It was a budget that nearly never was. The Indian government had to wait until January 23 for Supreme Court permission to present the federal budget on February 1. The reason: The court had to rule on a clutch of petitions saying that the budget could be used by the ruling party to influence the coming state elections.
It was a budget that may soon be forgotten. The Indian stock markets welcomed it: The Bombay Stock Exchange Sensitive Index (Sensex) ended the day at 28,141, a gain of 485 points or 1.76% and moved further up the next two days. But that was more because of the absence of “bad news.” “The 2017-2018 Budget has the shortest list of bad news for the markets in nearly two decades,” Ridham Desai, head of India equity research at Morgan Stanley, told news channel CNBC-TV18, adding that, unlike his predecessors, Finance Minister Arun Jaitley “had resisted the temptation to plant bombs in the fine print.”
Part of this was because of a government decision to remove the mystique from budget-making. Earlier budgets were prepared behind a cloak of secrecy, with small excise changes affecting prices — from bread and butter to laptops and lingerie. The newspapers the next day were full of commentary about “who gains and who loses.” The tinkering leitmotif has been all but abandoned.
An indication was available from the budget itself. The Railway Budget has been an independent part of the budgetary exercise, tabled separately a couple of days before the Union Budget. This time, it was merged with the main budget; a voluminous document was compressed to a few paragraphs. “We have discontinued the colonial practice prevalent since 1924,” said Jaitley. “The [Railway Budget] had in the past couple of decades also become a means for populism, so it may be good to do away with that,” says Saikat Chaudhuri, executive director of Wharton’s Mack Institute for Innovation Management.
Besides, Prime Minister Narendra Modi had contrived to steal Jaitley’s thunder. In his year-end address to the nation (earlier, it was assumed he would speak on the impact of demonetization), Modi held forth instead on affordable housing. Jaitley also took the housing line and, like Modi, found little room for demonetization.
The Impact of Demonetization
The impact of demonetization was left for India’s chief economic advisor, Arvind Subramanian, to unravel. Presenting the Economic Survey, the finance ministry’s view on the annual economic development of the country, a day before the budget, Subramanian estimated real GDP growth to slow down by 25 to 50 basis points (one basis point equals 0.01%). A chapter in the survey titled “Demonetization: To Deify or Demonize?” notes: “Demonetization has been a radical, unprecedented step with short-term costs and long-term benefits. The liquidity squeeze was less severe than suggested by the headlines and has been easing since end-December 2016.” India is expected to clock a GDP growth of 7.1% in 2017-2018, according to an HSBC report. “We expect GDP to grow from 6.3% in 2016-2017.” The International Monetary Fund (IMF) has trimmed the growth forecast for the current fiscal year (2016-2017) by one percentage point, citing demonetization. The World Bank has cut the rate from 7.6% to 7% for calendar 2017.
“What is … positive is that the middle class, for once, also gets a break through reduced taxes, as well as the small and medium enterprises (SME) sector.”–Saikat Chaudhuri
Calling the Budget “mildly growth supportive,” rating agency Crisil (part of the Standard & Poor’s network) notes: “The Union Budget 2017 has performed a balancing act. With an eye to reducing deficit and simultaneously improving growth prospects, the budget refrained from stretching its fiscal coffers to give a steroidal push to the economy. Yet, sectors like transport and affordable housing received a shot in the arm, which in turn, is expected to push demand in areas such as cement and steel, generating positive multiplier effects in employment and incomes. This, to an extent, will help alleviate some stress in rural areas which were hit hardest by the demonetization drive.”
The budget has others who see both positive and negative features. “Overall, the budget focuses on the basics necessary to facilitate economic development, much like Modi had done in Gujarat, too, before embarking on attracting investments. People tend to forget that part, which occurred in his first term as state chief minister,” says Chaudhuri. “The budget focuses on infrastructure as the foundation for development and economic growth. What is also positive is that the middle class, for once, also gets a break through reduced taxes, as well as the small and medium enterprises (SME) sector.” What is missing, Chaudhuri adds, is any indication of reforms such as opening up the financial sector and insurance, changes in labor and pension laws to facilitate restructuring or improved land acquisition policies. “It would have been useful to send a positive signal on those fronts, especially to foreign investors, who have had to make do with primarily the Goods and Services Tax (GST) as far as major reforms are concerned,” Chaudhuri notes.
“This budget, like all budgets, is a mixed bag, with what appears to be a greater thrust on long-term, systemic reforms than on ensuring growth per se,” says Rajesh Chakrabarti, professor and executive vice dean at Jindal Global Business School. “The bigger concern is that no immediate steps seem to have been taken to reverse the job losses in the informal sector that have doubtless occurred in the aftermath of demonetization. While the ability of any budget to significantly boost growth is somewhat suspect, this one is an underwhelming budget, which is not necessarily a criticism.”
What did the markets like about the budget? First, there was no change in the capital gains tax. Modi had first tested the waters in a meeting in Mumbai in late December. “Those who profit from financial markets must make a fair contribution to nation-building through taxes,” he told the audience. That was promptly taken to mean that the budget would remove some of the largesse now available. (Long-term capital gains on securities held for over one year are free of capital gains tax.) But Jaitley held firm; capital gains were left untouched. “While is it always difficult to ascribe reasons to market movements, one could venture the thought that this was a ‘sigh of relief’ that the budget was not particularly disruptive,” says Chakrabarti.
Then there was the whole realm of excise duties. Jaitley left the entire list to the GST regime, expected from July this year. Even “sin” products like cigarettes, always the target of every budget, faced only marginal new levies.
