Economic Growth and Macro Stability: Budget 2016-17

Introduction

   Sustained fast growth of the economy requires a stable macro-economic framework,  policies that stimulate growth and institutions(including laws & rules) that support competitive self sustaining job creating business and promote employment opportunities. Though India's GDP growth rate has risen gradually to 7.6% in 2015-16 (estimated), parts of the economy are buffeted by global growth deceleration, capital market uncertainty and deflationary pressures. These have reduced nominal growth to 8.6% and put pressure on the globalised corporate sector, reducing the nominal growth rates of their sales and profits. The rural economy has been weakened by two consecutive droughts, the first such dual drought since the end 1990s.  In this note we review the budget to identify, what if anything the budget proposes to do about these issues.

Fiscal Balance

   The 2016-17 budget implicitly recognizes that a growth rate of 7.5% to 7.75% doesn't require an expansion of government expenditure or wide tax incentives, by sticking to the fiscal deficit (FD) target of 3.5% of GDP for next year. Such a panicked reaction that will haunt us for the next decade. The decision to stick to fiscal targets enhances the credibility of the government, reduces the risk of contagion from World turmoil & sudden stops in capital flows and lays the basis for a reduction in policy interest rates by the RBI. A reduction in the interest rate by 50 BPS will considerably ease the stress felt by the corporate sector by stimulating demand for consumer durables, including housing and automobiles. The proposed amendment of the RBI Act to create a Monetary Policy Committee will formalize flexible inflation targeting, enhance the credibility of the RBI and allow better Monetary-Fiscal policy balance. 

Subsidies & Investment

    When the fiscal deficit target for 2015-16 was loosened to accommodate more infrastructure investment by government. The question in our minds was whether the government would be able to shifting expenditure from consumption cum subsidies to investment. The fact that the Revenue deficit(RD) for 2015-16 is 0.3% point below the revised target suggests that it has successfully achieved an improvement in quality of government expenditures. As the revenue deficit is a rough measure of government dis-saving, this will help raise national savings and reduce dependence on foreign savings. The RD is projected to decline by only 0,2% point of GDP in 2016-17 compared to the 0.4% of GDP reduction in FD. This is partly due to wage pressures arising from pay commission report implementation, however the budget could have done much more on reform of the fertilizer, food and kerosene subsidy.  In the longer term the proposed bill to provide statutory backing to use of Aadhar for providing targeted benefits, will greatly improve the efficiency of subsidy expenditure and reduce leakages & corruption.

The adoption of Kelkar committee recommendations on Private-Public Partnership would also help in completing stalled projects and promote new PPP projects by reducing regulatory uncertainty. Among the proposals in the budget are, one a Public Utility Dispute resolution Bill, Guidelines for PPP re-negotiations if the external environment changes unpredictably and a Credit rating system for infrastructure taking account of special risks involved. 

Policy Initiatives

  There are a few notable policy initiatives in budget that will help improve the competitiveness of the economy, promote productivity and generate employment. The budget speech proposes to allow 100% FDI in food processing. Along with the previously proposed setting up of a National e-market in agricultural produce could be a game changer for agricultural marketing . For decades we have talked about the huge wastage of food because of lack of farm to market linkages and marketing. Recommendations of many weighty commissions have been received and implemented by Govt without much success. This is the only thing which has not been tried in India, though it has worked in other countries. According the FM 12 States have already amended their APMCs to allow them to join the E-marketing platform to be inaugurated in April 2016. This will set the stage for the FDI in marketing.

   The other measures announced in the budget, should tide the agriculture sector till the next monsoon, which is expected to be normal. The year following the last two consecutive droughts in the late 1980s, saw a jump of 16.7% in agriculture production. With a normal monsoon in 2016-17, we estimate an agricultural growth rate of 7% to 9%. The reform measures proposed in the last two years will help restore rural income, consumption & depleted savings.

The second significant reform is the proposed change in the Motor Vehicles Act to open up the passenger transport sector. Road transport falls in the concurrent list of the constitution but passenger transport has been declared a monopoly of the State Govts in most State. The proposed bill will allow private road transport companies to compete in States which adopt this change. This would allow a modernization of the sector, improving productivity and generating higher quality jobs.

The third significant reform proposal is a model law amending the Shops an Establishment to provide greater flexibility in operation to small establishments, subject to undiluted health & safety requirements. This will provide them with greater freedom and flexibility to compete with malls and other large establishment. This law too would require States to adopt it. The basic approach is to promote inter State competition in reforming laws and rules to promote employment.

Financial Sector

FM reiterated his intention to carry forward the financial reforms, such as Bankruptcy law (for non-financial companies) and proposed some new initiatives for financial firms and banks. The most significant long term reform was a Financial Firms Resolution bill. A number of changes were also announced regarding FDI in and taxation of Asset Reconstruction Companies (ARCs), DRTs, and Public Sector Banks which will expedite solution of the bad debt problem.

Conclusion

    There are were a number of small changes in the personal income tax, corporate tax, customs and excise duties. Some of these will help simplify the tax system while others will complicate the tax system. The net effect is a bit difficult to determine at this point. The budget also carried forward the effort to improve the system of tax administration and dispute resolution based on the recommendations of two tax administration reform committees. But the proof of the pudding in bureaucracy is always in the eating. Overall, the fiscal consolidation and reforms highlighted above make this good budget.
    I expect GDP growth to accelerate by about 0.2% points from the growth rate for 2015-16, and to be much better distributed across sectors & segments of the economy. In particular, rural economy will do much better,  with normal economy, I project an agricultural growth rate of 7% to 9%, based on past performance after two consecutive drought in late 1980s. The corporate sector is also likely to revive with a better mix of monetary-fiscal policy and improvement in the quality of the fisc with a shift from consumption-subsidies to infrastructure investment.
 

