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Business News/ Opinion / Online-views/  Budget 2017: A case for aggressive fiscal stimulus
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Budget 2017: A case for aggressive fiscal stimulus

India will have to depend largely on domestic initiatives for 8%-or-above GDP growth rate, given the global growth slowdown and threats to globalization

Finance minister Arun Jaitley will present the Union Budget on 1 February. Photo: ReutersPremium
Finance minister Arun Jaitley will present the Union Budget on 1 February. Photo: Reuters

A comprehensive calculus of demonetisation’s net gains, if any, can await the release of appropriate data. The priority is to uplift the economy from its current contractionary phase. Given the global growth slowdown and the inward orientation of major developed countries, India will have to depend largely on domestic initiatives to reach and sustain its potential growth of 8% or above. The Union budget of 2017-18 provides a significant opportunity for a substantive push to growth.

Slowdown preceded demonetisation

An economic slowdown clearly preceded demonetisation. By the second quarter of fiscal year 2017 (Q2FY17), investment demand as measured by gross fixed capital formation had already been contracting for three consecutive quarters. As shown by year-on-year negative growth rates of -1.9% in Q4FY16, -3.1% in Q1FY17 and -5.6% in Q2FY17, this contraction has increased in magnitude. Growth in exports had been negative throughout FY16. It was near zero in Q2FY17. The growth, year-on-year, of the centre’s gross tax revenues in Q2FY17 fell to 8.7%, compared to 24.1% in Q2FY16. This was mainly due to corporate and personal income tax, and customs duties. The Central Statistics Office’s Advance Estimates for FY17 indicate that even private final consumption expenditure has slowed down. Without taking into account the effect of demonetisation, its FY17 gross domestic product (GDP) growth estimate at 7.1% is 0.5 percentage points lower than that in FY16.

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Available evidence indicates that demonetisation has accentuated these contractionary trends. At 49.6 for manufacturing and 46.8 for services in December 2016, the Purchasing Managers’ Index (PMI) has gone below the threshold of 50, indicating contraction. The services PMI showed contraction in November itself. Growth in bank credit fell to 6.6% in November 2016 with food credit contracting sharply by 15.7%. Although year-on-year growth in the Index of Industrial Production (IIP) at 5.7% in November 2016 shows an upturn, this was driven by a favourable base effect. Month-on-month IIP growth shows contraction in October at (-) 0.7% and November at (-) 1.3%. The International Monetary Fund has reassessed India’s post-demonetisation GDP growth for FY17 at 6.6%, 1.4 percentage points below the potential growth of 8%.

Financing fiscal stimulus

A substantive fiscal stimulus is needed and feasible. First, the government can access a one-time fiscal windfall linked to currency extinguishment supplemented by additional tax revenues through Income Disclosure Scheme (IDS) 1 and IDS 2. Together, the extent of this gain could be as much as 0.75% of GDP. Second, given the economic slowdown, the government may relax the Fiscal Responsibility and Budget Management Act norms. Cyclical adjustment is desirable in a slowdown. Borrowing 0.5% points above the FY18 target of 3% of GDP would be justifiable, noting that the consolidated government’s debt-GDP ratio has fallen to 69% in 2015 from its peak of 84% in 2003. Many states asking for relaxation of their borrowing norms due to revenue erosion can together be allowed additional borrowing up to 0.5% of GDP. But cyclically adjusted targets call for strict discipline to ensure that borrowing is driven below the mean target in the expansionary phase.

Further, departmental enterprises such as posts and railways and non-departmental public enterprises can take up expansion plans given the prevailing low prices of investment goods. Their borrowing, largely off-budget, can add another 0.75% of GDP to the fiscal stimulus, which together may amount to 2.5% of GDP. The surge in bank deposits implying augmented financial savings would enable the government to borrow the extra amount without putting pressure on the interest rate. Most of this stimulus should be directed towards augmenting infrastructure. Qualitatively, some push to construction, housing and manufacturing particularly for the automobile sector through sector specific incentives should help these demonetisation-afflicted sectors. Investment demand would pick up only after existing inventories are exhausted. At that point, monetary stimulus would become effective.

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Uplifting tax-GDP ratio

Due to demonetisation, people who have deposited unaccounted money in banks would remain in the tax net for the current as well as subsequent years. With Goods and Services Tax and greater coverage of transactions through digitized means, the tax buoyancy should significantly go up on a sustained basis. We estimate that with a buoyancy of 1.3, the tax-GDP ratio can increase by a margin of 2 percentage points by 2020-21 under feasible growth assumptions. The country needs to augment the tax-GDP ratio by about 4 percentage points to give due attention to education and health.

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Expenditure side reforms

Significant efficiency gains can also be obtained on the expenditure side. With the abolition of Plan and non-Plan distinction, and the merger of a large part of Plan grants in the regular fiscal transfers under the Finance Commission, the central government should scale down many of the ministries that have been dealing with state subjects and administration of Plan grants. Together, these initiatives can provide the means to uplift India’s growth close to its long-term potential. Expenditure restructuring is crucial for the much-needed increase in expenditure on health and education. Spread of education would lead to a sustained increase in digitization.

D.K. Srivastava is chief policy adviser at EY India.

The views expressed are personal.

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Published: 25 Jan 2017, 05:18 AM IST
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