Monday, March 7, 2016

Economic Growth and Macro Stability: Budget 2016-17


   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.


    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.
 A version of this article appeared in the Indian Express of March 3rd, 2016, under the banne, "Race To The Top," at .

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