~ By Dr. Arvind Subramanian
I am happy to speak about the budget and its context. First of all, this budget came at a somewhat unusual and momentous time. This is a critical juncture in history. If you look at the international background, 2016 will go down as something very significant happened around the world -Brexit and the American elections.But more fundamentally it was about the long march towards globalization – something has happened to it. There is indeed anxiety about globalisation at least in some of the advanced economies, which is going to have significant repercussions for emerging market countries like India.
The structural shift which has happened against which government had to craft this year’s budget. The last 7-8 years were an era of low interest rates, a kind of deflationary environment in advanced economies, and that was broken with election of president Trump. The feeling is that the US economy is picking up, policy is going to change, both fiscal and monetary policy. Notably, this means that the emerging market countries can no longer take for grantedthat they would get all these capital inflows. So, there was a kind of minor regime shift in that sense as well. These were the big international developments.
Domestically, I think there are two very big things that had happened. One is demonetization and the other absolutely path breaking reform that happened was the passage of goods and services act, which will go down in history as the landmark tax reform that the country has ever undertaken. So, these two domestic developments as well which created the context for the budget.
I will talk a little bit about the budget and what the implications are likely to be. Structurally three major innovations happened in presenting this budget. The calendar for the budget was advanced. Instead of being presented on 1st of March, it was presented on 1st of February. It is quite possible that India would move towards calendars that are much more aligned with international best practices and go towards calendar year based. This is the first step.
The second structural change that has happened is,we have done away with plan and non-plan expenditure from the Planning Commission era. The categorizations were based more on which agency was doing the spending rather than what it was for. We got rid of those anomalies, the distinctions which were more bureaucratic than economically meaningful. If you see the budget, there used to be capital expenditure, revenue expenditure, the world over everyone thinks about when you think about how to understand budget. It is an attitude or mindset that thinks about the impact of spending rather than which institution is doing the spending.
The third big innovation relates to the merging of rail budget into the regular budget. One of the colonial legacies we had that we presented a railway budget. There were historical reasons for it. We kind of persisted with it for no good reason apart from a bureaucratic inertia. The merging of the budgets, apart from rectifying the anomalies, is also going to be important in one sense. The two budgets that the minister presented were very significant in one way, which hasn’t been appreciated enough. It is one of the consequences of time being linear that the governments get credit for what they do and not enough credit for what they do not do. In the first two budgets it is quite noteworthy the lack of populism in those budgets. Traditionally Indian budgets have been a lot about – we need a train line from this constituency to another constituency for no good economic reason, the people would routinely succumb to it. The two budgets were noteworthy for absolutely repudiating any kind of populism. And that kind of decision making we would like to carry over.
Now, I would like to speak something about the content of the budget. As a macro economist, one number you look at first is what is the stance of fiscal policy that the government has embraced. It is embodied in fiscal deficit number. And this year what we did was, given the background of uncertainty, every budget has to balance a number of different considerations. We accord a lot of importance to maintaining macro-economic and fiscal stability – you are reminded of its consequences when you do not have it.
I want to take you back to 2013. In the fall of 2013, the Indian economy was falling apart because of lack of macro stability. India was part of fragile 5, a small trigger from US led to massive capital outflow, India barely avoided a full scale crisis. We should keepthat period in memory when I say that being wedded to macro-economic stability is a major tenet of this government. One of the manifestations of it is what is happening to fiscal policy. And the government has been steadily reducing the fiscal deficit. At the end of this year is going to be 3.5%. It is going to be a very steady reduction in fiscal deficit. It reassures investors that the commitment to macro-economic stability and fiscal prudence is rock solid. Head line number is the fiscal deficit going down from 3.5% to 3.2%.
There were some who actually wanted the government to increase the deficit because of the consideration that growth will dip a little because of demonetization. The economy certainly needed some impetus from the government. That is one point of view. The fiscal ayatollahs as it were, wanted it to be reduced to 3% at all costs. The government had to do this very delicate balancing act where it wanted to maintain the commitment to stability. Yet you do not want to squeeze so much and compound slightly inflammatory forces in the form of reduction in growth in short run. The government was committed to fiscal stability with reduction in fiscal deficit, continuing the onward march towards fiscal consolidation.
The second number was on spending side. Obviously the government was to devote resources to agriculture, especially to public investment. We are in a situation in last 3 or 4 years or slightly longer where private investment has weakened in the economy for a number of reasons. There is no real threat that the extra government spending will crowd out private investment because the sector itself is quite weak, the balance sheets are not very strong. The government had this responsibility to increase public investment. So, the allocation for public investment was also quite strong.
