Indian finance minister Nirmala Sitharaman’s maiden budget, presented on July 5, was a keenly awaited one.
Besides being a curtain raiser to the second Narendra Modi government’s economic policies, financial markets and analysts were also anticipating measures that would address the Indian economy’s current growth challenges.
Sitharaman set an ambitious target of expanding India’s economy from the current nearly $3 trillion (Rs205 lakh crore) to $5 trillion by 2024. However, meeting that target requires a real GDP growth rate of 8%—higher than the 7% rate forecast for this financial year.
Achieving the $5-trillion goal requires policy measures that will help the economy tide over its current banking crisis, high unemployment rates, and a weak global environment.
On that count, the budget’s proposals seem inadequate.
To catalyse growth, the budget primarily tries to deepen the “supply-side,” or it tries to make it easier for firms and producers to supply goods in the market.
By raising the revenue threshold to qualify for lower corporate tax, and by allocating Rs70,000 crore for recapitalising public sector banks—to get lending channels flowing again—the budget attempts to revive investment in the domestic economy.
The easing of foreign direct investment (FDI) norms for insurance intermediaries and single-brand retail can also be seen in this light. FDI will help firms in these sectors raise money without being constrained by limited domestic capital.
However, these measures will work only in a scenario where private investments are growing healthily and are yet constrained by high taxes, and complex regulations.
The problem facing India today is weak demand curtailing incentives for private investment. Hence, any amount of easing constraints to investment might not work, simply because there is not enough demand to absorb the output of the private sector. The automobile industry, for instance, has been grappling with a drastic decline in sales.
The introduction of the goods and services tax (GST), demonetisation and high levels of unemployment have led to this drop in consumption. Besides, the prices of agricultural products have declined much faster than that of manufactured goods, implying lower income for farmers, which has curtailed rural demand.
It is widely recognised that in times of a significant shortfall in demand, the government must step up spending. Unfortunately, the Modi government seems to be of a different persuasion.
The budget reveals its policy mindset—deepening access to markets is enough to ensure growth. This is evident in its proposal to raise public shareholding limits in listed companies from 25% to 35%, and plans for a “social stock exchange.”
This reasoning also reflects in the worrying proposal to increase borrowings from abroad, justifying it on the grounds that India’s sovereign debt is low. The argument goes that if the government were to borrow from abroad, there would be a large amount of savings available for the domestic private sector at lower interest rates, which would spur investment.
This proposal is disturbing on two counts. One, if the government borrows from the domestic market, instead of overseas, and carries out spending and investment, it can raise incomes, leading to a larger pool of savings for the private sector. Secondly, external borrowings in foreign currencies leaves the government vulnerable to currency fluctuations.
It does not make sense for the government to shoulder such risk on behalf of the private sector.
Obsession with fiscal deficit
The announcement by the government that it would reduce fiscal deficit to 3.3% of the GDP this financial year, from 3.4% in the previous year, is another retrograde step. It amounts to reducing expenditure, on employment schemes like the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), at a time when it is most needed.
The danger of adhering to such a strict fiscal deficit target is that important expenditures will face cuts, more so if revenue targets are not met.
The government has pinned its hopes on healthy tax collections, a surcharge on high-income individuals, an increase in petrol and diesel cess and disinvestment receipts to plug the revenue gap. Yet, there are legitimate concerns over meeting these targets, especially given the problems GST has run into.
The current budget has assumed that constrained conditions of supply, and not falling levels of demand, are holding the economy back. The government seems unwilling to increase public spending, hoping that easing access to capital markets will revive private investment.
There is nothing to suggest this will happen.
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