Prime Minister Narendra Modi is expected to unveil on Monday a package of measures to give a boost to the economy, whose gross value added at basic prices grew by 5.6 per cent in April-June 2017, a two-percentage-point drop from the growth recorded in the same period a year ago. The writer explains the various options before Modi in the current situation.
Prime Minister Narendra Modi
could on Monday unveil measures to boost the economy, after gross value added (GVA) growth at basic prices saw a two-percentage-point drop in April-June 2017 from that in the same period a year earlier.
What options does Modi have? Note that whatever decisions he takes on Monday or later in the week will be largely determined by the state of government finances. Thus, an assessment of the government’s fiscal situation will be important before any guesses can be made about Modi’s options.
State of the fisc presents a few worrying signals
Data on the government’s expenditure and revenues during the first four months are available now. The broad number of how over 92 per cent of the budgeted fiscal deficit has been reached in the first four months has already rattled many public finance experts. Last year, the comparable number was only 74 per cent at the end of four months.
Government sources, however, allay such fears, arguing that the higher deficit now is because of an enhanced release of money meant for both revenue and capital expenditure as a consequence of the early passage of the Budget. Indeed, the extent of increase in revenue as well as capital expenditure in the first four months of this year is less than the rate of annual increase that was provided for in the Budget. And the increase in revenues has maintained the growth rate provided for in the Budget. So, it is theoretically possible that by the time the year ends, the total deficit level would be within the targeted level of 3.2 per cent of gross domestic product (GDP).
Yet, there are serious doubts about the maintainability of the current pace of revenue mobilisation. The dividend contribution from the Reserve Bank of India (RBI) has already declined by about Rs 27,000 crore, compared to what the government had budgeted as receipts under this head. A projection of Rs 44,000 crore under spectrum fees from auctions could become a stretch. Disinvestment proceeds of Rs 72,500 crore would also be a difficult target to meet, unless big-ticket strategic disinvestments like that of Air India are completed in the current year. And the current glitches in the implementation of the goods and services tax (GST) may result in some pressure on indirect tax collections during the remaining months of the year.
Whatever the options, expect a breach in the fiscal deficit target
Thus, meeting the fiscal deficit target for the current year could be touch-and-go. The first three Budgets of the Modi government have seen a fiscal deficit reduction in each year – from 4.4 per cent in the last year of the United Progressive Alliance in 2013-14 to 4.1 per cent in 2014-15 and further down to 3.9 per cent in 2015-16, followed by 3.5 per cent in 2016-17.
And if, as has been reported in the media, the government decides to spend more on some projects and programmes to the tune of Rs 50,000 crore in the current year to tackle growth deceleration, the target of 3.2 per cent of fiscal deficit will be breached and the final figure would be over 3.5 per cent of GDP, the level that was reached last year.
Perhaps the only certainty in the current uncertain times of an economic slowdown is that the government response to the challenge will mean a slippage in the fiscal consolidation target set in the Budget for the current year. Worse, the trajectory of fiscal deficit reduction indicated in the NK Singh Committee’s report on fiscal consolidation will have to be revised and the goalpost of reducing the fiscal deficit to three per cent of GDP
by next year will have to be deferred.
Expenditure push & its challenges
The first option before the Modi government will be to increase capital expenditure in a big way. There are constraints – both physical and fiscal. Physical constraints would be that the absorptive capacity of the Union ministries and other organisations in the government is severely limited in quickly implementing projects and programmes to translate their impact into growth and creation of jobs in a relatively short time.
Fiscal constraints are more serious, though for a different reason. Consider the numbers. An infusion of just Rs 1 lakh crore of additional expenditure will widen the fiscal deficit to over 3.9 per cent of GDP.
This will still be lower than the deficit level in the first year of the Modi government. And proponents of counter-cyclical fiscal policies always are of the view that in times of a slowdown it makes more sense to spend more even if that results in fiscal expansion.
But two serious questions will arise if the Modi government were to opt for a counter-cyclical fiscal policy response. One, can it put in place a system by which the funds additionally released are used without facing any delays or bureaucratic hurdles? Two, can the government ensure that the additional money released is meant for productive purposes instead of being used up in meeting the government's consumption needs, higher wages or increased subsidies?
In other words, will the additional funds be classified as capital expenditure or revenue expenditure? Remember that the absolute increase in the government’s capital expenditure this year was just about Rs 30,000 crore, which represented an increase of around 11 per cent over last year’s revised estimates. To plan for an increase of say another Rs 1 lakh crore in capital expenditure in the remaining six months of the current year will be a big challenge. It might have a positive impact on investment sentiment, but the actual short-term impact on the ground is likely to be limited.
Can non-tax revenues & disinvestment receipts help?
