Friday, July 11, 2014

Maiden Budget of FM Arun Jaitley


     During the tenure of the UPA II government, the emphasis of socio-economic policy had shifted heavily towards entitlement and legal rights and away from actual outcomes in terms of endowments (e.g. ability to read and write) and employment.  As a result, Indian Agricultural inflation averaged an unprecedented  11% per year during the last five years, and economic growth has declined since the bubble year of 2010-11 to an incredible 4.6% average during last two years. The budget had to break out of this stagflation.  
    The BJP’s PM candidate’s campaign speeches and the BJP had clearly indicated a desire to restore the balance, by focusing much more on economic development and improved governance!  First the BJP manifesto and then the President’s speech to the new Parliament spelt out the sectors and industries which the government would focus on. The Railway budget applied this approach to one sector of the economy, by trying to shift the focus from railway’s social role to its development role and by spelling out its approach to improving railway governance (E-governance) for improving the quality of service provided to passengers and other clients.  The national budget translates into hard budget allocations the government’s approach to economic development and fleshes out how tax administration and to some extent expenditure management is to be changed to provide better service.

Budget Expectations

    An analysis of PM Modi’s record as CM of Gujrat had led me to write after the election results came out, that his government would be pragmatic and goal oriented, without bothering much about ideological dos and don’ts that had hobbled earlier governments.  In other words they would focus on finding out and implementing whatever had a greater probability of achieving the desired results rather than worrying about certificates of purity from global development community.  I therefore declared on TV, before the start of FM Jaitly’s speech, that I expected a good budget but not a revolutionary one or one that would stand out as contender for the top three such.  The budget has confirmed this forecast.


   The budget is very much along lines one would expect from a first time FM who has been in office for only 45 days (not enough time to plumb the depths of revenue bureaucracy) and who has no Chief Economic Advisor (to give a broader perspective to his speech or provide non-bureaucratic perspective on macro-economic & tax policy issues) or eminent economist as “Advisor to FM”(to ferret out information & raise searching questions for FM to seek answers to)  Among the noteworthy feature of the budget are the fiscal balance, expenditure allocation, tax administration, financial and other promised reforms.

Fiscal Situation

      The FM decided not to shift from cash accounting (with its non-transparent rollover of expenditure allocations) to accrual accounting.  This allowed him to retain the fiscal and revenue deficit (RD) estimates for  2013-14- 4.5% and 3.2% of GDP respectively. The FM has signaled his determination to restore fiscal stability by sticking to the 4.1% fiscal deficit (FD) target for 2014-15 and 3% for 2016-17. The projected 0.4% point reduction in fiscal deficit is accompanied by a projected 0.3% point reduction in the revenue deficit.  The FM’s speech gives an indication that FRBM will be restored in letter and spirit. This is essential for breaking out of the stagflation of the last two years and ensuring stability in capital flows over the next five. Are the 4.1% FD and 2.9% RD targets realistic? The revenue targets, though lower, are still ambitious.  On the other hand the disinvestment targets (60,000 cr), though higher are easier to attain given capital inflows and the rise in stock markets.  There also higher cash balances that can be drawn on. The fact that an FM cannot start missing targets, from the first year of his tenure as FM, means that they are likely to be met.

Expenditure Allocation

        It was necessary for the Finance Minister to show the governments seriousness of purpose, by translating the objectives of the Modi led government and the sectoral thrust areas that it had identified for achieving these objectives, into budgetary allocations.  The expenditure allocations reflect a realistic mix of what can be achieved during the rest of the year by accelerating ongoing programs of interest and therefore merit higher allocations and what needs time to study, plan and implement and therefore merits token allocations. Though some commentators have criticized the large number of small new programs, I think it is wise for a new, relatively inexperienced council of ministers, to take some time to get a realistic picture of the capabilities and limitations of a Central Government.  When viewed from an overall perspective the expenditure objectives signal the government’s resolve to achieve its economic development objectives along the lines indicated in the President’s speech and the BJP manifesto. Thus allocations to Tourism, Highways and other labor intensive sectors and to skill development ("Skill India": integrated national multi-skilling mission, teacher training) assure that the job creation objective will be seriously addressed. In my view the much greater importance given to creating a “digital” India” (e-governance, 'virtual classrooms'), and a “Swach Bharat” (clean water, sanitation & sewerage) hold revolutionary promise for overcoming the challenge of pervasive corruption in government and child “malnutrition”(stunting, wasting) respectively.  At the same time the budget has signaled pragmatism, by making only small exploratory allocations for some of the more expensive/ambitious schemes like bullet trains. The one noticeable gap is in recognition of the revolutionary possibilities of using e-medicine/e health to deliver better health in rural areas

