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

INDIA and WTO: Distinguishing GeoPolitics From Economics

Introduction

    At the start of the Doha Round of WTO negotiations, I warned against confusing the Economics and GeoPolitics of WTO negotiations [Virmani(2003)]. I quote extensively from this note (below) because it remains relevant today, in the context of the decision of the Indian Government to make approval of the agreement of “Trade Facilitation” contingent on a commitment to revise the agreement on Food subsidies.  I conclude with an economic analysis of protection and subsidies that clarifies the economic issues and puts them in proper perspective

Geo-Politics Of Negotiations

 “Economic theory and empirical analysis as understood and accepted by academics in the USA, Europe and the emerging market economies, says that removal of controls, restrictions and obstacles to Imports will by and large lead to an increase in the welfare of both the importing and the exporting countries.  Then why is it that each country ignores what its own academics tell it with respect to policy reforms and focuses mostly on the import restrictions imposed by other countries on its export items (whether these are goods, services or factors)?  The answer is politics.  In every country, politics imposes a cost on the nation as a whole while benefiting some sub-set of individuals.  The geopolitics of negotiations is motivated by a desire to transfer some of the national costs of policy distortions onto other countries, while retaining as much of the benefits for sub-groups within the country.  A good example of this from the rich countries is the multi-fibre agreement (MFA).

One implication of this strategic approach to multilateral economic rules is that there can be an apparent dichotomy between our domestic reform intentions and actions and our public posture and negotiating stance at WTO.  Economic analysis must drive our (autonomous) reforms in the external sector irrespective of what happens (or does not happen) at WTO.  That is, liberalisation is beneficial to the country and must continue independent of the WTO and at a pace and timing of our choice.  Economic analysis also provides us with the true costs and benefits to our citizens, of specific policy changes.  This forms the basis of our evaluation of what rules we should be willing to accept in the negotiations- those resulting in policy change that have a higher benefit to us in any case.  Conversely it also determines which changes we should resist conceding (those that have higher cost).  The public position that we take at the negotiation need not however lay all this out publicly for other countries. In the tactics and strategy of negotiations, politics/geo-politics will inevitably play a substantial role.” Virmani(2003)

Trade Facilitation

“Trade facilitation is the global equivalent of the Indian mantra,  ‘red tape and bureaucracy’ in international trade (import-export) system.  Trade facilitation would directly address this problem on which there is a national consensus (with the exception of the customs bureaucracy).”

“From the perspective of politics/geo-politics therefore, it is quite rational for India to concede to others on any of the Singapore issues if and only if we gain concessions and benefits in other areas. In other words we must use these as counters to bargain for what would not be available to us otherwise.  It should be remembered however that these bargains are sometimes informal, on the sidelines of the formal negotiations or a meeting in another capital.” Virmani(2003)

WTO Negotiations on Agriculture

                “Agriculture is an area where the economic arguments of rich countries are very weak (because of high subsidies) while those of poor countries are relatively strong.  It is quite clear that many countries in the EU and to a lesser extent the USA are hostage to agriculture producers who constitute a small fraction of their population.  On our side a large proportion of the population is dependent on agriculture, lives in rural areas, is very poor and less educated and has little access to up to date and relevant knowledge.  This puts their lively hood and sometimes even their survival at risk from exogenous shocks.  Over the last few years we have also raised the import duties on a number of agricultural products above the peak rate.[1] The inter-ministerial expert group argued that in the interest of economic efficiency, these should be brought down to the peak rate, with an intermediate step of two times the peak rate.  In the meanwhile, we should carry out a thorough de-control and reform of the agriculture, agro-processing and food retail sectors (as detailed in a Planning commission working paper).[2]

As far as the WTO negotiations are concerned, however, offence is the best form of defence.  We should marshal the global NGOs to expose the hypocrisy of the rich countries vis-à-vis free trade and verbal concern for the poor (while giving subsidies to rich farmers that destroy poor agriculturists jobs).  The outcome of this will either be a stalemate (both rich and poor countries retain their preferred distortions) or less likely a trade-off relating to (one or more of) the Singapore issues.  A commitment to reduce rich country agricultural subsidies in return for a reduction in (bound) tariff rates on agricultural goods in poor countries the third but least likely possibility.” Virmani (2003)

