This week was all about Greece but next week it can be both Greece, as well as the India’s Union Budget. I have written extensively about the causes and remedies of imbalances facing the Euro zone as well as the political realignment that is occurring in the currency union. Today let me delve into the wish list from the Government and the finance minister. I would not restrict the wish list to the Union Budget but would go beyond that. I will briefly touch upon the importance of co-operative federalism, overhauling the taxation system and redesigning the process of natural resource allocation.
With the proliferation of the electronic media, social media and information technology, our societies are undergoing a rapid change. Over the past 10 years, as the digital revolution has shrunk the communication gap in the country, so has changed the behavior of the populace. The impact of this social re-engineering is also having an impact on the political process as well. Over the past few years, we have seen political parties, across the divide, join ranks in promoting the idea of federalism in India. The top down form of command and control political and administrative structure could be giving way to a more bottom up and informative administrative system. For instance, the idea of co-operative federalism, which our Prime Minister has emphasized, is a step in that direction. As Indians become more educated, upwardly mobile and financially well-off we will see a penchant need to participate in the political and administrative processes. The populace might not just be happy electing representative for a 5 year term, they would want to play a greater role in the conduct of affairs of the nation.
The government has emphasized on the need to hand over more economic and financial powers to the states. Niti Aayog can play a key role in this process. In fact, our honorable Prime Minister has talked about reducing the number of central designed schemes and also moving towards a system where schemes will be designed and implemented by the individual state governments. Central government may change its role to being simple allocator of financial resources. Government may however continue to play a greater role in designing of the many of the economic policies, which needs to portray India as a single market or economy. However, even in such economic processes, we expect the state governments to participate in its design and implementation, through the institutions like Niti Aayog. In my opinion, this experiment of devolution of power to states is a single biggest realignment of Indian economy and politics towards a much better future.
In the Union budget, I hope to see more evidence of the co-operative federalism, through transfer of funds and powers to the state. However, on a medium term basis, markets and rating agencies will keep an eye on how the government strikes a balance between quality fiscal consolidation and investment priorities. The finance minister has a tough job in his hands. He is facing significant shortfall in budget tax revenue, but thanks to a sharp drop in the commodity prices and partial removal of the petroleum subsidies, he might be able to meet the budgeted number. However, over the next couple of years, achieving a 3-3.6% of fiscal deficit will need the operating revenue growth to kick in. For revenue from taxes to grow at a pace of 13-15% on a yoy basis, Indian economy has to be regain the lost momentum. Private sector and banks are grappling with the ill effects of over-leverage. In such a time, in order for the economy to achieve a higher rate of sustainable growth, investments need to rise. However, for government to play the role of a catalyst it needs to continue to play the dual role of an enabler for the private enterprise by freeing up the economy from the clutches of state control and also ushering in an era of simple and rule based policy formulation.
It is estimated that close to USD 300 billion (12/13% of GDP) of capital projects are stalled. Majority of the projects are in infrastructure and infrastructure related sectors. A number of factors have played a role in their delays:-
1) Unavailability of land
2) Lack of clearances
3) Changed market environment
4) Lack of raw material supply
5) Corporate governance
6) Lack of financial resources.
I do not think that all of the USD 300 billion can be rejuvenated or restarted, as some of the projects may have become outright unviable. However, a combined solution of stressed asset resolution and resuscitation of viable projects need to be done. We cannot afford to remain in a state of wishful disillusionment, as that would not make bad debts in the banking system and unviable projects in the corporate balance sheet go away. However, for government to clean the banking system and provide a boost to investment, it either needs to secure resources or abandon goal of fiscal consolidation. I hope that former is done and not the latter.
Government spends around 63/64% of its revenue receipts (excluding capital borrowings or liquidation of investments) on interest payments, defense outlays and pension payments. At the same time, around a fifth of the revenue receipts go into several kinds of subsidies. Subsidies in fertilizer and food could account for nearly 70/75% of the total subsidy of 2-2.20 lakh crore rupees. Therefore, around 1.5-1.7% of GDP could still be paid out as subsidy next year. Therefore, in order to secure additional resources and not adversely impact fiscal deficit number, government has to reduce a chunk of this 1.5-1.7% of subsidies being paid out. The ongoing implementation of the direct benefit scheme for paying subsidies would improve the savings of the government and so will the tweaking of many of the central sponsored schemes. Government can look at divesting a sizable chunk of its public sector holdings, including banks, to secure resources for investment in road, port, railways and power.
Like the goods and services tax is expected to overhaul the indirect taxation in the country, there is an urgent need to redesign the direct tax code. I would go to the extent of saying that instead of incremental changes of tweaking tax slabs and punching in a few more exemptions, we need a complete redo of the direct taxation. Around a fifth of India’s tax revenue comes from person income taxes and around third of the revenue comes from taxes paid by businesses. There is need to simplify taxation and even lower the effective tax rate, to improve tax compliance in the country.
Effective monitoring of tax compliance and fast track of judicial remedy can also increase the ratio of direct tax to GDP , from its current low rate of around 6%. For example, in personal taxes one can do away with the slab based taxation and instead have a one single flat tax rate. However, that rate of tax would have to be low, to discourage tax evasion. At the same time, government can do away with the norm of defining income on the basis of its source of origin, instead we can club all forms of income, irrespective of source and tenor into a singular definition of income earned and on that a uniform flat rate can be charged. At the same time, almost all of the exemptions provided to individuals can be done away with. There is little sense in using taxation to influence the savings decisions of the individuals. History has shown, that using government policies to alter savings pattern can run the risk of greater miss-allocation of capital and imbalances in the long term. With such a simplified personal taxation norm, there is will less grey areas to hide under and it can improved objectivity of taxation.
From Budget expectation I will touch upon one more key development, coal auctions. I feel the government has shown immense steadfastness in implementing the online coal auction mechanism. A fair and transparent system of natural resource allocation is the way forward. Government has also talked about the need for commercial mining. I too feel it is important, as coal blocks need to be auctioned without the end use requirement. Such a requirement impedes efficiency. As mining is a specialized industry and so is power generation; tying the two together makes less economic sense. Therefore, in the future, once government is able to push through the bill for commercial mining in coal, it can look at doing away with the end use restriction in coal mine auctions.
Now let me do a rundown of the financial markets over the past week and what can be expected next week. Over this week, we have seen USD/INR remain in a broad range between 62.07 and 62.35 levels on spot. Next week, I expect Rupee to drift towards 62.40/50 levels, before the presentation of the Union Budget, but thereafter, it can strengthen towards 61.70/80 levels. However, over the last few months, Dollar/Rupee pair has been forming a very strong base below 62.00 handle, thanks to the timely and spirited intervention from the central bank. Therefore, we would advise importers to use the levels between 61.00 and 62.00 to shore up their forward hedges and exporters can wait for a rally towards 63.50/64.00 to initiate medium term hedges. Technically, the region between 60.80 and 61.40 is a major congestion zone and hence would be buyers on decline, with stop and reverse on a daily close below 60.80 levels on spot.
By Anindya Banerjee, Analyst, Kotak Securities