There were some inducements for foreign investors. Gray areas on their liability to pay tax were clarified. The Foreign Investment Promotion Board (FIPB) is being abolished. “In the meantime, further liberalization of the foreign direct investment (FDI) policy is under consideration,” said Jaitley.
“This budget, like all budgets, is a mixed bag, with what appears to be a greater thrust on long-term, systemic reforms than on ensuring growth per se.”–Rajesh Chakrabarti
FIPB to Be Wound Up
The incipient demise of the FIPB will cause no heartburn. “The FIPB only debated the FDI proposals that were [part of the] non-automatic route, only 10% according to the statistics,” says Chakrabarti. “What it has been replaced with is not very clear, but it may not be unreasonable to expect that the automatic route will be expanded to cover close to all FDI. That will certainly make investing easier for foreign investors, but given that it only affects 10% of FDI flows anyway, the impact of this move on overall FDI flows is unlikely to be huge.” The Economic Survey is upbeat about current FDI flows, however. FDI increased by 36% in the first half of 2016-2017 over the same period last year, the report says. “[This is] despite 5% reduction in global FDI inflows. Foreign exchange reserves have reached $361 billion as of January 20 2017, which represents a comfortable cover for about 12 months of imports.”
The numbers are comforting and give Jaitley some leeway on other fronts. He would prefer a tight rein on the fiscal deficit. But, with private sector investment showing no signs of picking up (thanks to high interest rates and bad loans), he didn’t have much choice. “I have pegged the fiscal deficit for 2017-2018 at 3.2% of GDP and remain committed to achieve 3% in the following year,” he said in his speech. “Fiscal prudence has not been the top priority for this budget,” says Chakrabarti. “Next year will have the last full budget for this Lok Sabha and it is perhaps unwise to expect much tightening going into an election. In that sense this was an opportunity wasted.”
Other commentators are prepared to give Jaitley more license. “We believe that against the backdrop of India’s credible fiscal consolidation history and the recent slowdown in growth, there is a case for breaching the medium-term fiscal deficit target of 3%,” according to an analysis by ICICI Direct. A Crisil study agreed: “The government has chosen prudence over populism with a budgeted fiscal deficit target of 3.2% of GDP. Moreover, fiscal arithmetic appears to be broadly credible, though the divestment target and GST implementation could cause hiccups.”
One point made by both Jaitley and Subramanian is that there are a lot of external imponderables. “The world economy faces considerable uncertainty in the aftermath of major economic and political developments during the last one year,” said Jaitley. “There are three major challenges for emerging economies. First, the current monetary policy stance of the U.S. Federal Reserve, to increase the policy rates more than once in 2017, may lead to lower capital inflows and higher outflows from the emerging economies. Second, the uncertainty around commodity prices, especially that of crude oil, has implications for the fiscal situation of emerging economies. Third, in several parts of the world, there are signs of increasing retreat from the globalization of goods, services and people, as pressures for protectionism are building up.”
Added Subramanian in an interaction with journalists after releasing the survey: “The world is very different. We don’t know exactly what will happen to NAFTA (the North American Free Trade Agreement), what will happen to US-China relations…. There are many domestic uncertainties, too. We have to see how demonetization plays out. With so many uncertainties, we should reflect them in our forecast.”
“The incentives for affordable housing are welcome, since much real estate development in the country has focused on the middle and higher end market in recent times.”–Saikat Chaudhuri
But India seem to be on a good path. The IMF estimates that world GDP would grow by 3.1% in 2016 and 3.4% in 2017. The advanced economies are expected to increase their growth from 1.6% to 1.9% and the emerging economies from 4.1% to 4.5%. India, meanwhile, has become the sixth-largest manufacturing country in the world, up from ninth previously. “We are seen as an engine of global growth” says Jaitley. The ‘Make in India’ thrust may be finally working.”
Merger Ahead for Oil PSUs
What else is there in the budget? The proposed merger of public sector oil companies — but this is not a new proposal. Disinvestment — but that always gets buried under charges of selling the family silver. An “electoral bond” – a device to remove the opacity from corporate donations to political parties. This, along with a new ceiling of Rs. 2,000 (around $30) for anonymous donations to parties is supposed to further the government’s crusade against black money. And, of course, affordable housing. “The incentives for affordable housing are welcome, since much real estate development in the country has focused on the middle- and higher-end market in recent times,” says Chaudhuri.
But the house that Jaitley (and Modi before him) needs to build should provide jobs. That is one area of failure for the government. “Despite a pick-up in GDP growth, fewer employment opportunities are likely to have been created in the past three years,” according to a Crisil report. “That’s because sectors with high potential to absorb labor have grown at a slower pace.” There are no easy solutions. One tack being tried is a set of incentives for SMEs, which collectively employ many times more workers than the organized sector. The other is housing. In rural India, building houses requires labor and migrant construction workers may find new destinations.
The budget, if nothing else, is a tribute to packaging skills. “Continuing with the task of fulfilling the people’s expectations, our agenda for the next year is: Transform, Energize and Clean India”, that is, TEC India,” said Jaitley in his speech. The 10 pillars of this are: “Farmers: for whom we have committed to double income in five years; Rural Population: providing employment and basic infrastructure; Youth: energizing them through education, skills and jobs; Poor and the Underprivileged: strengthening the systems of social security, health care and affordable housing; Infrastructure: for efficiency, productivity and quality of life; Financial Sector: growth and stability through stronger institutions; Digital Economy: for speed, accountability and transparency; Public Service: effective governance and efficient service delivery through people’s participation; Prudent Fiscal Management: to ensure optimal deployment of resources and preserve fiscal stability; and Tax Administration: honoring the honest.” This is the necessary — but unglamorous — part of any budget.
You can TEC it or leave it.