The art of doing more with less

Expectations have been very high from the Budget given that fiscal policy is expected to be the heavy lifter for growth and capex revival going forward. Due to increasing global uncertainty, rising commodity prices, tightening inventories and other factors, metals prices have risen sharply over the last year, and have remained high.

It was imperative to extend a helping hand to the three sectors which had borne the brunt of the cash extraction – agriculture, MSMEs and real estate. In large measure, the juggling of revenues and expenditures has been successful.

Under the given circumstances, both domestic and global, the Budget was the best possible. Coming squarely in the middle of a massive economic, social and behavioural  experiment – demonetisation – and only a few months prior to another transformative change – GST – the optimal course would have been to incrementally push the ongoing reform agenda. At the same time, it was imperative to extend a helping hand to the three sectors which had borne the brunt of the cash extraction – agriculture, MSMEs and real estate. In large measure, the juggling of revenues and expenditures has been successful.

To begin with, the Budget was correct in choosing to remain (mostly) on the path of fiscal consolidation, abjuring the allure of using the Government’s balance sheet to stimulate the economy. The fiscal deficit was moved up only marginally from the FRBM milestone of 3% of GDP to a budgeted 3.2%, with the milestone now to be achieved in FY19. The RBI Governor has repeatedly emphasised the need for fiscal prudence and advised against an unwarranted build up of debt. In comparison to the macro fundamentals of our EM peers, India’s weakness has been a relatively high stock of Government (sovereign) debt and the rate at which this is increased via comparatively large fiscal deficits.

In his speech, Finance Minister argued his conviction, that despite the apparent bias of a slight push for fiscal stimulus by the FRBM Review Committee, it was more prudent to remain fiscally conservative, and this was reiterated in the Economic Survey: “India’s economic experience underscored the fundamental validity of fiscal policy principles enshrined in the FRBM Act”.

This is not just a matter of conviction, but also carries real world benefits. The first is the prospect of an eventual upgrade in India’s sovereign outlook and subsequently ratings, which would have large material benefits in terms of boosting India’s share in global investment portfolios, higher capital inflows, lower interest rates, etc. As an aside, note that even though RBI might not be able to cut rates significantly from here, interest rates have already come down significantly over the past year, and particularly the last couple of months, with the infusion of deposits into banks. These lower rates are now in an automatic stabiliser mode, and are likely to move up only when growth (and bank credit) revives.

The growth rates of indirect tax collections, while being more in line with what we expect might be the drivers, are to a large extent less relevant, if they do get eventually subsumed under the imminent introduction of GST and merged into a common structure.

The next question then is how likely the Centre is to achieve the Fiscal Deficit target. The first issue is to assess the expected GDP growth. (recall that the Economic Survey had earlier forecast a growth of 6.75 – 7.5% real GDP growth for FY18). The Budget has assumed a nominal GDP growth rate of 11.75% for FY18. This is based on a “Revised FY17 GDP”, but the source of this estimate remains unclear. The last official estimate of the FY17 GDP are the Advance Estimates (AE) of the Central Statistical Organisation, which is Rs 1.2 lakh crs higher than the figure in the Budget. Nominal FY17 (over FY16) growth based on the AE estimate is 11.1%, the one based on the Revised GDP (in the Budget) is 10.2%. So that’s a hint of the probable extent of the slowdown factored in official baselines. This also explains the range for the FY18 GDP growth; the lower the growth for FY17, the larger the base effect for a higher growth in FY18.

The next point is the realism of the revenue growth assumed in the Budget. If the growth rates are overstated, there will be a natural tendency for the fiscal deficit ratio to slip, or else there will be a necessity to cut expenditures, and the brunt of the cut is inevitably capital spends, which is inimical in an investment constrained economy.

The growth of both personal and corporate income taxes is retained at the high rates that are expected in FY17. This is almost certainly, given the moderate growth assumptions, based on expectations of a rise in both an increased audit driven hike in interest and penalties, as well as spreading the tax net wider with the data analytics, disclosures and cash transactions limits being progressively imposed.

The growth rates of indirect tax collections, while being more in line with what we expect might be the drivers, are to a large extent less relevant, if they do get eventually subsumed under the imminent introduction of GST and merged into a common structure. Non-tax revenue targets are also more modest, with spectrum and telecom receipts halved. The higher disinvestment target is also likely to be met, with the next tranche of the Central Public Sector Enterprises (CPSE) ETF likely to be issued. In any case, if the higher budgets are indicative of a plan for strategic sales of PSEs, IPOs of state owned general insurance companies, etc., the objective will show a determination to reform.

So will the moderately higher revenues work to revive growth? This is where the next trade-off kicks in. Given the persisting high levels of excess capacity (RBI surveys estimate this at 72% for September ’16), a boost to consumption demand will be necessary to close the gap and consequently revive private capex. But this will take a while and consumption without enabling capacity will inevitably lead to excess demand, even if it is mostly transitory. The Budget has fortunately opted for a capex push, with revenue expenditures scaled back. Whether higher revenues permit these spends without the usual scale back remains to be seen.

In the meantime, the Budget has a wide canvas to work on.

(Saugata Bhattacharya is Senior Vice President and Chief Economist of Axis Bank. Views are personal)