Budget and growth equations

The Organisation for Economic Co-operation and Development, while trimming its global growth outlook for 2016, pointed out the need for urgent policy response—of supportive monetary and fiscal policies—and structural reforms to preserve global growth. One can argue that India, despite being the fastest-growing major economy in the world, also needs these.

How strong are India’s growth prospects? What roles can budget boosters, and reforms and resources play in improving the country’s growth story? What are the growth equations possible?

We believe that India’s GDP growth can quicken to 7.9% in fiscal 2017 from 7.6% in the current fiscal year, but it will be a fragile recovery and critically dependent on how the monsoon plays out. Normal rain in fiscal 2017 will give agriculture a one-time growth kicker because of the low-base effect of the last two years. This should lift sagging rural demand and, by extension, overall GDP growth. The rural economy contributes significantly to India’s growth with 50% share in manufacturing and a fourth in services. A third straight inadequate monsoon can scupper India’s one-legged consumption story (scripted by urban demand) and lower GDP growth to 7.3% in fiscal 2017.

True, monetary and fiscal stimuli can come in handy as domestic demand remains subdued and fragile amid underutilized capacities and intensifying global headwinds. But the ability to deploy these stimuli depends on fiscal space available and inflation dynamics.

The need to bring down high debt and fiscal deficit limits the wiggle room available to pump-prime the economy. In addition, it is not the Centre but the states that do the heavy lifting in capital spending and overall spending now. For example, in fiscal 2015, the central government’s capex was just ₹ 1.92 trillion compared with over ₹ 4 trillion for the states. With the share of states’ total divisible pool of tax revenue rising to 42% from 32% as per the recommendation of the 14th Finance Commission, states now have a greater role in public spending. So the central government’s ability to create demand via fiscal spending is anyway waning.

The question before finance minister Arun Jaitley, as he presents the budget next week, is not whether he should sacrifice fiscal rectitude at the altar of growth. It rather is whether the budget needs to be less restrictive than the commitment made in the Fiscal Responsibility and Budget Management (FRBM) Act in view of the prevailing economic conditions.

Revenue expenditure in fiscal 2017 will remain sticky because of the implementation of the Seventh Pay Commission and One Rank One Pension recommendations, and the need to support the rural economy. In my opinion, the Union budget could target moderately higher fiscal deficit than the FRBM commitment of 3.5% of GDP, say at 3.8%.

While doing so, it needs to give a clear signal that such a deviation is transitory arising from the need to revive the investment cycle, which has failed to lift in the last five years. In the last fiscal year, too, the government tried to front-load investments in roads, railways and defence, with major success in roads. This approach should continue in fiscal 2017 as well and the budget should use the resources thus freed (~ ₹ 50,000 crore) solely for infrastructure investment. The government could have raised the same quantum of resources through divestment as well. But the experience of the last few years and the state of the markets suggest that it would be a risky bet.

Monetary policy will only mildly support growth, benefitting somewhat from improved transmission of the Reserve Bank of India’s (RBI’s) repo rate cuts. That’s because it impacts the economy with a lag and we expect this to play out only next fiscal year. And as banks shift to marginal cost of funds calculus to set their lending rates, transmission of RBI’s signals will improve.

To be sure, some space for monetary easing has opened up on low crude oil prices amid rising risks to global growth, and we do expect another cut of 25 basis points in the policy rate after the budget. But support from monetary policy will be mild as RBI is unlikely to move and the ability of banks to create credit will be hampered by the millstone called non-performing assets.

Today, clamour for structural reforms is pretty loud from the investor community. The ability to push big-ticket reforms, however, hinges on statecraft—or the ability of the Narendra Modi-led government to build consensus. So far, the government has not been able to usher in game-changing reforms such as the goods and services tax (GST), and has moved the land and labour reforms to the domain of states. To its credit, though, it has eased the business environment and is cleaning up the mess in the power and banking sectors.

Calendar year 2016, which will mark the midpoint of the Modi government, will be closely watched for its success in getting the pending big-ticket reforms bills such as GST and bankruptcy code passed. The passage of these bills would not only be a big sentiment booster but is necessary to enhance India’s medium-term growth potential. It is also important for the government to make a meal of the National Investment and Infrastructure Fund. Additionally, a year of reckoning beckons for reforms already announced, such as Indradhanush for public sector banks and UDAY (Ujwal DISCOM Assurance Yojana) for the power sector.

After 2016, the ability of the government to unleash big reforms is likely to diminish with the advent of the political cycle. While the budget may not be a make-or-break for the economy, many of the things done beyond it in 2016 will certainly be.

The author is chief economist at Crisil Ltd.