrastructure, tax reforms and the reform of industrial policy constitute a mid-course correction. In undertaking this correction the government has tried hard to maintain a balance between its social commitments and investment in the rural economy, on the one hand, and the ease of doing business and promotion of small and medium enterprise, on the other.

How credible is the fiscal arithmetic underpinning the budget’s growth strategy? Much will depend on the rate of growth of the economy and how the global economy and commodities, especially crude oil, prices behave in months ahead. If there was a year in which Jaitley could have taken a risk, it is this. If growth falters, if inflation revives and if the global economy slows down, all bets would be off.

Whatever the views of the government’s critics, Prime Minister Narendra Modi has chosen to tread the middle path like any Congress-led or Third Front government would. It should now be clear that on economic policy and foreign policy there is no major difference between Modi and his predecessors. At the end of the day, the difference between the BJP and its critics is essentially on social and cultural issues.

Whether Modi goes into the 2019 election claiming achievements on the economic front or whether he pushes hard line ideological issues to the fore would depend on how the economy responds to the incentives for investment and growth provided this year.

The political bottom line, however, is that Modi and Jaitley have to work together to ensure that the investor, the consumer and the job-seeking youth remain optimistic about India’s future. Optimism about the future generates growth. Expectations have a way of getting fulfilled.

Sanjaya Baru is Honorary Senior Fellow, Centre for Policy Research, New Delhi