When the country's first woman finance minister Nirmala Sitharaman presents her maiden budget on July 5, everyone would anxiously wait to see what's in her bag -- if it's going to be somber, populist, mixed bag or lame duck? The interim Budget presented ahead of the general election was a dream one with Piyush Goyal announcing cash support to farmers, tax sops for individuals, pension for unorganized workers, interest subvention for MSMEs and higher budget for the defence but still managing to keep the fiscal deficit at 3.4%.
After coming back to power, the Modi government now finds itself in a spot of bother with the growing concern about declining demand, increasing joblessness and lack of investment recovery. The economy that was among the fastest growing in the world over the last few years, now faces the risk of slowing growth amidst a weakening global economic environment and plummeting domestic demand. Farm crisis remains unresolved although the central and some state governments have tried to dole out freebies to farmers. The stock market, which at one point breached 40,000 now remains stuck in a range. In this backdrop, the first Union Budget for the next five years becomes a crucial exercise.
India was able to wade through the global headwinds in earlier years as the growth was supported by growing domestic demand. Low inflation on account of subdued food and oil prices had contributed towards higher consumption growth. But, that is no longer the story. The recent signs of slowdown in the economy stem not only from slowing investments and subdued exports, but also from weakening growth in consumption. India reported its 4QFY19 GDP at 5.8%, below Bloomberg consensus estimate of 6.3%. The growth was largely supported by the services sector, including construction and government spending, but gross fixed capital formation (GFCF) slowed sharply as it reflected a cut in capital expenditure by the government and private investment slowing ahead of elections. The Reserve Bank of India (RBI) has been on an interest rate-cutting spree, a trick that is yet to show any sharp positive impact.
The first five years have gone by. The renewed and a much stronger mandate in 2019 polls meant the Modi government now has to deliver on the economic front. While it can be argued that the Union Budget is a day in economic life of India, this annual exercise sets the foundation for the incoming policies and reforms.
Let us first have a look at the economic challenges in front of Modi 2.0 era.
Addressing the agrarian distress and reviving rural economy is undoubtedly the biggest challenge. The Interim Budget 2019-20 included a Direct Income Support (DIS) of Rs 6,000 annually to small and marginal farmers. While this is a welcome move, weak commodity prices have been aggravating the farmers’ plight. If this goes on, pretty soon there will be demand for a higher quantum and expanded coverage. The farm crisis seems to be grim. As many as 12,021 farmers committed suicide in Maharashtra from 2015 to 2018 for reasons that included bank loans and crop failure, averaging eight deaths a day. The problem is not specific to one state alone.
Declining soil fertility, sinking water tables, rising costs and poor returns to farmers are some of the key factors for the farm crisis. The government has been doling out Rs 6,000 per year to small and marginal farmers annually, which translates to Rs 16 a day. The farm sector requires more than just money
Solution - Farm investments have to be made by the government. One other way is by removing inefficient existing agriculture subsidies. To enhance agriculture yields and mitigate risk of monsoon vagaries, the government should step up investments in irrigation across the country. There is also a need to strengthen the agriculture supply chain to reduce wastage and enable better prices for farmers. Farmgate and near-farmgate storage should be developed on priority. Use the rural development schemes to enable small producers to store produce until market prices are remunerative enough to sell.
Boost investments to lift economy
The outlook for the global economy remains gloomy. IMF projects global growth to slow down from 3.6% in 2018 to 3.3% in 2019. Growing trade tensions, especially the China-US trade war, will have a negative impact. India’s exports scenario has remained muted for significantly long period. Domestically, industrial production remains weak.
Weak demand has been a key factor for low industrial growth. The Union Budget should be leveraged to boost business sentiment and encourage higher investments. One of the biggest problems is the lack of job creation. This stems from the fact that demand is slow. Investments can change this negative cycle. Merely cutting interest rates are not enough to revive the investment scenario.
Corporate tax rate for all companies should be cut to 25% (irrespective of turnover), as had been proposed earlier. This will enable the industry to remain globally competitive, especially in the wake of significant cut in corporate tax rates by the US and France. A counterpoint, however, is that the tax rate on large enterprises is likely to remain unchanged at 30%, given the pressure on the government revenues. The government should take a more proactive approach when it comes to manufacturing. Creation of special industrial zones for manufacturing and exports with attractive tax concessions and a light regulatory regime would help. China has successfully run this model to create thousands of jobs. While boosting local investment will play a big role in changing the sentiment, the Union Budget should introduce specific schemes like offset policy to other sectors which import large quantities of products and machinery. India must enable greater investments for indigenisation and domestic manufacturing of products. It should announce some major public projects across sectors like power, infrastructure, oil & gas, thus creating demand for capital goods.
The signs of slowdown in domestic demand are visible both in urban and rural areas. Automobile sales during 2018-19 has slowed down significantly when it comes to passenger cars and two-wheelers. Annual sales growth in scooters has been below 1% during 2018-19 compared to over 19% growth registered in previous year. Sales of passenger cars have seen a contraction. Consumer durables are witnessing slow growth. One reason could be the weak farm incomes that is impacting rural consumption.
