Budget 2017 was expected to be the most challenging budget in the light of the recent demonetisation initiative taken by the government, a protectionist global environment, new legislations like GST and the new Bankruptcy Code. From a financial services standpoint, too, the amendments focussed on creating a non-adversarial tax administration, increased certainty in the tax regime—particularly related to public markets and strategic investors—and paved the way for an improved business environment.
While we are not critical of the Budget, there could have been clearly more incentives to propel the growth of the sector. In this article, we discuss our thoughts on its key provisions for financial services.
Capitalisation for banks: Shoring up the capital of public sector banks (PSBs) is a pressing issue for the banking sector, especially given elevated NPA levels. The gross NPA has climbed to almost 12% for PSBs as on September 2016. As per our estimates, PSBs would require R2.5 trillion (at 1% capital conversion buffer) to comply with Basel III norms. Additionally, the existing level of stress would require banks to shore up their capital at least by another R2 trillion by 2019. Hence, the banks would need a minimum of R4-5 trillion of capital by 2019.
In line with this, we expected the Budget to allocate more towards propelling banking system capital. The Budget providing just R10,000 crore under the Indradhanush roadmap is insufficient given the magnitude of current capital requirements. While budgetary allocations need to be higher, banks too need to look internally and realise the value of many hidden assets, particularly through property sale and lease, and issue preferential bonds that qualify for Tier 1 Capital.
Assuming that RBI is left with excess capital (the official number is not yet available) after demonetisation, there could have been some provisions in the Budget to infuse this excess capital as fresh capital to PSBs.
No clarity or quantification of dividend from demonetisation: Providing clarity on the dividend from demonetisation of high-value currency notes was one of the key expectations from the Budget. After the pain caused by demonisation, it was always going to be important for the government to provide comfort and information on the potential dividends from the effort through concrete quantification.
The Budget outlined long-term benefits including reduced corruption, greater digitisation, increased flow of financial savings and greater formalisation of the economy, as the benefits from demonetisation. It also indicated that surplus liquidity in the banking system will lower borrowing costs and increase access to credit. However, clearly it did not quantify potential dividends from demonetisation.
More needed to propel credit: Growth in bank credit has remained subdued in the last two years, largely due to the twin problem of slowdown in the key sectors and stress in the banking system. The problem has been compounded by the demonetisation. Total bank credit growth slowed down to 9.1% y-o-y in FY16 to reach R65 lakh crore as of FY16. Priority sector lending grew 10.7% y-o-y to reach R22 lakh crore.
Against this backdrop, the Budget was expected to outline some measures which would boost credit in the real economy. To achieve the growth target of 7.2% in FY18, as outlined in the Budget, bank credit should grow by at least 15-18%. In line with this, the priority sector lending target is expected to be at least R29-30 trillion in FY18.
The Budget outlined an increased target ofR2.44 lakh crore under the Pradhan Mantri Mudra Yojana compared to ~R1,00,000 crore in FY17. While this is a notable step, there were expectations towards encouraging the channelisation of credit through the newly-promoted Small Finance Banks, NBFCs and MFIs. Also, some encouragement for larger banks to subscribe to priority sector bonds, and norms to ease direct lending would have helped improve monetary transmission.
Thrust to digital: Focus on digital and cashless economy was one of the key pre-budget expectations. Some of the notable initiative outlined in the budget include:
Target of 2,500 crore digital transactions for FY18 through UPI, USSD, Aadhaar Pay, IMPS and debit cards
Service charges on e-tickets booked via IRCTC to be withdrawn
No transaction over R3 lakh will be permitted in cash
These provisions were mostly in line with our expectations to incentivise digital transactions. However, the Budget did not outline any incentives or allowance for banks to build a robust digital or payments infrastructure. It could have considered providing some form of investment allowance and tax-breaks to the banks for investing in digital or payment infrastructure as was done for industry capital formation earlier. In addition, providing incentives in the form of savings from budgetary allocation for going cashless were expected.
Other notable measures: Reduction of holding period from three years to two years for computing long-term capital gains accruing from transfer of immovable property will reduce the capital gains tax burden on property sellers and will encourage them to disclose correct prices. This move could benefit home-finance institutions.
Tax-cuts to MSMEs are welcome, but the disparities between spending trends and tax collections clearly indicate that the tax administration is ineffective. All measures proposed to increase collections presuppose an efficient administration. This seems to be an anomaly that needs correction. Initiatives around digitising 63,000 agricultural outfits through Nabard and also the availability of credit would ensure sustained fiscal support to the rural sector.
All in all, while the finance minister has projected certain key changes in economic and tax policy, the proposed fiscal deficit target of 3.2% for FY18 should have been increased to the maximum limit of 3.5% with an additional R45,000-50,000 crore infused into the banking system which, transmitted effectively to the real economy, would have boosted growth. The key is transmitting deficits to the real economy rather than unproductive public spending.
The author is partner and national leader (financial services), EY India. Views are personal