When you look at the spending side of this budget, what is important for me is that there is no scope for simplistic or knee-jerk expansion in creating new programmes. There was a strong feeling that new programmes would be wasteful, unproven, untested. Whatever we do is high priority but all spending is in programmes having some proven record of having worked. One of the successful programmes in India whose allocations we increased is rural road programmes, Pradhan Mantri Gram Sadak Yojana, launched by the previous NDA government. Similarly, the employment guarantee programme, especially in the aftermath of demonetization. It has some reasonable features like self targeting as a way of helping people who are more distressed and so the government decided to allocate more money to that programme as well. Housing was another area, but the spirit, logic and thinking was to build on programmes that work and not to be populist, not to start experimenting and thereby increase the number of programmes whose track record may not be terrific.
You get fiscal prudence by reducing fiscal deficit. Very responsible, but targeted spending- that is what the government had to do in the short run. The most exciting part of this year’s budget was on revenue side. Instead of all the things that were done on revenue side, I would focus on what was the underlying thinking to that. What are the themes on revenue proposals? Essentially the revenue proposals must be seen in the context of demonetization. The measures on revenue side tried to reward tax compliance and hence there were reductions in individual tax rates for people at the low end of the spectrum. Lowest tax rate was reduced from 10% to 5%. Second, this is one of the aims of demonetization, incentivize non-compliers to become compliers.
Remember, it is a sad fact about India that we need to make lot of progress in terms of the number of people who pay tax- something the Prime Minister and Finance Minister have been talking about a lot. For the first time, for tax payers the administrative requirements would be quite relaxed to try and get the people into the tax net. So, having rewarded compliers, you also have to have sticks against non-compliers. It is quite significant in this budget that, the finance minister actually laid out statistics on what is happening on tax paying side as well as highlighting on what is happening to the money that has come back to the banks as a result of demonetization. It is basically a signal to non-compliers saying that government has a fair amount of data now and we started the process of big data analytics. To be able to reconcile what is coming, with the status of who is paying and who is not paying taxes, reward the compliers, also send a signal to non-compliers that there would be some surgical analysis, and follow up action against them.
The fourth innovative part on revenue side, for the first time there were proposals on tackling major sources of black money. If you think about India, there are four types of major sources of illicit money, black money – cash, gold, and the two other big areas are election financing and real estate. The budget has for the first time spelt out the initial steps that would be taken towards addressing the black money that is generated in election financing.
In the economic survey, we forecast for the year that is going to end 2016-2017, growth which is otherwise going to be 7%, something like 0.25% to 0.5% is going to reduce relative to that base line on account of demonetization. The actual liquidity crunch was smaller than the people thought it was, in fact remonetization is proceeding at pace. Our estimate is that within a month or month and half the liquidity is going to be close to what the underlying demand isgoing to be.
There would be an impact on growth. We should not hide that. It is felt most severely felt on the cash part of the economy that is relatively short lived. As remonetization happens, the economy should come back and converge the underlying potential. The range we have given is between 6.75% and 7.5%. India needs about 8 to 10% growth in the medium term. That is how we see demonetization.
One of the macro challenges in the economy is what we call the twin balance sheet problem. After the go-go years, over exuberance and over indulgence in investment, we are saddled with the legacy of weak private sector balance sheets. It is not strong as it should be except that who invested in infrastructure. As a consequence of that bank balance sheets are also weak because they were not able to service their debts.
There were lot of comments saying why didn’t the budget specifically address it. It is important but not everything. Policy making is a 365 days affair. We are completely aware of the seriousness of the problem on twin balance sheet. There are very serious and high level discussions underway in terms of how to address the problem. It is not an easy problem. You cannot use magic wand. All countries around the world face this problem. How do actually the political class write off debts to the private sector including to big corporates. That is the heart of the problem. Even Denmark, often referred to as utopia of how the world should be, has such problem. It is a constraint on the economy. It is holding back growth. We need to address that.
Finally, in the survey we have raised discussion about universal basic income. There is radical discussion going on about the idea whose time has come. The idea is ripe for discussion. There are some states which are enthusiastic about the idea whether this idea takes hold or not. Budget came in the back drop of fairly difficult international environment. It had to do difficult act of maintaining balance, providing stimulus, filling in weak private sector, taking actions to follow on demonetization.
(This is the summary of the speech delivered by Dr. Arvind Subramanian, Chief Economic Advisor, Ministry of Finance, Govt. of India at the breakfast briefing to young diplomats organized by India Foundation on 22nd February, 2017)