An ef­fec­tive bud­get will be crit­i­cal for the Modi gov­ern­ment as it tries to steady an econ­omy reel­ing un­der the ef­fects of de­mon­eti­sa­tion

India Today - - ECONOMY/PRE-BUDGET - By Sh­weta Punj and M.G. Arun

Fi­nance Min­is­ter Arun Jait­ley’s pre­vi­ous bud­get came amidst a se­ri­ous drought, and he ad­dressed it with plenty of sops for ru­ral In­dia. His fourth bud­get, to be pre­sented on Fe­bru­ary 1, comes in even more try­ing cir­cum­stances—an econ­omy thrown into dis­ar­ray by the de­mon­eti­sa­tion that sucked out 86 per cent of In­dia’s cur­rency. Can Jait­ley pull off a bud­get that can heal the wounds and nurse the econ­omy back to health?

The FM faces a chal­lenge al­right. Post-de­mon­eti­sa­tion, growth es­ti­mates have been slashed—Crisil es­ti­mates In­dia’s GDP growth for 2016-17 to drop by a per­cent­age point to 6.6 per cent. Ex­perts say for ev­ery per­cent­age point drop in GDP growth, the econ­omy would suf­fer a loss of around 6 mil­lion jobs. The Cen­tral Sta­tis­ti­cal Or­gan­i­sa­tion (CSO) has pegged GDP growth at 7.1 per cent for 2016-17, but Pran­jul Bhan­dari, chief In­dia econ­o­mist at HSBC, says the data has lit­tle

cre­dence as it ig­nores the im­pact of de­mon­eti­sa­tion (CSO has used data only till Oc­to­ber 2016 for its GDP es­ti­mate). Add to this, the global tremors caused by Brexit and US Pres­i­dent Don­ald Trump’s pro­tec­tion­ist rhetoric, and the fis­cal year ahead looks chal­leng­ing. The econ­omy needs more than a balm, an elixir per­haps.

That Bud­get 2017 is be­ing pre­sented a month in ad­vance and will in­clude the rail bud­get only raises more chal­lenges for Jait­ley (Fe­bru­ary could have given a clearer pic­ture of the fis­cal year’s fi­nal quar­ter). While there is a con­sen­sus that the FM needs to put together a bud­get that soft­ens the blow of de­mon­eti­sa­tion, spurs con­sump­tion, and yet main­tains fis­cal dis­ci­pline, it’s all eas­ier said than done. His op­tions are lim­ited. WIG­GLE ROOM “The only cer­tainty we have is the global un­cer­tainty,” says D.K. Joshi, chief econ­o­mist at Crisil. What­ever hap­pens with growth will largely be shaped by the do­mes­tic econ­omy. “Not that the bud­get has the abil­ity to re­vive the econ­omy; we don’t have the fis­cal mus­cle to give a large stim­u­lus,” he adds.

Does the gov­ern­ment data (till Oc­to­ber) of­fer some com­fort? Not re­ally. “We might see a more se­vere im­pact in the fourth quar­ter,” says Joshi.

With the Re­serve Bank of In­dia (RBI) still com­put­ing the cur­rency de­posited and ex­changed at banks post-de­mon­eti­sa­tion, it is dif­fi­cult to make as­sess­ments about any stim­u­lus based on ex­tin­guish­ing the un­re­turned cash. Ac­cord­ing to D.K. Sri­vas­tava, chief pol­icy ad­vi­sor, EY In­dia, on the brighter side, as­sum­ing that 5 per cent of de­mon­e­tised cur­rency does not come back, it could still be a mean­ing­ful source for short-term stim­u­lus. Pe­nal tax rates on un­ex­plained de­posits, or de­posits on which tax has not been paid, could be another source of rev­enue. These together could add up to 0.75 per­cent­age point of the GDP and of­fer the scope for a stim­u­lus of more than 1 per­cent­age point of GDP. There is also an ex­pec­ta­tion of higher tax col­lec­tions next year.

The sharp con­trac­tionary ef­fect of de­mon­eti­sa­tion in the short term is vis­i­ble across sec­tors. Pas­sen­ger ve­hi­cle sales of In­dia’s top three au­tomak­ers plum­meted in De­cem­ber de­spite an ag­gres­sive sales push. Ditto for two-wheel­ers. Sales at Mahin­dra & Mahin­dra dropped 8 per cent; at Maruti Suzuki and Hyundai Mo­tor In­dia, they fell 4 per cent dur­ing the month. Com­mer­cial ve­hi­cle sales were down 7 per cent in Novem­ber (year on year). Fig­ures put out by the Cen­tre for Mon­i­tor­ing In­dian Econ­omy (CMIE) show that new in­vest­ment pro­pos­als worth only Rs 1.25 lakh crore were made dur­ing the quar­ter ended De­cem­ber 2016, com­pared with an av­er­age Rs 2.36 lakh crore ev­ery quar­ter in the pre­ced­ing nine quar­ters. Con­sump­tion con­tracted, too. Adi Go­drej, chair­man of the Go­drej Group, said FMCG sales took a hit in Novem­ber, but re­cov­ered in De­cem­ber as the cash crunch eased. The group has de­cided to cut back on ad­ver­tis­ing to tide over the pe­riod.