Economics Of Food Subsidy

    In several articles during the last year I opposed the Food Security Bill on the grounds that it was barking up the wrong tree. As I showed the real problem is child malnutrition and this requires improved sanitation not more food.[i]  However, we now have the food security Act and the Govt. has to implement it as it stands, until it is amended or redirected.  If the pessimistic calculations of the fiscal critics of the Act come true, implementation will involve huge subsidies. There is a fear in the Indian bureaucracy, that unless the exiting WTO subsidy limits are changed, India could be constantly in the dock at the WTO, having to answer to Global agricultural exporters for domestic subsidies.  To put this fear in perspective, we need to understand the three aspects of Agricultural protection-subsidy:

(1)   Production Subsidies (S_f)

    Subsidies on agricultural inputs given to the farmer, such as fertilizer, electricity and water, that reduce the cost of production. If the subsidy per unit of output is S_{f  =}  s P_d  this will reduce domestic market price from P_d to P_d’ = P_d  - S_{f  =} (1-s) P_d  . The last WTO agreement on Agriculture puts a limit on production subsidies of 10% based on a three year average of prices prevailing at the time the agreement was signed (1986-88). This is clearly outdated and needs to be updated to current/recent price levels. Once this is done a 10% subsidy limit would mean that input subsidies cannot exceed 1.8% of GDP (as GDP from agriculture is about 18% of total GDP).  Current input subsidies are less than 1% of GDP.[ii] To pump even more than this amount into agriculture input subsidies instead of into enhancement of agricultural productivity, would be reflective of very bad agricultural policy.[iii] In the medium term, direct income transfers to poor farmers could eliminate even the need for this level of input subsidy.

(2)   Tariff Protection (t)

      Protection of domestic agricultural/food output through tariffs (and QRs). If the effective tariff rate is t this will mean that with World Price P_w ,  P_d’= (1+t) P_w  or P_d = (1+t) P_w  + S_f  =  [(1+t)/1-s)] P_w  . The effective tariff rates on Wheat and rice have varied between 5% and 10% in the recent past, without exceeding the latter.

     The WTO agreements on tariffs, stipulates that the “actual” tariff rate cannot be higher than the “bound tariff rates”. Even though our peak tariff rate on non-agricultural goods is 10%, the bound rates on agriculture are two to three times the bound rates on non-agriculture imports. Therefore elimination of input subsidies could be offset by raising the import tariffs to t’ = s +  t (1+s), thus keeping the degree of import protection to farmers unchanged.

(3)   Consumer subsidies (S_c)

    Consumer subsidies reduce the price of food paid by the consumer (P_c) below the market price. P_c = P_d’- S_c = (1+t) P_w  - S_c . There are no WTO limits on consumer food subsidies.  However, our consumer subsidies are provided through the FCI which also runs the price support system for farmers. Therefore it is not always clear what part of the subsidy given to FCI is compensation for its inefficiency and corruption and how much is a subsidy to consumers. 

       Further, foreign producers argue that the MSP acts as a subsidy to farmers and must be included in the production subsidy calculation, as the Govt. does not allow foreign agriculture producers to supply FCI imported agricultural produce at the MSP. Though this point is debatable, it could be another issue for putting Government in the dock at the WTO. If food subsidies were provided directly to consumers through a food debit/credit card or a bank account (instead of through FCI), the issue would not arise.

Conclusion

    The Indian Government has stated that it is willing to continue discussion on the Bali issues when the WTO meets again in September after a recess.  It seems to me that a reasonable compromise that meets the domestic political objectives of India as well as of Agricultural exporters such as the USA and Australia is possible before the end of the year given a genuine desire to reach agreement, instead of trying to scapegoat India.

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[1] See references in Planning Commission Working Paper No. 4/2002-PC (April 2002), “Towards a Competitive Economy: VAT and Customs Duty Reform,” by Arvind Virmani, for a list of items (Table 3, p 30) and tariff rates (appendix table).

[2] See Planning Commission Working Paper No. 5/2002-PC (May 2002), “Excess Food Stocks, PDS and Procurement Policy,” by Arvind Virmani and P V Rajeev.

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[i]  See articles & blogs at http://dravirmani.blogspot.in/p/blog-page_25.html and research papers at  https://sites.google.com/site/drarvindvirmani/social-welfare .

[ii] Even if highly questionable items are added from FCIs MSP operation (see below) the total agricultural subsidy is less than 10% of Agricultural GDP.

[iii] For a benchmark of good agricultural policy see,  https://sites.google.com/site/chintan1997reg/economic-policy-and-regulation/agriculture