The upcoming Budget 2019-20 is an opportunity for the government to boost consumption and investments through appropriate fiscal stimulus and policies. It should provide a solid measure on consumption/liquidity. On rural economy front, expanding farm income support could help.. Modi 1.0 regime ensured consolidation, reform and facilitated corporate restructuring. In its second term, it has to step up its game.
Tough Fiscal Math
Does Budget 2019 have any fiscal space to support growth? The macroeconomic backdrop of the current budget has changed materially since the interim budget in February. This is why there needs to be a reassessment of the fiscal stance.
It is true that the fiscal math is likely to remain challenging. This is due to the big tailwinds from oil or disinvestments that have been done and dusted. Tax revenues in FY19 has been lower-than-anticipated. Gross tax revenue collections grew just 8% in FY19 versus revised estimate was 17%. This is one of the largest misses relative to RE over the past 10 years.
The interim budget built in 15% growth, a markdown from 20% growth expectations in FY19. Even achieving 15% growth may be difficult. Tax buoyancy usually slides in line with nominal GDP growth.
The interim budget projected GST growth of 19% for FY20. Given the economic slowdown, achieving this growth projection would be an uphill task. Do not be surprised if the GST growth projection is moderated.
Given the fiscal situation, should we expect a sombre Budget? The finance ministry indicated that the allocations presented in the Interim Budget 2019-20 would not be altered. The government would make provisions for additional funds for unavoidable commitments which have not been fully been accounted for in the Interim Budget 2019-20. Accordingly, most expenditure allocations are unlikely to change meaningfully in the Union Budget 2019-20, according to Aditi Nayar, Principal Economist, ICRA.
She argues that with few expenditure allocations expected to be altered from the interim budget estimates, the upcoming budget for 2019-20 is unlikely to reveal the revised priorities of the new government. Since the revenue growth assumptions in the FY2020 Interim Budget Estimates appear optimistic in light of the FY2019 Provisional Numbers, there is a possibility of a downward revision in the targeted level of tax revenues in the upcoming budget, which would likely result in an increase in the targeted fiscal deficit relative to the FY2020 Interim Budget Estimates.
Notwithstanding the tricky fiscal situation, some expect Sitharaman to boost investments by reducing capital costs without major fiscal impact.
Indranil Sengupta, director, senior economist, BofA Merrill Lynch feels a trifecta of growth boosters like 2% subvention on bank credit to SMEs for a year will defuse the liquidity crunch at a minor fiscal cost of 0.05% of GDP each in FY20-21, a new issue of infra bonds by a SPV to fund additional public capex will boost growth without crowding out private investment and earmarking excess RBI capital (Rs1-3 trillion) to recapitalize PSU banks will enhance credit availability and reduce lending rates.
1. 2% subvention for SMEs will fast track transmission
BofA Merrill Lynch continues to expect Budget 2019 to offer 2% interest rate subsidy/subvention on bank loans to SMEs for a year at a minor fiscal cost of Rs 200 billion/0.1% of GDP over FY20-21. This is already available on fresh loans for GST-registered SMEs. If the FinMin offers 2% subvention for a year in the July 5 budget, it will have to pay out just Rs100 billion each in December-March of FY20 and June-September quarters of FY21.
2. 0.5% of GDP of infra via SPV bonds to boost capex
The FinMin can issue infra bonds via a SPV to fund additional public capex, of say, 0.5% of GDP. While this does expand public sector borrowing, the market is unlikely to mind if the monies raised are tied to funding investment. In any case, the Modi regime has sufficiently proved its commitment to fiscal discipline by not matching the Congress's universal basic income scheme plan (of 1.9% of GDP) even in the heat of polls, in BofA Merrill Lynch's view. SPV borrowing will not likely crowd out private investment. If the public buy SPV bonds, at a premium to deposit rates, funds will likely flow from its fixed deposit (FD) to the SPV's current account. This will not impact bank deposits, or credit.
3. Excess RBI capital to recapitalize PSU banks
Sengupta expects Budget 2019 to earmark excess RBI capital (of Rs 1-3 trillion), to be identified by the Jalan panel, to recapitalize PSU banks to enhance credit availability and reduce lending rates. This is a liquidty- and fiscal deficit- neutral transaction.
The Modi 1.0 regime has so far been fiscally prudent, and resisted the desire to go populist. Amar Ambani, President & Research Head, YES Securities feels that we can expect the government to persist with reasonable levels of deficit on the fiscal front, as indicated in their earlier budget. The FM’s reassurance on sticking with the path of fiscal prudence in the years ahead will be equally important. The next on the agenda would be the much-needed boost to economic growth.
The domestic slowdown has spread to consumption while investment and exports remain weak. The global economy too is losing momentum as seen in global trade, PMI, etc. This warrants a fiscal response from Indian government. The key to savings revival lies in reviving spending and, hence, incomes through a fiscal push. A fiscal expansion is unlikely to push inflation and rates up in the current macro backdrop. Will FM bite the bullet? Let's hope and pray she does.
The author is a financial journalist with 15 years of experience