India’s fiscal fortune
Indian Prime Minister Narendra Modi’s government must be feeling lucky. The decline in world commodity prices, led by crude oil, has made managing the national budget easier. And now, after the Central Statistics Office revised its methodology for calculating GDP data, that task has become easier still. According to the CSO, as a result of the methodological change, annual output growth in the second quarter of 2014 stood at 8.2%, up sharply from the original estimate of 5.3%.
Based on the revised GDP figures, India is expected to average 7.4% growth in the fiscal year ending March 2015. Moreover, the country is projected to grow at an 8-8.5% rate in the next fiscal year. No budget changes could generate such a marked, cost-free acceleration in growth. It is fair to say that the usually staid statistics department stole the thunder from this year’s budget.
Nonetheless, Finance Minister Arun Jaitley’s budget succeeds on several fronts – not least in its alignment of vision and implementation. Specifically, it advances the government’s vision of a pro-growth agenda that enhances the ease of doing business in India, while targeting better delivery mechanisms for welfare schemes.
On the expenditure side, the budget is expansionary, scaling up investment spending dramatically, introducing new welfare programmes, and increasing credit for various sectors. While there is no significant effort to cap spending on some of the largest fiscal programmes, including the National Rural Employment Guarantee Act (which guarantees 100 days of wages to rural households) or the fertiliser subsidy, measures to improve implementation and reduce leakage are being put in place. Though the budget mentions disinvestment in lossmaking public-sector units, the budget conveys no sense of urgency on this front.
With private investment remaining weak, owing to the corporate sector’s heavy debt burden and banks’ huge volume of bad assets, the government has clearly decided to jumpstart the process through infrastructure spending. But India’s infrastructure needs far exceed what the government can spend. In this sense, the new “plug and play” scheme for public-private partnerships, whereby “all clearances and linkages will be in place before the project is awarded,” is a major improvement over the previous PPP model.
The budget’s success will be determined by how these public-sector investments play out, which in turn will depend on other policies, especially the Land Acquisition Bill (designed to enable industrial development in rural areas), which has already run into trouble. Moreover, government investment and allocation of resources has long been tainted by corruption, and Modi’s government has yet to show that it can implement the budget’s promises in a transparent and sustainable manner. On the tax side, there is one major announcement: a reduction of the corporatetax rate from 30% to 25% over the next four years, thereby encouraging private-sector investment. The implementation of the Goods and Services Tax – a form of value-added tax on which the government has made admirable progress – would be a major accomplishment and a huge boost for the economy. Despite raising expenditure substantially, however, the budget relies mainly on growth and improved tax collection to keep the country’s fiscal deficit within reasonable limits.
Of the budget’s many proposed measures to boost inflows of foreign investment, one appears risky from a macro-prudential perspective. The government would “do away with the distinction between different types of foreign investments, especially between foreign portfolio investments and foreign direct investments, and replace them with composite caps.”
There are many reasons to treat the two types of investment differently. Portfolio investment, often called “hot money” because of its volatile nature, can increase the economy’s vulnerability to the vagaries of international finance. Foreign direct investment, on the other hand, is far more stable and driven by domestic fundamentals. With interest rates set to rise in the United States this year, volatility in international capital markets can be expected to increase. In this context, it would be prudent to maintain the distinction between portfolio and FDI.
In general, the budget plan addresses the major issues facing India’s economy. But translating good intentions into desired outcomes will depend crucially on the government’s ability to push through complementary and urgently needed reforms on hot-button regulatory issues like land, labor, and the environment.
In any case, the budget sends a clear signal about the Modi government’s intentions. At least in the near term, it is shifting its practice of “minimal government and maximum governance” to one of “moderate government and maximum governance.”