While de­mon­eti­sa­tion was done in one stroke, re­mon­eti­sa­tion is tak­ing con­sid­er­able time. “Re­mon­eti­sa­tion has been char­ac­terised by sharp rigid­ity,” says Sri­vas­tava. “For the next two quar­ters, there will be a sharp con­trac­tion.”

Ac­cord­ing to a Citi es­ti­mate, the RBI might have re­plen­ished around 45 per cent of the high-value cur­rency notes by the end of De­cem­ber, but nearly half of it could be in the form ‘low ve­loc­ity’ 2,000 ru­pee notes, which don’t cir­cu­late eas­ily. As­sum­ing that the cur­rency presses have the ca­pac­ity to print 1.5 bil­lion notes of Rs 500 de­nom­i­na­tion ev­ery month, it could take up to March-end or be­yond to re­plen­ish the Rs 500 cur­rency in suf­fi­cient num­bers (there were 16 bil­lion of these notes in cir­cu­la­tion be­fore the de­mon­eti­sa­tion drive). This cash crunch has had a rip­ple ef­fect across the econ­omy—the PMI (Pur­chas­ing Man­agers’ In­dex, an in­di­ca­tor of busi­ness ac­tiv­ity) of both the man­u­fac­tur­ing and ser­vices sec­tors de­clined. The ser­vices sec­tor con­tracted for the sec­ond month in a row in De­cem­ber. A TIGHTROPE WALK So, what are the op­tions be­fore the FM to al­le­vi­ate the pain? One school of thought holds that the gov­ern­ment should re­lax its FRBM (Fis­cal Re­spon­si­bil­ity and Bud­get Man­age­ment) norms to al­low for more spend­ing. They ar­gue the gov­ern­ment should have the flex­i­bil­ity to ad­just the fis­cal deficit tar­gets suited to the eco­nomic cy­cle of the coun­try and not be rigid while set­ting tar­gets. Cycli­cally ad­justed fis­cal deficit tar­gets are prac­tised in other coun­tries, too. Jait­ley, in his first bud­get in March 2015, laid out a fis­cal con­sol­i­da­tion roadmap that pro­jected fis­cal deficit at 3.9 per cent of GDP in 2015-16, 3.5 per cent in 2016-17 and 3 per cent in 2017-18. The gov­ern­ment has man­aged to de­liver on the 2015-16 tar­get and wants to con­tinue

do­ing so, de­spite de­mon­eti­sa­tion and the pay com­mis­sion pack­ages (grant­ing cen­tral gov­ern­ment em­ploy­ees big pay in­cre­ments). How­ever, some econ­o­mists ar­gue that the gov­ern­ment should bol­ster sen­ti­ment by re­lax­ing its self­im­posed fis­cal deficit tar­get of 3 per cent of GDP to 3.4 per cent in or­der to boost spend­ing.

Another way of stim­u­lat­ing the econ­omy could be to per­suade the pub­lic sec­tor en­ti­ties to go through their ex­pan­sion plans and ask de­part­men­tal en­ti­ties, such as the rail­ways and postal de­part­ment, to raise money out­side the bud­get through special pur­pose ve­hi­cles.

Al­though banks are flush with funds from the in­creased de­posits, the de­mand for credit has been low. This presents an op­por­tu­nity to re­duce in­ter­est rates. “They (the gov­ern­ment) should con­cen­trate on ra­tio­nal­is­ing the tax struc­ture in the light of GST,” says econ­o­mist Lord Megh­nad De­sai. “They should im­pose fi­nan­cial trans­ac­tion tax and re­duce in­come tax.”

The bud­get is ex­pected to usher in a new tax­a­tion regime for both in­di­rect and di­rect taxes. The GST, which has made rea­son­able progress and could be im­ple­mented dur­ing the next fis­cal in July 2017, would be a de­fin­i­tive step in in­di­rect taxes—mov­ing to­wards a more stream­lined, trans­par­ent tax­a­tion sys­tem. The gov­ern­ment has man­aged to re­solve the ques­tion of tax ad­min­is­tra­tion, but the next few GST Coun­cil meet­ings will greatly de­ter­mine the ef­fi­ciency of the tax. “The goal of tax re­form is sim­plic­ity, eq­uity and ef­fi­ciency, and these as­pects are im­pacted by the rate struc­ture, what is tax­able and what isn’t,” says Satya Pod­dar, tax part­ner, pol­icy ad­vi­sory group, EY In­dia. The gov­ern­ment has not fi­nalised those ques­tions. Mean­while, it seems to be strug­gling, with some states, such as West Ben­gal, in­sist­ing that the tim­ing is not right for im­ple­ment­ing GST. One of the key rea­sons cited for this ar­gu­ment is the im­pact of de­mon­eti­sa­tion on states’ fi­nances.

In di­rect taxes, the gov­ern­ment wants to broaden the tax base. In the 2014-15 bud­get, it had an­nounced its in­ten­tion to re­duce the cor­po­rate tax (ba­sic) rate to 25 per cent by fi­nan­cial year 2019-2020 and im­ple­mented changes to the In­come Tax Act in the 2015-16 bud­get, which will re­move sev­eral tax ex­emp­tions for com­pa­nies over a pe­riod of time, start­ing April 1, 2017. The gov­ern­ment left the ba­sic cor­po­rate tax rate un­changed in the 54 FE­BRU­ARY 6, 2017 IN­DIA TO­DAY

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