NEED FOR A BOOSTER SHOT

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

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