The Promise Of “Sabka Saath, Sabka Vikas”: Eyes on Execution Now

Given that the government is continuing its fiscal prudence moves despite headwinds from rural and exports, it is important that monetary policy steps are taken with aggressive rate cuts, says Vikas Khemani, President & CEO of Edelweiss Securities

Going into the FY17 budget, the government was expected to deal with a large number of conflicting objectives – pushing growth, allaying rural distress, maintaining fiscal consolidation, lending impetus to infrastructure, reviving investor sentiment through reforms, among others. Given these, I would say that the budget has done a good job. The finance minister (FM) enunciated the government’s 9-point programme to propel the country on growth path.  

Overall, the budget hinges on 4 key parameters – continued fiscal consolidation to maintain policy credibility, shifting focus to rural/agriculture economy as it suits both economically and politically, continuing infrastructure spending, and fixing the economy through small/incremental steps in several areas (rural, financial reforms, infrastructure) rather than big bang reforms.

Fiscal consolidation: Government has met its target thereby exhibiting its commitment to fiscal prudence. While there was a reasonable case for boosting public spending amid weak private sector demand (exports and rural demand both are anaemic), the government prioritised credibility given uncertain global market conditions. More importantly, the fiscal math looks credible. While the revenue targets from telecom auctions and disinvestments are clearly optimistic, tax revenues have been budgeted conservatively. More specifically, a look at the projections of excise duty collections and oil subsidy provisions suggests budgeting has been done assuming crude oil price of ~USD45/barrel. This provides sizeable cushion to the overall fiscal math. In case the government does manage to achieve its asset sales targets (disinvestments + telecom auctions), it will ensure consolidation without hurting aggregate demand.

Rural focus: On the expenditure front, government’s spending is focused on rural/agriculture sector, given substantially higher allocation for development schemes in rural areas. In fact, this rural push started in FY16 itself. For instance, in FY16, while the government met its overall expenditure target, the mix of spending clearly tilted towards rural. Spending on rural development has beaten the budget estimates, especially in schemes such as rural roads (PMGSY), NREGA and even the food subsidy bill. We estimate the government has achieved 7% higher spending for rural/agri sectors compared to Budgeted in FY16. This trend is expected to continue in FY17 too. For instance, overall development spend in FY17 is expected to grow 14-15% YoY. But, within this development spend, rural/agri focused spending is projected to grow 19%. Areas such as irrigation and rural housing have been accorded higher priority apart than initiatives such as crop insurance, etc. Note that nature of such spending is capacity enhancing and hence will not be inflationary.

This extra spending on rural economy was done at the expense of defence capex. In FY16, defence capex was scaled back to 0% YoY growth (versus 16% YoY budgeted growth). This scale back in growth now implies only 5.5% capex CAGR over FY11-16. The trend of subdued defence capex has continued in FY17 too, with only 6% growth being budgeted.

Infrastructure: Sizable jump - The government’s focus on urban infrastructure continues with substantial spending on national highways and Indian Railways. If one adds the budgetary support and internal resources of NHAI and Railways, total spending in these 2 critical areas has moved up from ~0.7% of GDP in FY15 to 1.2% in FY16 and projected to reach 1.5% in FY17. This is a sizeable jump and should help support demand in the economy.

Banking:  Fixing it structurally - There was some disappointment with regards to the lower-than-expected provision allocated for bank recapitalisation (INR25000cr), though the government stated it would provide more if the need arises. However, I think more important is the government’s intention to fix the sector structurally through better appointments, providing more autonomy and fixing accountability. This will go a long way in putting the economy on structural growth path.

Taxation: Incremental and structural changes have been proposed to the taxation regime. To boost revenues a lot of tinkering was done with the tax structure, both direct and indirect, instead of which the FM could have just hiked the tax rate rather than levying additional cess -  luxury tax, environment tax, etc. Some of these tactical moves such as collecting tax at source on purchases increase the burden on citizens.

Clearly, the intent was to make a political statement rather than revenue collection around taxing the rich. Levying tax on dividend in the hands of recipient is in a way taxing the same income three times, which is quite regressive.

This wealth transfer, which aims at reducing inequality, is justified especially given that wealth is being transferred by creating productive assets (irrigation, rural housing, etc.) rather than just doling out freebies. However, the method is a little disappointing. Instead of increasing such a large number of excise duties, the government could have just increased the income tax rate for the top bracket.

However, it was very heartening to see some measures to remove the discretions provided to the tax officers and provide a dispute resolution mechanism. This will go long way in facilitating the ease of doing business in India and curb corruption at lower levels.

Others: First, there was focus on reforms as well. The proposal to provide statutory backing to the AADHAR platform to avoid legal hurdles through a bill in Parliament is a step in the right direction. Over the long run, this could have huge benefits as it will reduce leakages and ensure that public resources reach the poor and needy. The FM also mentioned the government will try to pass the Bankruptcy code, again a salutary step. This will help create a formal insolvency resolution process for businesses, either by coming up with a viable survival mechanism or ensuring their speedy liquidation will likely see the light of the day in the current parliament session. Review of the FRBM framework and amendment of the RBI Act to make provision for Monetary Policy Committee (MPC) are some of the other issues that are high on agenda. The government remains committed to enhancing the ease of doing business and de-bottlenecking projects. Overall, while the reforms are all incremental their sum is greater than their parts and cumulatively it amounts to extremely significant reforms over a period of time.

Second, corporate tax was left unchanged at 30% versus last year’s indications of a 1% cut in the current Budget as a part of the process to take the tax rate to 25%. This tax rate was not lowered, despite reduction in exemptions.

Third, no provision was made for GST compensation to the states and neither has service tax been hiked as was widely anticipated. Both these moves suggest that one might have to wait for the GST bill a little longer. 

Overall, fiscal prudence remains the overarching theme of the Union Budget with focus incrementally shifting towards fighting the rural distress. From growth perspective in FY17, the Budget is a growth enabler. But sticking to fiscal target of 3.5% opens up further room for rate cuts and rating upgrade. Given that the government is continuing its fiscal prudence moves despite headwinds from rural and exports, it is important that monetary policy steps are taken with aggressive rate cuts. Else, tight fiscal and monetary policy will continue to weigh on aggregate demand.  The ball is now in the RBI’s court.