Implementation is the key
Budgets are an opportunity to analyse a government’s priorities, and the recent budget afforded a useful look into how this government wishes to reshape India. There is a lot to like about the budget—in broad terms, it has set an agenda to try to address the obvious inadequacies in the Indian economy. However, the key to the success or failure of the agenda laid out in the budget, to paraphrase the finance minister Arun Jaitley’s own statements, lies in the remaining 364 days of the year.
The main intentions of the budget can be summarized into three broad areas.
First, this government is willing to postpone hitting its fiscal deficit targets temporarily to provide a boost to capital expenditure for infrastructure across a range of sectors in the economy. Second, there are moves to relax constraints on investment so as to allow easier access to alternative sources of capital to finance infrastructure spending. Third, there are a few concrete moves to streamline the financial architecture in the country, and a number of promises about future implementation of Financial Sector Legislative Reforms Commission recommendations.
Pushing up capital expenditure is an easy sell. No sensible commentator could argue that the state of infrastructure in the country is currently wonderful, and it is obvious that there are supply-side impediments to growth that desperately need alleviation. Most investors think of the India story as a story of growth, and they will likely be willing to provide fiscal slack if they feel that capital expenditure will relax constraints on critical inputs such as power, roads, irrigation, and rail. The move in the budget to cut corporation taxes should (in theory) also encourage greater private sector participation in the investment story. This is where implementation holds the key. Investors of all stripes will be watching carefully to see whether capital investment in infrastructure is indeed productive.
India’s record on this front has been dismal. Massive delays in project implementation, significant cost overruns, ex-post reneging on ex-ante promises—the list goes on. Can the government ensure that this will not be the case with the investments in ultra-mega power projects, road, rail, and agricultural infrastructure that this particular budget proposes?
The fact that a substantial fraction of the capital expenditure promises in the budget arise from an increase of roughly Rs.80,000 crore in public sector undertaking (PSU) expenditure is ominous. Changing the productivity of the investment process in PSUs is not going to happen overnight. This is a major risk factor which could upset the noble intentions in the budget.
What about relaxing constraints on investment? On the foreign investment front, the moves to abolish the distinction between foreign direct investment and foreign portfolio investment, and moving to a system of tax pass through to investors in foreign funds should (in theory) encourage foreign investors looking to participate in the India growth story. Once again, let’s remember that foreign investors will vote with their feet if implementation is not satisfactory.
There are other laudable moves to encourage savings to be channelled productively. Continuing the expansion of financial inclusion plans and attempting to wean capital away from physical gold to more formal savings in the financial system are eminently sensible.
Once again, if these savings move into the formal banking system, there needs to be significant work done to improve the investment technology in public sector banks, which are stewards of the vast fraction of formal savings in our country. We have to fix bank governance, relax constraints on pay to ensure that the best and the brightest can be employed in public sector banks, and ultimately relax the stranglehold of the state on bank ownership. None of this will happen overnight.
The moves to streamline financial architecture in the country to make it fit for purpose in a modern open market economy are welcome. Giving the Reserve Bank of India further autonomy over monetary policy within the framework of a flexible inflation target, and the move to introduce an monetary policy committee to set policy rates brings us closer in line with the standard monetary policy toolkit used by large economies. It also seems sensible to push ahead on evaluating and implementing the recommendations of the FSLRC, especially in the area of consumer financial protection. How fast and how well will the government implement these initiatives? The markets will be watching.
A final note—there has been a lot of sabre-rattling about the issue of black money, resulting in draconian penalties for undeclared overseas assets announced in this budget. It is obvious that we need to find ways to repatriate ill-gotten gains to the country. But once again we face the issue of implementation. It can be dangerous to introduce new, harsh laws into an environment in which enforcement is generally half-hearted, and when intense, often politically motivated. Why not concentrate on dramatically improving enforcement and compliance? The government must resist the temptation to introduce additional regulation into an over-regulated, poor enforcement environment.
Tarun Ramadorai is professor of financial economics at the Saïd Business School, University of Oxford, and a member of the Oxford-Man Institute of Quantitative Finance.
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