Budget 2018: A trinity of challenges confronts Arun Jaitley
There is something magical about the number three. In Shakespeare’s tragic play, it is three witches who provide Macbeth with a prophecy. The Chinese consider three as the perfect number, three represents the holy trinity, and so on. Finance minister Arun Jaitley’s last Union budget turned out to be quite prescient when he presaged three identifiable risks for the Indian economy: the Federal Reserve increasing interest rates, oil prices rising, and a retreat from globalization. Most of these risks are playing out with slight variations.
There are new fault lines developing now and it will be interesting to see whether the upcoming Union budget has a toolkit for these challenges.
One emerging danger is the capital market’s decoupling from the real economy. This was perceptively highlighted in recent interviews by Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank. In one interview he said: “Money is coming to a broad funnel and it’s going into a narrow pipe where massive amount of Indian savers’ money is now going into few hundred stocks…The amount of money that’s going into small and mid-cap stocks is something on which we have to ask tough questions. Is there a risk of a bubble?”
Kotak could be on to something. According to data from the Association of Mutual Funds in India, investment in mutual funds (net of redemptions) during April-December 2017 was up 28% over the previous year’s corresponding period. Much of this is flowing into stocks and influencing key indices: the 30-share S&P BSE Sensex has appreciated over 29% in the one-year period between 18 January 2017, and 18 January 2018. No other asset class can match these returns. State Bank of India’s fixed deposits for one year pay 6.25%, the government’s 364-day T-bills were recently auctioned at a cut-off rate of 6.52%, metals have ranged between 14-18%, gold yielded about 4%, crude oil is roughly 6% up and real estate continues to remain in the dog-house.
Two provisos merit mention: bitcoins are excluded because they are not available widely (like art or horses) and all the above returns are taxable while returns from investment in stocks for more than a year are tax free.
Curiously, and by serendipitous timing, discussions over a long-term capital gains (LTCG) tax on equity holdings are suddenly in play. LTCG—defined as gains realized from equity sales after holding for more than a year—are exempt from taxation. Short-term capital gains are taxed at 15%. The LTCG debate looks and feels like a test balloon floated to gauge the mood for new taxes. The guessing now is that tax-free LTCG may require a longer holding period of, say, two years. Even then, it is unlikely to yield great tax revenues.
Herein lies Jaitley’s dilemma: a larger section of Indians is now affected (directly or indirectly) by market movements and there’s no saying how additional taxes will have an impact on share values. Jaitley may want another Tobin-like tax to slow down runaway markets—investors already pay securities transaction tax, averaging around Rs7,400 crore annually—but without rocking the boat. The market’s reception to government slashing its additional borrowing programme by Rs30,000 crore was euphoric—the BSE Sensex rose over 300 points—ignoring that Rs20,000 crore extra will still be borrowed. It is all down to managing the news cycle so that markets do not reverse course.
The LTCG speculation may have been prompted by need for new tax sources, given the slowdown in overall tax revenue accretion—till November 2017, 57% of the full year’s target had been collected while expenditure has raced ahead. Tax revenue growth is slack because the goods and services tax is taking time to settle down. Cheerleaders have made much of the spike in income-tax collections (15% higher than the corresponding period last year) but are silent about the slowdown in indirect taxes which not only provide a larger proportion of tax collections every year but also indicate continuing stagnation in the real economy with direct repercussions on unemployment.
There are red lights flashing elsewhere. Post demonetisation, money supply is in a frisky zone—in the 12 months to 22 December 2017, it has grown by 10.5% against 6.2% in the previous 12-month period. This has forced the Reserve Bank of India to suck out around Rs3.4 trillion? liquidity between 26 December and 6 January. So, a rate cut looks remote at the moment.
Add to these the persistence of risks Jaitley mentioned last year—oil prices inching up and the Federal Reserve’s December interest rate increase with more likely to come in 2018. Then there’s the US’s new corporate-friendly tax bill which incentivizes companies to take back home roughly $3 trillion of global profits—Apple, for example, has announced it is repatriating close to $252 billion.
All this complicates Jaitley’s task. This is his last full budget before next year’s general election and he may choose to do nothing but wait it out. But he has to contend with three (that number again) challenges, which will directly have an impact on eight state elections this year and a general election next year—balancing a hysterical stock market with a slow real economy, providing enough policy measures to incentivize private sector investment and spur job creation, ensuring adequate allocations for the rural sector given the continuing farm distress.
Beyond that, it is most likely to be a holding operation which, in itself, is no mean task.
Rajrishi Singhal is a consultant and former editor of a leading business newspaper. His Twitter handle is @rajrishisinghal.
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