Union Budget 2018 had three telling themes
This Union budget came against the backdrop of a raft of reforms, economic slowdown and fiscal stress: the launch of the goods and services tax (GST), the front-loading of recapitalization of public-sector banks, and some headway in the implementation of bankruptcy code.
But the economic environment turned a tad challenging as crude oil prices and inflation rose, straining the fiscal math amid ongoing rural distress. And the summary indicator of the health of the economy, gross domestic product (GDP) growth, slipped to 6.5% in fiscal 2018 from 7.1% the fiscal before.
While the proposals will incrementally contribute to economic expansion, with its de facto elements of stimulus, the pace will largely be due to factors outside the budget. In fiscal 2018, for instance, despite a near-normal monsoon and a rural-focused budget, the economy slowed and rural distress increased—all because extra-budgetary factors turned adverse.
Growth has already bottomed out, so the key drivers in fiscal 2019 will be 1) improved ability to benefit from strong global growth as domestic headwinds from demonetization and GST implementation fade, 2) enhanced ability of banks to lend following recapitalization and 3) normal monsoons.
To be sure, there was limited headroom for a big spending push due to fiscal constraints. After GST, there is no scope for tinkering with indirect taxes and limited scope for direct tax changes. In addition, spending by the states, now accounting for 57% of the government spending (up from 51% in fiscal 2014), matters more than the central government’s.
The focus on rural housing and roads will help build assets and create jobs. Construction is a very labour-intensive activity and, more importantly, it can absorb low-skilled workers—a key characteristic of rural India. This, together with the retained allocation (at Rs55,000 crore) to the Mahatma Gandhi National Rural Employment Guarantee Scheme, will help provide an employment buffer if the rains fail this time.
The initial forecasts from the India Meteorological Department rule out an El Niño condition (associated with a weak summer monsoon) in 2018, but it is better to err on the side of caution, given that we have had two successive normal monsoons.
This budget also shows that the government has slipped on its fiscal goal. The fiscal deficit has been budgeted at 3.3% of GDP for 2018-19, or 30 basis points (bps) more than the target of 3% articulated in the previous budget. The slippage in revenue deficit was more pronounced at 70 bps to 2.6% of GDP in fiscal 2018. Consequently, three-fourths of the borrowings were financing the revenue deficit, up from 58% in the previous year. That number had come down to below 60% in the past couple of years, so that would draw frowns on the quality of fiscal consolidation.
Another worrying aspect on the fiscal side is that capital expenditure was 11.7% short of the budget target for fiscal 2018 and 3.9% lower than the previous fiscal and is projected to trail revenue expenditure in the coming fiscal.
Fiscal consolidation is important from the point of view of the credibility of policy-making and macroeconomic stability. The recent spike in bond yields in response to fears of a fiscal slippage bears testimony to the criticality of a prudent fiscal stance. The market participants this year are not focused merely on the deficit target but also on the credibility of its arithmetic. The budget targets rely heavily on a sharp increase in tax revenues. I expect GST revenues to improve as growth accelerates and systemic bugs get sorted out; this will boost tax revenues as well due to increased transparency. The number of indirect taxpayers has gone up by 50% and direct taxpayers by 1.8 million post demonetization and GST. The direct taxes should also do well.
India’s tax-to-GDP ratio at 11.9% was the highest-ever achieved—a number that’s been elusive since fiscal 2008. The good news is that it has been inching up in the past years and despite a growth slowdown, it was at 11.6% in fiscal 2018. For fiscal 2019, the target of 12.1% is a tough ask.
One thing is certain, though: the government cannot afford to slip on its divestment and non-tax revenue targets and needs to keep a close watch on expenditure to achieve the fiscal deficit target of 3.3%.
The budget delicately balances the need for fiscal consolidation over the medium run with its short-term expenditure priorities. While it relaxes the near-term targets, its intention to accept the N.K. Singh Committee’s recommendation of bringing down the fiscal deficit to 3% of GDP by fiscal 2021 should offer comfort on the medium-term fiscal trajectory.
The recent rise in rural distress propelled the budget to focus on that geography. Stepping up minimum support price (MSP) to 1.5 times the cost of production and mechanisms to ensure that farmers realize the MSP for non-cereal crops and supporting development of farmer producer organizations to reduce the hold of middlemen and commitment to a flexible trade policy tuned to the needs of the farmer will also help in raising farm incomes.
As past experience shows, announcing new measures and committing resources is not enough to improve farmers’ lot. For success to be visible, these have to be complemented by measures outside the budget, support from states and relentless implementation of what has been announced, that too in double quick time.
Dharmakirti Joshi is chief economist, CRISIL.
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