New Delhi: It was in December that finance minister Arun Jaitley gave the first inkling of his priorities in the budget for the next financial year starting April.

Last year was one of “tectonic changes", Jaitley said, in an implicit reference to the landmark goods and services tax (GST) that took effect in July, a Rs2.2 trillion bank recapitalisation plan and moves to resolve the Rs10 trillion of toxic assets choking the banking system. In addition, the ripples of the government’s November 2016 invalidation of high-value banknotes, which took out 86% of the currency in circulation by value, continued to be felt in 2017.

“ is the time really to concentrate," Jaitley said in a speech at the Hindustan Times Leadership Summit. “And the two areas to be concentrated on are infrastructure and rural India. And, therefore, whatever additional resources we have, a lot is going to be spent in these areas."

The budget that Jaitley will present on 1 February is critical for the National Democratic Alliance (NDA) government that assumed office in May 2014. For one thing, it will be its last full-fledged budget before the general election due in 2019, which will be preceded by assembly elections in eight states this year.

The budget will be an opportunity for the Narendra Modi government to give a much-needed fillip to economic growth and alleviate widespread agrarian distress that was blamed for the ruling Bharatiya Janata Party’s (BJP’s) poor performance in rural constituencies of his home state, Gujarat, which went to the polls in December.

The pressure on the government is to present a populist, please-all budget, but faltering revenue collections after implementation of GST, and rising oil prices could mess up the finance ministry’s budget math.

Economic backdrop

The Indian economy, Asia’s third largest, is forecast to expand 6.5% in the year to March, the slowest pace in four years, partly the result of demonetisation and GST-related implementation issues.

The forecast released by the Central Statistics Office (CSO) assumes that the economy is on a recovery path. The economy grew 6% in the six months to September, indicating that it will accelerate to 7% in the year’s second half ending 31 March, if the forecast is to come true.

The World Bank and the International Monetary Fund project India’s growth to accelerate in 2018-19 to 7.3% and 7.4%, respectively, which will reposition India as the fastest growing major economy, a position it ceded to China for a year.

But the government can’t afford to be complacent. The finance ministry’s worries have increased significantly on the fiscal front, and it is staring at the imminent possibility of breaching its target of containing the fiscal deficit at 3.2% of gross domestic product (GDP) in the year ending March. The government exceeded its Rs5.5 trillion full-year fiscal deficit target by November end because of lower-than-expected revenue collections and higher revenue expenditure.

Government revenues have been under pressure due to a shortfall in indirect tax collections under the GST regime, prompting it to announce an additional borrowing of Rs50,000 crore in December to fund spending in key sectors of the economy. It subsequently reduced additional borrowing to Rs20,000 crore after surprise gains from asset sales. The government has already garnered Rs91,253 crore by divesting stakes in state-owned firms, exceeding the budget target of Rs72,500 crore for 2017-18.

Suspected tax evasion and a cut in tax rates on many items have seen GST collections fall progressively since the tax was implemented on 1 July. In December, GST revenue (for the month of November) collections came in at Rs80,808 crore, falling from Rs94,063 crore in August.

The government is hoping to arrest the decline by plugging loopholes. From 1 February, all interstate movement of goods worth more than Rs50,000 will require securing an e-way bill—an electronic permit—through prior online registration of the consignment.

“Once the e-way bill system and invoice matching (two self-policing features of GST) are implemented, tax compliance will improve," said a tax official, who asked not to be named.

To shore up revenue, the federal indirect tax body, GST Council, decided on 16 December to advance the introduction of e-way bills by two months. The authorities are now working on a simpler tax return filing system that will reduce evasion.

Direct tax collections, meanwhile, grew faster than estimated at 18.7% this fiscal, up to 15 January, representing 70.3% of the full-year budget estimate, providing a breather to the government. Most economists now think the fiscal slippage, if any, in 2017-18 will be relatively smaller than expected earlier, in the range of 3.3-3.4% of GDP.

Budget expectations

State Bank of India chief economist Soumyakanti Ghosh, in a report released on 22 January, said he believes the budget will ultimately be a balance between pragmatism and fiscal consolidation.

“We expect the government to continue on its fiscal consolidation path. However, this may not be construed as the overarching criterion and should not come in the way of growth," he said.

The finance ministry has signalled that it may defer implementing the new fiscal consolidation road map recommended by a high-level panel by two years after it tasked the 15th Finance Commission, which deals with resource allocation to states, to dwell on the matter. The panel had suggested a medium-term fiscal framework under which the government is supposed to reduce its fiscal deficit to 3% of GDP in 2018-19.

The committee’s recommendations on fiscal discipline were supposed to come into force in the fiscal year starting April this year; the 15th Finance Commission’s recommendations will be implemented starting April 2020.

