The annual exercise of budget-making is often a balancing act between fiscal conservatism and providing growth stimulus. On top of that, political economy considerations drive the bent towards redistributive strategies and then the optimists hope that the budget will also lay down a reform roadmap. Satisfying these multiple objectives might not be easy.
So, as the dust settles, let us look at what were the priorities of the FY18 budget and how it ties up with the broader macroeconomic challenges that India faces now? The first objective seems to be signalling intent of continued fiscal consolidation. It is quite an achievement that FY18 would be the sixth consecutive year of continuous decline in central fiscal deficit despite different phases of political and economic cycles. Although rating agencies have not yet rewarded India for this prudent behaviour, the government’s resolve seems to be unwavering. In fact, the new FRBM committee report imposes further restraints, to be brought in through a gradually reducing debt-GDP ratio target.
An eye on fiscal prudence is necessary in an uncertain global context where investors will attach a premium to economies with high macro-stability. It is necessary for India to keep on attracting foreign capital inflows because the current account deficit might expand in 2017. Also, in a reflationary environment with rising global interest rates, any scope of maintaining an accommodative monetary policy in India also depends crucially on a relatively tighter fiscal policy. In our view, monetary policy cycle might be nearing its bottom, but low interest rates can be maintained for longer if the quality of fiscal is improved.
The second macroeconomic consideration was the scope of providing a consumption stimulus, particularly in the context of demonetisation led disruptions to near-term growth. If we use growth in government revenue expenditure as a crude proxy of the emphasis on consumption then the 5.9% growth budgeted for FY18 clearly indicates that there is little generalised consumption stimulus in the budget. However, we concur with the government’s view that right now, normalisation of demand conditions is more a function of the pace of the re-monetisation process rather than specific budget announcements. The small changes in income tax might improve consumer sentiment but the broader, more sustained driver of consumption demand has to be from job creation and wage growth which we discuss below.
The ability of the budget to kick-start the private investment cycle would be the third consideration. It is a welcome development that the budget proposes a higher growth in capex spend of 11% compared to the lower growth in revenue spends. In particular, allocation of funds to infra ministers are up 14% from the revised estimates of FY 17. However, we have to keep in mind that some of the ministries, like roads, were unable to spend their allocated funds in FY17. So, the implementation ability and the absorptive capacity need to be enhanced for the higher capex spend to have its desirable impact.
Given fiscal constraints, public capex spend is unlikely to be large enough to move the needle on total investments which is dragging down GDP growth. The critical issue is the complementarity between public and private investment where it was expected that the former would “crowd in” the latter. Unfortunately, this “crowd in” effect that has worked in the past, does not appear to be working in this cycle. Two issues could be at work—demand weakness/ overcapacity is too large and health of the financial system is too weak.
How does the Budget approach these? The budgeted total nominal expenditure growth at 6.5% is the lowest after FY07 and less than half of the last ten year’s average. With only about 2% real expenditure growth and a reduction in overall fiscal deficit, it is unlikely that the budget will provide much of a demand stimulus. Although we would hasten to add that revenue collections could turn out to be higher than budgeted opening up more capacity to spend.
The economic survey has identified improving the health of the financial system as one of the policy priorities and noted that most of the efforts till now have not yielded much result. It is true that an overhaul of the institutional set up for resolution of NPAs, might be beyond the scope of the budget exercise but a higher funding of bank recapitalisation could have signalled the policy priority. Progress on the institutional set up of the Insolvency and Bankruptcy Bill has been encouraging. This could be the hope behind an otherwise elusive solution to the NPA challenge.
The fourth macro objective could be job creation and improving the quality of jobs—from informal to formal, from agri to non-agri. The focus on affordable housing and a 40% increase in allocation for PM Awas Yojna are going to boost construction activity. Between 2004 and 2011, 50% of the non-agri jobs were created in the construction sector and one hopes that the push towards ‘Housing for All’ creates more opportunities for people to step out of agri jobs. However, more avenues of job creation need to be strategised and incentivised to make a larger impact in the labour market. The FM has also brought in the labour reforms agenda back on the table. The effort should be towards reducing the proportion of informal jobs to aim for higher productivity.
Finally two political economy goals were to achieve a better redistribution of the economic gains and further the anti-corruption stance. The Budget is replete with redistributive measures—income tax slab reorganisation to benefit the people at the bottom end, corporate tax-cut for MSMEs but not for the larger ones, etc—without being overtly populist. On the other hand, streamlining political funding, disincentivising cash payments and measures to improve tax compliance would buttress the anti-corruption messaging in a less disruptive way.
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Beyond the philosophy behind the budget, it does not hit the mark till the fiscal math is credible. In our view, the revenue and expenditure projections look quite credible although uncertainties over demonetisation and GST impact cast some shadows. The budget has made a cautious, prudent beginning and set the stage for the government to push its reform strategy further in 2017.
The author is chief economist (India) and managing director, Citi Research