Expenditure growth has to be high, a lot of privatisation, no new cess, big infra-push & 1991-style sweeping reform
In this context, there will be a temptation to find some way to tax the rich to defray part of the costs, possibly through a Covid tax or surcharge, a one-time wealth tax etc.
Whether finance minister Nirmala Sitharaman can pull off the one-in-a-hundred-year budget she spoke of remains to be seen, but it is clear she has a daunting task. She must spend a lot to take care of the Covid-induced collapse in, especially, the informal part of the economy – without this, the economy will remain sluggish after FY22 – but, at the same time, convince bond markets, and rating agencies, that this is a one-off that will make both debt and deficits reduce over 2-3 years.
And since she cannot possibly spend enough to offset the slowing in private consumption over the past few years or the collapse in investment and export levels, she needs 1991-style reforms to boost investor spirits and India back on the export path. Over the last seven years, investment and exports have fallen by nearly 12% of GDP, and government can’t possibly spend enough to make this up, so that requires a different fix.
Even under normal circumstances, deciphering a budget speech is confusing, this year will be especially bewildering. After falling by 8-9% in FY21 over those in FY20, FY22 taxes are likely to be 16-17% higher than the actuals in FY21, but they will still lower than those budgeted for FY21! You get the picture? So how do you evaluate the budget?
The very first headline number you must look for is expenditure. In the last five years, total government expenditure has risen by around 10% annually, this year it needs to rise by at least 15-16% if any meaningful repair of the economy is to take place. This is a temporary fix, just to keep the economy ticking even if at a lower level, to ensure those who lost jobs can survive till such time that, when growth is back, they can return to their jobs.
And while there is a lot of talk over how the higher expenditure is to be financed as interest rates will rise, raising expenditures is not that easy since a large part of the expenditure grows very slowly. Salaries and defence expenditure that account for around a fifth of the budget, for instance, grew by less than 3% in FY21; pensions account for another seven percent or so and while they grew 14% in FY21, they grew by under six in FY20. Roads and highways which, under Nitin Gadkari, is probably the most efficient infrastructure ministry managed to raise its expenditure by around 14% annually over the last five years but not everyone can replicate the performance.
The Rs 100-lakh crore National Infrastructure Pipeline (NIP) over the next five years is certain to figure in the budget but this is a tall ask since achieving the target requires around doubling the expenditure made in the last seven years. A fourth of the proposed capex is to be invested in the power sector but who will invest if, despite a plethora of ‘reforms’ like UDAY over the last few decades, the state electricity boards (SEBs) remain bankrupt and unwilling to change; this newspaper has suggested allowing RBI to deduct state government accounts if SEBs default on payments, as they routinely do, but prime minister Modi has stayed away from this (this is where the 1991-style reforms come in, more later).
If there is a serious lack of capacity to absorb extra expenditure – including in MGNREGA – maybe cash payments of Rs 500 per month for a year to the bottom fifth of the population can be thought of; if families know they are going to get the money for a year, they are more likely to spend it instead of trying to save.
In this context, there will be a temptation to find some way to tax the rich to defray part of the costs, possibly through a Covid tax or surcharge, a one-time wealth tax etc. This is a bad idea since taxing the rich will lower demand whereas the need right now is to increase consumption; only when demand rises will capacity utilization in factories rise from the 65-70% it is right now, and only when it is up to 85-90% levels will the investment cycle resume. The top 10% of the population account for around 22-23% of consumption and around 30% of income in the country.
Also, when even something as draconian as demonetization couldn’t get too much money from the rich, it is quite likely they will find a way to escape any major tax imposition or scheme to get part of their wealth; the signals it sends in terms of the government being confiscatory is an even bigger issue, so any fresh tax is to be avoided.
Indeed, it would be a better idea to go for a massive PSU sell-off, say of around 1-1.5% of GDP to help finance the increased expenditure. But since the government has almost always failed to achieve its target – even the FY21 budget had a Rs 2.1 lakh crore disinvestment target – this needs to be done differently. And while the new PSU policy the FM has spoken of envisages retaining just 3-4 PSUs in strategic sectors while selling off the rest, it is a good idea to see how it really pans out since many attempts at big privatisation like Air India have failed; also if, as it did for banks, the government decides to merge PSUs to reduce their number, it doesn’t really help.
Ideally, the government should look at selling Rs 15,000-20,000 crore of PSU shares every month regardless of their price, a Systematic Withdrawal Plan (SWP) in quite the same manner people invest in mutual funds via Systematic Investment Plan (SIPs) of a fixed day of the month.
Since the government did not have an SWP in FY21, it is likely to raise just Rs 30-35,000 crore this year; to put this in perspective, in just April to November this year, India Inc raised Rs 1.4 lakh crore from equity markets. By the way,since Modi first came to power, while the BSE market cap rose 2.2 times, that of PSUs fell 9%; that means every day the government holds on to PSU stocks, it loses money.
Last, watch out for 1991-style reforms. Genuine PSU privatisation could be one such reform and, if that happens, even if overall demand doesn’t pick up, firms may want to buy good assets priced attractively. Indeed, NIP can’t take off till there are a series of reforms such as in the power sector and, as this newspaper has documented so assiduously, if government policy improved, many industries like telecom and oil & gas would jumpstart investments immediately. But what they want is consistent policy aimed at helping industry resolve issues immediately, not sclerotic policy that promotes PLI and cuts tax rates one day but challenges Vodafone arbitration rulings the next.