Jaitley has hinted at a recalibration of the fiscal consolidation road map. “No pause (on fiscal consolidation) but challenges arising from structural reforms...could change the glide path," Jaitley said at the annual Asia-Pacific summit organized by Morgan Stanley in Singapore in November.

To be sure, most analysts do not expect the government to be fiscally imprudent even under electoral pressure.

D.K. Srivastava, chief policy adviser at the Indian unit of EY, the consulting firm previously known as Ernst and Young, said while elections are often preceded by a proliferation of fiscal giveaways, the present government has been very cautious about taking up costly welfare programmes.

“Given the difficult fiscal situation, it is quite likely that the programmes designed for job creation and for uplifting the rural economy would be aimed at maximizing the welfare augmenting and growth supporting effects without imposing heavy costs on the exchequer," he said.

Push for rural economy

The expectation that the budget may not be a populist one was reinforced by an interview Prime Minister Modi gave to Times Now television news channel on 22 January. “The common man expects honesty; he expects to get what he deserves. He doesn’t demand sops and freebies. It is our myth. And I trust the common man of the country. We run the government, take a decision to fulfil their needs and aspirations," he said, when asked whether the next budget will be populist.

Given the fact that agriculture continues to be a drag on overall GDP growth and the government’s ambition of doubling farm incomes by 2022, Jaitley can’t afford to neglect the rural sector. In a report released on 17 January, securities house Angel Broking Ltd said it expects a big push for rural employment generation programmes and a sharp thrust on rural infrastructure.

Axis Capital, in a report on 15 January, said the government would bump up spending on rural employment schemes and expand subsidies for affordable housing so that construction picks up. It cautioned that the central government has limited levers for actionable rural stimulus plans. “The key problem the government needs to address this time is fall in farm sector realization; for this, increasing credit availability or investment in marketing infrastructure would not help. A direct intervention into the market like increasing MSP and raising procurement is the only way to get quick results," it added. MSP is short for minimum support price, the price assured by the government for procuring foodgrain for sale through the subsidized public distribution system.

Srivastava said that in order to ensure farmers’ incomes do not fall below a defined minimum threshold, a suitable farmers’ income insurance scheme may be designed, financed through subscriptions by farmers, insurance companies and the government. “This would be fiscally far more feasible than a universal basic income programme," he added.

The government may also incentivize logistics, including industrial parks, cold chains and warehousing facilities and significantly raise allocations for projects such as Bharatmala that is already off the ground. Bharatmala is a new umbrella programme for the highways sector that focuses on optimizing efficiency of road traffic movement across the country by bridging critical infrastructure gaps through economic corridors, inter corridors and feeder routes.

Angel Broking, in its 17 January report, said the coming budget will continue its thrust on infrastructure although the focus could be predominantly on rural infrastructure. “Rural roads, post-harvest infrastructure, last-mile connectivity, massive irrigation projects could all be a part of the budget package. The theme of the budget could be infrastructure with a big focus on rural infrastructure," it added.

While addressing rural distress, job creation through infrastructure building is likely to remain high on Jaitley’s priority list, big business is keen to receive the benefit of a lower 25% corporate tax rate now available to new manufacturers that do not claim tax breaks and to small companies with sales of up to Rs50 crore. Big business now pays a corporate tax of 30%.

Weak indirect tax receipts in the GST regime may restrain the government from making major concessions although, globally, governments including those of France, China, the UK and the US are slashing corporate taxes to encourage businesses to create jobs.

The risks

Apart from a fiscal slippage, if the government chooses to adopt a populist stance in the budget, the biggest risk the economy and the budget calculations may face are rising crude oil prices.

India was a major beneficiary of a sharp fall in oil prices starting in 2014 to $28 per barrel in 2016; the government shored up its revenues by significantly increasing excise duties on petroleum products without fully passing on the benefits of lower crude prices to consumers. The Indian basket of crude, which cost $46.56 a barrel in June 2017, rose to $77.22 on 22 January as the Organization of the Petroleum Exporting Countries, or Opec, and Russia cut supplies. A further rise in oil prices could force the government to reduce excise duties in what already portends to be a fiscally uncertain year. Already the central government has slashed taxes on petrol and diesel, which remain outside of GST, by Rs2 a litre in October. High oil prices will also lead to increased spending on cooking gas subsidy.

The immediate worry is the inflationary impact. Retail inflation surged to a 17-month high of 5.21% in December from 4.88% in October, after remaining below 4% for 12 consecutive months, on higher food and fuel prices. Most economists say the Reserve Bank of India will keep its policy rates unchanged, but don’t rule out a rate hike if retail inflation remains above 5% for two consecutive quarters in 2018.

Higher interest rates at a time of tepid investment demand and weak consumer sentiment will put the onus of reviving the economy on fiscal policy, which may make the job of the finance minister tougher.

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