Better Governance

     The taxation parts of FM’s speech have focused heavily on legislative and administrative reform, reducing tax arbitrariness, and moving to e-governance. This is another application of the belief that better governance is essential for improving the quality of service which government provides to its citizens, and specifically to tax payers. Given the deeply entrenched “Inspector raj” mentality of the tax departments, the FM will have to drill much deeper to achieve significant change. A good place to start would be the report of the committee on reform of tax administration chaired by Dr Partha Shome. 
    A similar philosophy is operating on the expenditure side, though here concrete action on better targeting of subsidies, improving the efficiency of government programs and reducing corruption will have to await the report of a committee. There are similar references to management of government owned financial institutions. However, my experience of 20 years of reforms in India is that very upright and determined leaders can improve governance during their own tenures, but such improvement is not sustained unless backed by policy and institutional reform that changes the incentives under which the political bosses, administrative managers, officers and staff operate.

Financial Reforms

     The rise of investment limits in FDI in Defense, Insurance and low cost housing, t allowing “pass through” for Real Estate Investment Trusts (REITs), the idea of Infrastructure Investment trusts(IITs), the attempt to learn from past shortcomings of PPP agreements so as to devise, improved,  more resilient models, can help in supporting investment revival.
    The required re-capitalization of Public Sector Banks is to be done only partly through retail sale of government shares, as the earlier government's policy of majority (51%) government ownership of Public sector banks (PSBs) has not yet been dropped. I am also saddened that industry associations managed to keep Defense FDI from being raised to 51%, which is the minimum needed by a defense company (in US) to set up an Indian subsidiary and transfer technology to it, without it being treated as sale of technology to a foreign company.
     There are also references in the FMs speech to a “single identity number” and specialized “payment banks.”  These can transform the lives of the Aam Aurat if, “mobile payments” from cell phones and genuine “mobile banking” is allowed and encouraged.

Other reforms

       It is encouraging that FM expects to bring in legislation for implementing GST within the current financial year.  However, changes made in this budget in direct and indirect taxes do not suggest a return to the successful tax reform policies of the 1990s & early 2000s, to simplify them by eliminating deductions-exemptions and reducing tax rates (in a tax neutral way), to enhance voluntary compliance. They still appear to reflect the approach of the 2010s, that was partly responsible for the collapse of corparate investment and FDI. Fortunately there is enough time before the next budget to bring in both tax policy expertise, and legal-administrative expertise to devise a more comprehensive reorganization of tax policy and administration. 
        The promise of a reform of the Apprenticeship Act can be seen as part of the effort to improve skills or as a first step in labor reform. The hint of creating a competitive, all India market in food and agricultural holds tantalizing possibilities, but needs further elaboration/action.


    The measures taken in the budget will be sufficient to increase growth by about 1 per cent point over the last year’s 4.7% to 5.7% (though down side risk from monsoon failure and oil shock remains). Actualization of some of the measures indicated in the budget will however be necessary to raise growth to the 6.5 to 7% range in 2015-16.  Raising growth to 8% and sustaining it at that level will require further policy reforms during the next 18 months. Similarly, fiscal consolidation (on the projected path), will need to be supplemented by more comprehensive reform of policies affecting the entire food supply chain if agro inflation is to be brought down and sustained below 6%.

     A version of this article appeared in The Hindu, July 11, 2014 under the banner, “Pragmatism and Revolutionary Promise”: .

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