Need to strictly adhere to a fiscal roadmap from now on

While the general backdrop for the presentation of any Union budget is noisy in a democracy like India, the economic backdrop for this year’s interim budget is rather complex and somewhat dichotomous. After the transitory and transitional impact of demonetisation and the Goods and Services Tax (GST), economic activity has started to stabilise, the evidence of which can be seen in the improving trajectory of corporate earnings, rise in the manufacturing sector’s capacity utilisation, and pickup in credit offtake. At the same time, there is also some mixed evidence of rural distress, particularly in the farm sector, where erratic rainfall in the recent past and supply of glut-driven food price deflation in certain cases contributed to subdued growth in rural income levels. If one were to juxtapose this with the volatility seen in the global economy and markets, especially with respect to heightened uncertainty on global trade and crude oil price, a further layer of complexity gets added to India’s economic outlook.

Given this economic prologue, the finance minister (FM) attempted to walk a tightrope.

At the outset, the FY19 fiscal deficit target was revised marginally up by 0.1% to 3.4% of the GDP. This reflects the substantial shortfall in GST revenue collection in FY19 along with the additional budgetary provision for commencing the implementation of the farm income support scheme.

•GST revenue collection has been trailing in FY19 so far and is expected to result in a shortfall of Rs 1000 billion vis-à-vis the budgeted target on account of reduction in GST rates for many items during the course of the year, besides the ongoing finetuning of the compliance architecture.

•Along expected lines, the FY20 interim budget announced a farm relief package (Pradhan Mantri Kisan Samman Nidhi) as per which landholding farmers having cultivable land up to 2 hectares will be provided direct income support at the rate of Rs 6000 per year. This scheme will entail an annual expenditure of Rs 750 billion. For the current financial year, the FM has made Rs 200 billion provision for PM-KISAN, which is to be disbursed before the end of March 2019.

Purists might not approve of such an outturn as FY19 would mark the second successive year of reneging on the commitment of fiscal consolidation. However, one needs to appreciate that private consumption demand is set for moderation (led by rural distress) while revenue collection is yet to stabilise in the GST era. There is ample historical precedence for this with countries taking at least two years for stabilising tax buoyancy under the GST-type tax framework. Hence a tax revenue-led fiscal challenge is not uncommon in the initial years of GST implementation. As far as supporting rural demand is concerned, one would be tempted to think that policy preference has gravitated towards the same in the backdrop of the upcoming general elections. While it’s difficult to disagree with that assertion, one also needs to acknowledge that policymakers across the world are exploring inward growth strategies in the current environment of heightened risks emanating from trade wars.

For FY20, the government has underscored its policy intent of further supporting consumption via tax rebates for the middle class. Incomes up to Rs 500,000 will receive a full tax rebate vis-à-vis the earlier exemption of Rs 250,000. Furthermore, the standard deduction was increased by Rs 10,000 to Rs 50,000.

These measures are likely to boost disposable income for the farming community as well as the middle class.

The focus on consumption will, however, come at the cost of a lower allocation for capital spending, which is budgeted to fall to 12.1% of total expenditure in FY20 from 12.9% in FY19. The shortfall is unlikely to be compensated by off balance sheet spending as capex by public sector enterprises is slated to moderate to 2.9% of GDP in FY20 from 3.4% in FY19. Lower allocation towards capex will result in an inferior quality of fiscal adjustment in FY20. However, we doubt it will stall the ongoing recovery in investments as the bankruptcy framework has started producing desired outcomes.

Further, since the budget could have a reflationary impact on the economy, there could be a bias for interest rates to harden somewhat from current levels. The FY19 revised estimates indicate a higher borrowing of Rs 300 billion (as per the H2 market borrowing calendar). For FY20, while the net g-sec supply is expected to remain unchanged at Rs 4.2 trillion, absorption by the market is unlikely to be smooth as large sized open market operations (OMO) purchases by the Reserve Bank of India (the central bank could potentially conduct Rs 3.0 trillion g-sec purchases in FY19 to infuse primary liquidity in the backdrop of balance of payment deficit) is unlikely to see an encore. Moreover, there is no clarity on other sources of funding, which is expected to finance 8.5% of FY20 fiscal deficit, up from 1.3% in FY19. Any shortfall on this account can potentially have a spillover impact on market borrowing estimates.

Overall, the interim budget has clearly made a policy preference for imparting a fiscal impulse of 0.4% of GDP for stimulating consumption. While this appears like a reasonable carve out for boosting growth in the current environment, the policymakers will have to strictly adhere to the fiscal consolidation roadmap hereon and rule out future slippages to avoid getting into an adverse cost-benefit out-turn.

Shubhada Rao is chief economist at Yes Bank

The views expressed are personal

First Published: Feb 01, 2019 20:42 IST