The government’s two other revenue sources are non-tax revenues and disinvestment receipts. Almost half of non-tax revenues comes from a single source: dividends from state-owned enterprises and the Reserve Bank of India. Non-tax revenues in the current year were already projected to decline by around 14 per cent compared to what was earned in 2016-17. If the RBI’s dividend payment and the state of public sector banks and other enterprises are any indication, the government’s non-tax revenues have little headroom for an increase.
The only option for the government would be to issue a diktat to all state-owned enterprises to transfer the bulk of their reserves to the shareholder i.e. the Union government. And this transfer could take place by way of a special dividend announcement. This is not unusual and has been done in the past few years. This might relieve the government of the pressure to find resources for spending on new projects and programmes or to keep the fiscal deficit within manageable limits.
The other option is to raise the fees on many public services that the government offers through its many departments and ministries. This might raise more resources, but can become unpopular and aggravate the popular sentiment against the government.
That leaves disinvestment receipts, which are estimated to fetch the government Rs 72,500 crore in the current year. So far, only about Rs 19,157 crore have been mobilised through disinvestment. The pace of disinvestment does pick up in the latter half of the year, but the target appears steep. The only way it can reach the target is to speed up the strategic sale of Air India and perhaps reduce government equity up to 52 per cent in some of the public-sector banks within the current year. This again will provide some headroom for the government as far as its resources are concerned.
Leaning on the RBI for a rate cut
An option that the government can explore is to persuade all the members of the Monetary Policy Committee of the Reserve Bank of India including its Governor Urjit Patel to reduce the repo rate, at which it lends money to banks. This might be controversial and seen as undermining the central bank's operational autonomy. But such an option does exist and the corporate sector will love it.
The only danger is of inflation. But then at present inflation is within the band mandated under the law. That might give the government and the RBI committee some comfort to explore this option.
Implement factor market reforms and improve administrative efficiency
An option that the Modi government should consider under the current circumstances is to speed up reforms of the factor markets i.e. relax the land acquisition rules, remove the labour law rigidities and ease discretionary controls on foreign investment. In addition, it could focus on improving administrative efficiencies to help improve the ease of doing business. The twin balance sheet problem afflicting the economy is already being tackled with the Insolvency and Bankruptcy Code, but efforts towards resolution of bad loans and stressed projects need to be strengthened.
But all these measures, much as they are needed to revive the economy, will hardly have any immediate impact on growth. These will help revive economic activity in the next couple of years. But for the Modi government the immediate priority is to show some quick results by way of an improvement in the GDP
numbers for the next few quarters, a task that these long-term solutions may not achieve.
Tax revenues remain the only other option under govt’s direct control
The question that the Modi government must examine in detail is whether it should simply increase expenditure on projects and programmes or provide more money in the hands of the people to make them feel a little better so that they will perhaps save more and spend more, which in turn can revive growth.
Increasing expenditure on projects and programmes has its own constraints like delays and government capacity on implementation. In addition, there are also problems of leakages and corruption.
An alternative option for the Modi government, according to many experts, is to reduce the tax rates for the Indian middle class, so that they have more money at its disposal. In 2015-16, an estimated 5.2 million people filed income-tax returns declaring an annual income of between Rs 5 lakh and Rs 10 lakh. Another 2.4 million returns were filed by people declaring an annual income of above Rs 10 lakh. Of these 2.4 million income-tax payees, as many as 2.2 million declared an annual income of between Rs 10 lakh and Rs 50 lakh.
The question the Modi government must be asking itself is whether it should do something more for the category of tax payers earning between Rs 5 lakh and Rs 50 lakh annually. These are also the most vocal people who can make a difference to the mood of the nation. Except for an annual rebate of Rs 12,500, these categories of income tax payers got no other relief. More money in their hands can not only lift their mood but also result in more savings and spending, which should help growth. That could well be one of the Modi government's options.
This will, of course, mean a revenue loss. Personal income tax collections are projected at Rs 4.41 lakh crore in the current year. But revenues under this head are buoyant and politically as well the move might win the middle class for the ruling party.
The same logic can be extended to the sphere of corporation tax, whose collections in 2017-18 are expected to be Rs 5.38 lakh crore. For companies below Rs 50 crore turnover, the corporation tax rate has already been brought down to 25 per cent. The question the Modi government must answer now is whether the promised reduction in corporation tax rate for the entire corporate sector can be reduced from 30 per cent with cess and surcharge to 25 per cent.
Yes, that move might be politically risky as the Opposition political parties will obviously accuse the government of being friendly towards big business and the label of the Modi government being a suit-boot ki Sarkar might return to haunt it.
Whatever be the final choice the Modi government makes out of the options listed above, it is clear that a mini-Budget of sorts can alone have any demonstrable impact on the state of the economy. Minor tinkering with some increase in outlay under one head or the other may not work in the short run. Expectations are such that a big fiscal package including outlay increase and tax relief can only make an immediate difference. Such a mini-Budget will also inevitably mean a new trajectory for the government's fiscal consolidation path.
Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.