In the upcoming budget, can the finance minister meet the 3.5% fiscal deficit target and increase public investment to galvanise growth at the same time?
When compared with around the same time last year, there are several similarities in the economic conditions in India, but also important and material differences. Our growth continues to look good and the International Monetary Fund (IMF) has projected that India will grow at 7.5% for 2016 and 2017. The persistence of low and falling global crude prices is clearly a bonanza, placing India in a ‘sweet spot’ yet again. In fact, the sweet spot may even be larger this year since many emerging market countries, including Russia, Brazil and South Africa, face enormous challenges. China, the bulwark of the global economy in recent times is set for a hard landing and IMF forecasts that it will grow at less than 7% for the next two years—at 6.3% and 6% for 2016 and 2017, respectively. In this context, India’s emergence as the fastest growing global economy is clearly a double-edged sword. Fears of contagion from other emerging economies, especially China, are real.
Weaker global growth compared with what was expected a year ago and the massive slowdown in world trade present a vastly different global environment compared to last year. The impact of the latter is in part reflected in our record export declines for 14 straight months, but in part it must also be due to our own stubborn infrastructural and logistical bottlenecks that affect our export competitiveness. While the precise mathematical scrutiny of the causes for export slowdown into global and domestic is indeed a worthwhile research and policy question, many commentators in the past, including the IMF and Reserve Bank of India governor Raghuram Rajan, have said that if India focuses on fixing domestic structural bottlenecks, the bite of adverse global conditions could be less painful due, inter alia, to the vast potential of India’s huge untapped domestic market.
There is however one crucial difference between now and around the same time last year. Hopes in 2015 were very high. There was widespread clamour for ‘big bang’ reforms in the run-up to the budget that had created enormous expectations and even invited comparisons with the path-breaking budget of 1991. The year 2015 was when finance minister (FM) Arun Jaitley presented his first full budget and the benign external environment of that time had led to a potent mix of expectations akin to shock therapy. The FM did not oblige—instead he cogently argued for “persistent, encompassing and creative incrementalism that could cumulate to big bang reforms". Although he has been charged with being an incrementalist, to be fair, much of global empirical evidence is in favour of gradualism. Big bang reforms in robust democracies like India are the exception rather than the rule and desirable only in times of crisis.
The good news for the FM in 2016 is that he has been unburdened of the massive expectations of last year. The bad news is that he is not unburdened of the economic challenges. The problems of cutting the budget deficit, achieving fiscal consolidation, reforming taxes and tax administration including the Goods and Services Tax (GST), widening the tax base and improving infrastructure are as real as they were last year.
His first objective in this year’s budget will be to clarify the dates for fiscal consolidation and in that context to give convincing reasons for deviating, if he does, from the fiscal deficit target of 3.5% of gross domestic product (GDP) for fiscal 2017 announced last year. Much public debate about the pros and cons of postponing the date has occurred centering around the loss of the government’s credibility versus the immediate and desperate need to kick start the investment cycle with increased public spending.
Can he achieve both objectives at the same time—that is, meet the target of 3.5% fiscal deficit and increase public investment to galvanise growth? This seems doubtful given that tax collections are unlikely to grow fast enough; disinvestment is not the best revenue-generating strategy during periods of volatility in capital markets; public sector banks are desperate for capital; and other expenses such as the 7th Pay Commission award and pensions loom. Given that fiscal space is limited, there is a need to unlock private investment to help bridge the infrastructure deficit.
But that will require strengthening the public-private partnership (PPP) model as announced in the last budget and subsequently elaborated upon by the Kelkar panel. The railways have announced ambitious new investments including those under the PPP model. This needs to be extended to other infrastructure sectors, including roads and ports. Implementation of the good initiatives of the previous budget, such as the bankruptcy code and GST deserve the government’s careful attention and perhaps require it to expend a lot of political capital.
These are both game changers—but achieving full potential will necessarily be subject to complementary reforms elsewhere—in land, capital and labour markets and especially in the institutional and enforcement apparatus that more often than not limit benefits of good intent.
Unburdened of the great expectations of last year, this is an opportunity for the FM to focus on the unspectacular yet vital element of the overall package—implementation.
Rajat Kathuria, director and chief executive, Indian Council for Research on International Economic Relations (ICRIER), New Delhi. Views expressed are personal.