It is a strange time for the observers of the Indian economy. Some commentators seem to place a great deal of hope in the future while others are worried that the headwinds of the global economy will inevitably overwhelm us. This is a rather stark conceptual binary. Clear answers are further obfuscated by three structural challenges that are highlighted here along with the salient features of the Union Budget announced today.
It worth pointing out that the finance minister (FM) himself did not succumb to the aforementioned binary. He began his speech
by lauding India’s resilience to a weak global economy and simultaneously cautioned against a continuing unfavourable external environment. This was a good hedge as the FM would be acutely aware that the even though India’s growth rate at constant prices is projected to increase to 7.6 per cent in 2015-16, real GDP growth is beginning to converge with nominal GDP growth. This is largely owing to the fact that wholesale price inflation (WPI), the index for producer’s prices, has collapsed to negative territory. Banks are still lending at over 10 per cent despite this. Moreover the convergence of the two GDPs means that the government’s balance sheet liabilities cannot be financed by assumptions of an expanding base.
In the face of new liabilities accruing from one rank one pension (OROP) and the seventh pay commission recommendations, sticking to the deficit target of 3.5 per cent in 2016-17 will prove difficult, especially given that public spending seems to be a primary driver of growth today. This is the first structural challenge. The FM was candid about the fact that some experts wanted him to expand spending to resuscitate the investment cycle and others wanted him to continue to be fiscally prudent. He decided in favour of the latter, which is perhaps the wiser option given that governments are bad resource allocators in general, and concomitantly the quality of spending should be the primary focus rather than quantity.
Second, another vexing challenge relates to the pace and pattern of manufacturing sector growth in the country. The ‘Make in India’ initiative is expected to generate growth and jobs. And the industrial production (IIP) shows that production in the sector grew by a healthy 3.1 per cent during April-December 2015, as compared to 1.8 per cent in the corresponding period in 2014. However, growth in credit to the sector was a subdued 2.5 per cent in in the same period as compared 13.2 per cent in the corresponding period in 2014. This does not bode well for the investment cycle.
Holes in the strategy
And, despite the ‘fiery’ Make in India thrust, the service sector contribution to growth continues to prove that there is something amiss in this strategy. The service sector’s share in the economy has increased by four percentage points from 49 to 53 per cent in 2015-16 and it contributed to about 69 per cent of the total economic growth between 2011-12 and 2015-16. Moreover nearly half of the tax revenues of the country come from corporate tax and service tax receipts. Yet, the FM has decided to add another cess (Krishi Kalyan Cess of 0.5 per cent) to the service tax starting June 2016, and to reduce the corporate tax by only one per cent only for small companies with turnover less than INR five crores and 25 per cent for new manufacturing companies. The embedded logic seems to be that service sector competitiveness cannot be undermined by any of the burdens imposed by the state.
A third challenge is that of the exports sector which has been witnessing a sustained contraction owing to weak global demand. The new Economic Survey has pointed out that every percentage point decrease in the global growth rate is now associated with a 0.42 percentage point decrease in India’s growth, compared with 0.2 percentage point decrease between 1991-2002T. The Budget has not made any attempt to address the export slowdown, despite the fact that the Economic Survey has highlighted that the contraction in India’s export, in services industries in particular, is cause for “alarm”.
Despite the potential for focused interventions in service industries such as tourism, manufacturing sector exports command all of government attention. Yet, even in terms of manufacturing, one of India’s strangest structural binaries lies exposed. On the one hand, a large share of the manufacturing exports contraction is due to lower value of petroleum exports. On the other, the Government has more than capitalised on the opportunity to tax domestic sales. The central excise duty collection from petroleum products has resulted in revenues to the tune of Rs. 1.3 lakh crores this fiscal (up till December 2015) as against Rs. 0.7 lakh crores in the same period the previous year. The question therefore arises: what happens if oil prices begin to recover? While this would be good for exports, does the government have a backup plan for fiscal consolidation?
Thankfully, this year’s speech was not littered with tall promises based on a gamut of Rs. 100 crore schemes which seem to have gone nowhere. The FM’s call to put a sunset clause
on all new schemes, along with a review of outcomes, is a leading contender for timely governance reform that could put an end to budgets such as last year’s. Other good moves include the much needed relook at the Fiscal Responsibility and Budget Management (FRBM) Act, as well as the promised statutory backing to the Aadhar platform for targeting beneficiaries of subsidies. The unwavering focus on roads and ports, as well as electrification too may yield some benefits in the medium term. In fact Nitin Gadkari and Piyush Goyal were the only two ministers chosen for praise by the FM in his speech. Conversely, some would say this indicates limited bench strength.
There are also some contenders for initiatives that are most likely to fail. There has been a severe contraction in lending by scheduled commercial banks to the ‘food sector’, with -4.1 per cent year on year decrease in 2014-15. Despite this, the FM promises to deliver Rs. 9 lakh crore by way of farm credit in the next fiscal. Similarly, the FM proposes to set up 1500 ‘Muti Skill Training Institutes’ with just Rs. 1700 crores. That’s just over Rs. 1.13 crores per institute – seemingly unviable from the outset, but it would be great to be proved wrong. In the end, what stood out was that the government has now pivoted to being more circumspect and social sector oriented. In the run up to this Budget, the finance ministry had asked Indian Twitter users’ opinions to determine the focus of the Budget. Perhaps better perspectives can be garnered from the ground next time, partly by enhancing the feedback loop with Panchayati Raj Institutions. One can hope that the massive grant in aid promised to Gram Panchayats (Rs. 80 lakhs on average) can help with this instead of being squandered in return for well-timed political mileage.
Vivan Sharan is a Partner at the Koan Advisory Group