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A file photo of finance minister Arun Jaitley. Photo: Pradeep Gaur/Mint
A file photo of finance minister Arun Jaitley. Photo: Pradeep Gaur/Mint

A social economy budget

The most important initiative that will radically change India's political economy is the allocation of nearly `3 trillion to gram panchayats

This is an interesting budget insofar as it has more initiatives on the non-fiscal side than on the budgetary and fiscal front. Notwithstanding finance minister Arun Jaitley’s curious fondness for the number 9, which may have something to do with numerology, there are just two key independent but inter-related pillars of this budget: first, furthering fiscal federalization, and second, strengthening governance structure to ensure improved service delivery. To the extent that this is so, this budget is more political than economic and fiscal.

The single most important budgetary initiative that will radically change the political economy of the country is the allocation of nearly 3 trillion to gram panchayats. This move, which comes hot on the heels of a new devolution of finances to the state governments announced in the last budget, is a game-changer.

There are 250,000 panchayats in the country that will now get almost 1 crore every year. This is by far the most important measure for the democratization of public spending in India. Over the next five years, if the state governments understand the value of this move and supplement it, the entire public expenditure policy of the country will undergo a change for the better.

This direct statutory allocation from the centre to the gram panchayats, based on the recommendations of the 14th Finance Commission, strengthens the third tier of governance by giving it financial empowerment and autonomy. The statutory funding of gram panchayats will give the village democracy—galvanized by the passage of the 73rd constitutional amendment in 1993—a decisive transformative push.

As stated above, this is a political budget. But this is by far the most desirable way of a budget engaging with the political economy rather than the sops and exemptions that budgets have been used to doing, especially in the face of elections. The focus is on enabling and empowering in a targeted manner rather than on doling out subsidies.

This is so because devolving almost 15% of the Union budget to panchayats will be the beginning of effective village governments and governance in India. Gram panchayats will now discharge their responsibility for maintaining local amenities such as village roads, drains, street lights and drinking water facilities, and for identifying beneficiaries for federal and state poverty alleviation programmes. And these things matter in not only changing the quality of lives but also improving market access to the rural enterprises.

Further, local governments are better placed than, say, centrally appointed bureaucrats to identify and respond to villagers’ needs. The villagers who are on-spot stakeholders will find it much easier to ensure better monitoring. This will improve the efficiency of public expenditure.

To see it in a larger context, the democratization of public expenditure can lead to a democratization of the public service delivery system, which has been a crucial missing aspect in the Indian decentralization experiment.

This has been quite nicely supplemented by the second major pillar of the budget: strengthening governance structures. This is proposed to be done by bringing in a slew of legislative changes, ranging from an amendment of the Reserve Bank of India (RBI) Act to making Aadhaar statutory or the proposed public utility disputes resolution Act, which seeks to provide a legal framework for dispute resolution and re-negotiations in PPP (public-private partnership) projects and public utility contract.

One of the key problems in targeting public resources has been to get them to those who need them the most. Apart from activating the panchayat system, which should in turn use the political process to create more effective targeting to needy households and villages, these legislative changes like the use of Aadhaar for the delivery of public services can plug the loophole of leakages by leveraging technology.

By according the enactment of a law to ensure all government benefits are conferred to people who deserve it, has the potential to change the entire system of public delivery. With nearly 980 million Aadhaar numbers having been generated, an average of 2.6 million biometric and more than 150,000 e-KYC transactions are already being made on a daily basis.

By making Aadhaar statutory, the finance minister has made it the key to public sector reform and governance transformation with huge fiscal implications; it is a cost-effective scheme with long-term gains. A National Institute of Public Finance and Policy study had estimated that Aadhaar could save around 110,000 crore of government expenditure by 2020 on various public service schemes. With government benefits linked to Aadhaar number, no one person can get multiple benefits for the same scheme. The system ensures that there are no duplicate payments and leakages.

While all these initiatives make it an interesting budget, it is not an exciting budget from a fiscal perspective. True, the previous targets have been met, be it the revenue deficit or the fiscal deficit. There is also a promise to meet next year’s target, which is more because of the courtesy demanded from the RBI than actual fiscal policy.

What, however stands out on fiscal management is not an increased level of expenditure but changing the structure of expenditure. It is here that the rural focus is most evident.

From a macroeconomic perspective, Jaitley faced three key challenges: first, under-consumption in the rural sector; second, under-investment in the urban corporate sector, especially in a downbeat global economy; and third, leverage in the banking system, which is threatening to convert real side sluggishness into a banking and financial sector crisis.

While the issue of rural under-consumption has been adequately addressed directly, it is hoped that the under-investment crisis will be addressed indirectly through rural stimulation, which is contestable. By trying to build a consumerist rural economy without a corresponding investing “urban" sector is flawed. Rural demand may drive overall aggregate demand, but its structure and composition need not match the investment needs of the economy and that can derail this budget very easily.

The third challenge has been left unaddressed. The tough challenge of preventing macroeconomic sluggishness from becoming a banking sector crisis and from there on to a financial sector crisis and then a full blown macroeconomic crisis remains unaddressed.

The fact is that the banking sector is sliding fast, threatening to take the ongoing industrial slowdown into its second stage and converting it into a macroeconomic crisis that will pervade the real and the financial side. Already, the currency and equity markets have been affected.

The lack of additional capital infusions/road map on banking sector non-performing assets (NPAs) is a big disappointment. The finance minister has maintained status quo on the recapitalization limit for public sector banks at 25,000 crore, even while stating that the government remains committed towards easing off the stress in the banking system.

Given the current state of the banking sector in terms of asset quality and capitalization, it would have been ideal had the funding not only been hiked but also front-loaded as the deadline set for cleaning up of balance sheets is March 2017.

Even as the earnings may be good in some cases, the quality of earnings has deteriorated considerably. Asset quality is no longer a bank-specific issue; rather it is a banking-sector problem. Now, even as a high loan concentration is posing a problem for some individual banks, sectoral over-leverages are threatening the banking sector as a whole.

To put matters in perspective, the balance sheets of all banks today are far worse and weaker than they were in 2008. The banking sector as a whole today is less liquid, less profitable, less stable, less sound and with poorer asset quality as compared with 2008 and the recent past.

It is not an unlikely scenario that regulatory compliance is bound to impair lending and thereby causing a further weakening of an already anaemic macroeconomic growth.

It seems to have escaped the finance minister’s eye that capital adequacy of Indian banks is the lowest in the world, except that of banks in Greece, Spain, Italy and France.

However, the complex challenges facing the Indian society often summarized as the social and economic disarticulation between India and Bharat have been addressed innovatively. In that sense, this budget is an effort to foster a constructive collaboration and coordination between India and Bharat.

To sum up, this is a budget for the social economy. The social economy, in the context of the budget, refers to financial allocations and economics embodying the principles of improving service delivery to citizens and the democratization of the expenditure decision-making processes; and processes and operations based on the principles of participation, empowerment, and individual and collective accountability. That is the intent and the framework.

The recipe is good, let’s see how tasty the dish turns out to be.

Haseeb A. Drabu, an economist, is the former finance minister of Jammu and Kashmir.

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