The focus of the government continues to be on lowering the cost of capital.
Fiscal deficit targets sometimes lead to vicious cycles. As an economy slows, so do tax collections, and if the government slows down its spending to meet the deficit targets, it exacerbates weak growth — one of the risks flagged in this column last year (‘Seize the slowdown’, IE, August 30, 2019). This risk has moderated with the government budgeting an increase in the expenditure to GDP ratio for both the current and the next fiscal years. The cuts to expenditure this year in the revised estimate versus what was budgeted are mostly due to the food subsidy being pushed off-budget, a reduction in interest payments (partly as short-term interest rates did fall during the year), and the known shortfalls in PM-Kisan (the number of farmers registering for it so far has been much lower than what was earlier anticipated).
There has been an attempt to address some of the criticism of the last several years: An explicit disclosure of extra-budgetary spending that is to be funded through the budget in future years (about 0.85 per cent of GDP), a more reasonable growth assumption for the next year, and tax growth estimates that do not seem unachievable. This is not to say that 10 per cent nominal GDP growth next year or the 11 per cent and 13 per cent growth for indirect and direct taxes respectively is a given. But, they cannot be written off outright. As expected, the bond market has rewarded the credibility of the numbers and the improved transparency in disclosures by pushing down bond yields quite meaningfully in the first day of trading.
However, there are two important fiscal risks still. The first comes from fiscal pressures felt by state governments. Of the Rs 3 trillion gross tax shortfall at the Centre, transfers to states fell by nearly Rs 1.5 trillion: This is only slightly offset by the pending payments on GST compensation. One needs to watch out for the state budgets this year to assess the impact on their finances. With state governments’ borrowings being frozen by October, effectively capping their fiscal deficit, any tax slippage necessarily results in slower spending. As states collectively spend nearly 90 per cent more than the centre, their spending matters for economic growth.
P Chidambaram on Union Budget 2020: Brace yourself for an economy that will grow at an unsatisfactory rate in 2020-21
The second relates to the non-tax receipts that will fund expenditure growth in 2021, providing a counter-cyclical buffer. This makes sense: After all, taxing more and spending is not always a stimulus as the net effect depends on how well the negative impact of higher taxes offsets the fiscal multiplier of expenditure. Non-tax receipts do not run that risk. The challenge in the target achievement is also less macroeconomic (which is hard to control) and more execution-related (which is more controllable). But listing LIC is unlikely to be easy — not just for the legislation that is needed and the political opposition needed to be surmounted as interest groups will find ways to slow down the process, but also the preparatory work that the management and investment bankers will have to do to prepare the internal system and processes for listing. Similarly, getting more than Rs 1 trillion upfront for either telecom spectrum, AGR dues (adjusted gross revenues) or both from the telecom sector whose annual industry revenue is only Rs 2.5 trillion, may be a challenge. Both these sources of funds need speedy action to get done in the next 12 months.
The focus of the government continues to be on lowering the cost of capital. The commitment to fiscal responsibility norms, increasing the threshold for foreign participation in corporate bonds to 15 per cent, and the exploration of a special category of bonds that can be freely accessed by foreign investors, and can thus become part of global bond indices, are steps in this direction. As banks are progressively freed from the need to buy government bonds for the statutory liquidity ratio (SLR), there needs to be an alternate and sizeable source of demand. Lowering of government bond yields is an important part of the rate transmission process, which in turn is a necessary (though maybe no longer sufficient) condition for a revival in growth.
These steps may not suffice: It may be several quarters before the special category bonds are issued, and given that foreign ownership of Indian corporate bonds is only about 5 per cent, the higher limit may not drive inflows immediately. Even as new ideas are explored, given that the country saw a 2.3 per cent of GDP worth of increase in currency reserves over the past year, measures like the RBI stepping in to buy more government bonds to push down yields may be less risky than they may have been otherwise.
More active intervention may be needed to address the credit risk in the financial system as well. While many financial firms that were in the cross-hairs of the bond market over the past year and a half have already defaulted, a few have not. Their failure may not destabilise the whole financial system, but their zombie nature continues to keep uncertainty high and credit costs elevated. The presentation of the budget may not have been the most appropriate event to address this risk, but the longer the delay in intervention, the greater the economic costs may be.
There were a few fronts on which the intention was perhaps good, but the implementation has created confusion: For example, the personal income tax changes. The introduction of several slabs at short intervals, after the surcharges introduced in the July 2019 budget for high-income earners, now takes the total number of slabs to ten, adding significant complexity to a system which was getting simplified over time. Similarly, the guidance to remove exemptions on interest and principal payments for home loans in the next few years, while an important medium-term objective, can discourage potential buyers today, as these benefits are used over multiple years. At a time when real-estate demand is weak, this announcement risks further incentivising renting versus buying, when the reverse may be necessary to improve confidence in the real-estate sector, and in the financial system.
It is perhaps the “muscle memory” of the decades gone that makes everyone focus on the central government’s budget presentation with such interest. With central reforms increasingly announced outside budget speeches, and both revenue and expenditures starting to become predictable, it might be more productive for public attention to move to other areas of government functioning like state and municipal budgets.
This article first appeared in the print edition on February 6, 2020 under the title "The other budgets." The writer is co-head of Asia-Pacific Strategy and India Strategist for Credit Suisse.
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