A budget of promises and missed economic opportunities
A screen telecasts India’s budget inside the Bombay Stock Exchange building in Mumbai on Feb. 1. © Reuters
Indian Prime Minister Narendra Modi has put politics before economics in his government’s last full budget before the next parliamentary election due in 2019.
Finance Minister Arun Jaitley on Thursday threw the government’s laudable five-year record for fiscal prudence to the winds and promised a slew of partly funded or unfunded promises to the Indian electorate capped by a national healthcare scheme touted as the world’s largest.
Given the confidence that Modi likes to exude, and the absolute majority enjoyed by his ruling BJP party, it is a bit of a surprise to see the government be driven to such an extent to appease voters with the public purse.
The fact that the government did so, perhaps suggests that the prime minister is not quite so sure of victory in next year’s polls as he tries to suggest. A government blessed with low oil prices for most of its five years in power — a key consideration in oil-importing India — should have been in a position to deliver more in terms of sound economic management.
Jaitley confirmed that India’s fiscal deficit for the year to the end of March 2018 will be 3.5% of gross domestic product versus a pledge of 3.2%. Moreover, the government will breach commitment of 3% deficit target for 2018-19 and will likely end up at 3.3%. This will probably make the ratings agency, Moody’s, cringe given its recent upgrade of India’s sovereign rating.
Jaitley also proudly announced that he was going to reverse India’s two-decade-old policy of reducing customs duties on imports by unexpectedly raising duties on imports of mobile phones, television sets, accessories and other such items.
This predictably tired justification is that this will spur domestic manufacturing and job creation. No matter that such policies have served India very badly in the past. Modi’s recent sermon at last week’s World Economic Forum at Davos, extolling the virtues of free trade, was struck out with this one stroke of Jaitley’s pen.
With India’s transition to a Goods and Services Tax (GST) regime last year, this year’s budget was always going to be a difficult balancing act given the uncertainty it created around tax revenue and the transitional impact on the broader economy.
The finance minister gloated that GST had increased the formalization of India’s economy and so enlarged India’s tax base. He even quantified India’s gains from its audacious demonetization exercise of 2016 — when large-denomination notes were taken out of circulation — saying nearly $1.5 billion in extra personal income tax revenues had been collected. If that is so, he has no reason to be proud: One can unambiguously conclude that the costs in terms of lost economic output due to the disruption of demonetization far outweighed the $1.5 billion revenue gain.
Going into this budget, there were three major issues threatening India’s economy — agrarian distress, lack of jobs and weak private investment. Inflation-adjusted wage growth for India’s 250 million workers employed in agriculture is nearly stagnant. The budget announced that the government will buy all agriculture produce from farmers at a minimum guaranteed price of 1.5 times the cost of production. Further, it announced initiatives to bolster supply chains from farm to table. It remains to be seen how effective these measures will be in improving farm incomes and its attendant inflationary impact.
The government’s chief economic adviser said in his recent economic survey that private investment and exports were the only two sustainable engines of growth for the Indian economy. But the Modi government’s tenure has seen a collapse in private investment from 36% to 27% of GDP, and an export-squeezing 21% rise in the rupee’s real effective exchange rate.
The budget could do very little to address these two fundamental and structural issues. Private sector investment in India has been anemic, a condition exacerbated by a bad-loan infested banking sector. While there have been some measures announced to recapitalize India’s ailing banks, there was wide expectation from the budget to revive animal spirits through a Trump style lowering of corporate tax rates.
Instead, Jaitley chose to hand out such incentives only to small businesses. He announced a reduction in corporate tax rates to 25% for small and medium businesses with revenues of less than $40 million which accounts for 99% of all businesses in India. He further announced a $50 billion credit pool for these small businesses.
The finance minister exhorted large businesses to tap into capital markets for equity and debt financing and leave the banking sector to cater to retail and small businesses. The budget also commendably ended India’s bizarre tax exemption for long term capital gains from listed shares which provoked a knee-jerk panic reaction in the equity markets.
Perhaps the biggest but most confusing announcement of the budget was a grand healthcare insurance scheme for the poor. Jaitley announced a “National Health Protection Scheme”, touted as the world’s largest, which will provide secondary and tertiary medical insurance coverage of up to $7500 per family for 100 million families. While the announcement was much-needed and laudable, it left analysts confused since there was no provision in the budget for this expenditure. The federal government’s entire healthcare budget for next year is only $8bn which will surely not suffice to cover the costs of the world’s largest health insurance program.
In summary, the budget struggled to balance the costs of a plethora of schemes for different sections of society and business with the need to generate sufficient revenues.
Overall, this year’s budget symbolizes the Modi government’s “lost five years” in terms of a lack of growth-boosting economic reform. There has been none of the much-promised “break from the past” structural reforms.
With oil prices now rising once again and India’s weak investment climate persisting, the economy is arguably as vulnerable as it was in the past – as Modi may learn to his cost if he wins the election.
Published on 02 February, 2018 in Nikkei Asian Review