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 A version of this article appeared in the Indian Express of March 3rd, 2016, under the banne, "Race To The Top," at http://indianexpress.com/article/opinion/columns/union-budget-2016-race-to-the-top/ .

Budget 2016-17; Macro highlights

Introduction

   India's real economic growth  is projected by CSO at 7.6% for 2015-16.  This is a respectable growth rate, despite two specific sectors that do not appear to share this prosperity. The agriculture sector is clearly distressed given two contiguous drought years. The other sector that hasn't seen the increase in growth anticipated two years ago. The excess capacity and deflationary conditions in the global metals and commodity is a major reason for this low growth.  The global growth slowdown and heightened risks in the global environment form a critical background for the budget

Fiscal Consolidation

   The most important and critical part of the budget is the fiscal balance. Despite suggestions  by many economists,  business men and corporates to let the fiscal targets slip for another year to finance higher  government infrastructure investment in 2016-17, the FM has rightly decided to stick to the 3.5% of GDP, fiscal deficit targets for 2016-17, outlined in the 2015-16 budget.  This will also bring the Primary deficit down to 0.3% of GDP in 2016-17. This is the best insurance against heightened global uncertainty.  The pleasant surprise is that the Revised estimate(RE) for Revenue deficit is 0.3% point lower than projected in the BE for 2015-16. The revenue deficit is an approximate measure of the dis-saving of the Government.  A reduction in this deficit adds to National savings and thus provides the most effective way of raising the National saving rate and reducing dependence on foreign savings.

Subsidy

   The most important subsidy reform in the budget is the decision to introduce a bill to give statutory backing to the use of Aadhar for providing benefits, transfers and subsidies to the targeted population of the poor and needy. This disconnects the general problems of secrecy & confidentiality and connects it to the governments duty to ensure that government's social expenditures reach the intended beneficiaries without being lost in administrative waste or corruption. A few small administrative steps are also being taken to reform the subsidy system. One is the program to provide LPG to BPL women so as to eliminate the health hazards of wood fueled open Chulahs. The second is a proposed test in a few districts  of a shift in provision of fertilizer subsidy from the current wasteful approach to a Direct Benefit Transfer (DBT) system successfully tried in LPG. Reform of the food procurement continues to make very slow progress through greater use of online & digital technologies. Disappointingly there was no mention of reform of the kerosene subsidy based on the previously started  DBT experiment.

Infrastructure Investment

    The budget also remains firmly on track with the infrastructure investment programs announced in the last two budgets and in the interim periods. This includes roads, electricity, ports, waterways,  airstrips and digital connectivity. To this has been added a greater emphasis on irrigation and on infrastructure connecting rural areas to State highways. The attempt to provide an integrated program for development of agriculture and rural areas has attracted more focused attention to irrigation & other inputs and processing of agri products. There also three proposals related to PPPs: A Public Utility Resolution of Disputes Bill, Guidelines for PP renegotiations and Credit rating system for Infra projects, which will help in resolving legacy issues while imparting greater regulatory clarity to bidding for new projects.

Tax Reform

        The picture on the tax reform front also remains mixed as in the last budget. Budget takes the first steps to reform the Corporate Income tax, by giving notice of phasing out of some exemptions and lowering the tax rate for new manufacturing firms that opt out of use of remaining exemptions to 25%. There is also a commendable effort to expand the presumptive tax effort including to professionals. However there are also a number of small tax changes that are an irritant to tax payers and slow progress on simplifying tax administration, even though the intent is reflected in adoption/acceptance of Administrative Reform Committee & Justice Eswar committee recommendations.  Numerous changes in excise and customs duty also suggest a move back from simplification to industry specific (dis)incentives.

Policy Reform

    Policy reforms are essential for sustained fast growth. There are three or four  policy reforms that are noteworthy. One is a reform of the Motor Vehicles Act to open the passenger bus transport service sector to private competition. So far this sector has been a monopoly of the State Govts. The proposed reforms will allow private sectors and even State companies from other States to provide bus transport service. This will be a model law which can be adopted by the States.  The second reform is the permission of 100% FDI in the Food Processing sector, for processing and storage of Indian agricultural produce and manufactures based on these products. This is a very important opening, that one has recommended for many years, after trying many other schemes without achieving the desired result of reducing the wastage of Indian grown agricultural produce. The third important reform is the Financial Firms resolution Bill, and related reforms of ARCs plus the amendment of the RBI Act to formally set up a Monetary Policy Committee (MPC). Even though this has been expected, the formalization of monetry policy system in the RBI Act will enhance the global credibility of the monetary system.

Over all it was a good budget, because of the fiscal consolidation and the policy reforms discussed above.

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An version of this note appeared in the Economic Times, under the Banner, "Fiscal Balance best Insurance against global knocks," on  March 1, 2016 at,

http://economictimes.indiatimes.com/news/economy/finance/budget-2016-fiscal-balance-best-insurance-against-global-knocks-says-ficci-mentor-arvind-virmani/articleshow/51201750.cms