Jaitley may present a popular budget, and not a populist one: Nomura’s Sonal Varma9 min read . Updated: 03 Feb 2017, 01:39 AM IST
Sonal Varma says the Modi government has stuck to policies that are prudent and long-term, and it is unlikely to shift its focus to populism in preparation for the 2019 general election
The Narendra Modi government has stuck to policies that are prudent and long-term, and it is unlikely to shift its focus to populism in preparation for the 2019 general election, says Sonal Varma, managing director and India chief economist, global markets division (Asia ex-Japan), Nomura Holdings Inc. The budget for fiscal 2018, to be presented by finance minister Arun Jaitley on Wednesday, would be a “popular one, and not populist", although it precedes crucial state elections, including in Uttar Pradesh, Varma said in an interview. Edited excerpts:
What are your estimates for FY18 growth?
Our expectation is about 7.4%. The demonetisation impact will be more visible in the December quarter 2016, and first quarter 2017. Big impact on growth has come because there was no cash for transactions. Until mid-January, RBI (Reserve Bank of India) had remonetized about 44% of the old notes, and at the pace at which new notes are being printed, by March-end, India will be at a cash level where activity will stabilize. Negative impact on growth was severe in November, December and January, and is gradually easing now. Beyond March, I see a release of pent-up demand. The government gets some fiscal gains out of this as well—collections through amnesty scheme, compliance will go up, there could be a special dividend from RBI, there has been some wealth redistribution from the rich to poor that has happened due to this process, and the poor typically have a higher propensity to consume… the best macroeconomic effect of this entire exercise has been that cash sitting under the carpets has moved to bank deposits and, therefore, lending rates are down. If you are looking ahead into FY18, the cash disruption should be gone and positive effects of these other factors should be visible.
But the government has maintained that demonetisation is only one in many steps to flush out black money. Do you therefore expect to see other steps to fight black money being unveiled in the budget?
Budget may not necessarily be the medium. Since the BJP (Bharatiya Janata Party)-led government has come to power, they have taken several steps – for instance, if you are buying gold beyond a certain amount, you need to show your PAN (permanent account number). The India–Switzerland treaty has come into force - in terms of disclosure of Indians who hold money outside, in two years’ time, the names will start to be disclosed to the government. Multiple steps are being taken to cut down corruption and scope for black money. Bulk of the black money is not stored in cash, but in property and land, and more follow-up measures on that asset classes will be required. But we don’t expect that to come through in the budget. What we expect to see in the budget is more means that incentivize digital payments, which they have been trying to push post-demonetisation.
What are your key expectations from budget?
The backdrop of the budget being UP (Uttar Pradesh) elections and demonetisation, people are expecting a populist one. Our view is it will be a popular one, and not a populist budget. We are looking at the government continuing to consolidate its fiscal deficit—this year’s target of 3.5% will be achieved, and the previous fiscal committee had suggested a target of 3% for FY18, and we expect them to meet it. Second, we expect to see more measures towards a digital economy. Third, measures focused on segments hit by demonetisation like rural, agriculture—we expect to see more measures on affordable housing, and also a continued push toward infrastructure spending. We expect corporate tax rates to come down, as they had promised earlier, along with removal of exemptions. It will be a simpler tax structure.
Considering that domestic demand will be key to reigniting growth, do you expect the government to unveil steps to revive growth in budget?
Budget can try to revive growth by reviving either consumption or investment. For consumption to go up, hypothetically, you can cut income tax rates so that disposable incomes go up, but budget is also operating under constraints. If you have to consolidate your fiscal finance, you can get some space to revive growth, but not too much. In the limited space that you have, do you use it to revive consumption or investment? I think the consumption hit post-demonetisation is temporary – people don’t have the cash. Consumption will come back. The proportion of population that pays income tax is anyways too low – there is a problem for the government, if you raise the threshold and more people get out of the tax net. Therefore, the focus has to be more on investment – whether it is capex on roads, railways or renewable energy, shipping and ports. Part of the funding will come from the government, and part from public sector companies, and some from market borrowings from PSUs (public sector undertakings), but funding is only one factor. Basically, it has to be about creating the environment for others to invest.
When do you see private capex coming back? For that consumption has to come back.
If you look at aggregate consumption growth in India, private consumption has been growing at 7%.... Demonetisation has changed a lot of things, but outside of that consumption has been doing fine. On the credit side, retail lending is still one of the fastest growing for banks. Excess capacity may be a problem, but there are multiple factors – when you are talking about investment, there is private and public, and within that, you are talking about manufacturing, infrastructure and real estate. On the private side, on manufacturing, you have the issue of excess capacity. Private infra balance sheet is an issue. From the private side...whether (because of) balance sheet issues, or excess capacity being there, an immediate pickup is unlikely. Coming to the government, it is not there when it comes to manufacturing -- maybe it can push low-cost affordable housing segments a bit – and spend more on infrastructure. But from planning to spending to execution to showing up on the ground takes time. For government investments, we are expect spending to pick up in roads and railways.
Is it a concern that India has not made much headway in terms of job creation?
Given our demographics, this is a very important issue. We don’t have a clear answer on how to create jobs. A lot of the people who are currently employed in agriculture will move out, and you need to find productive areas for them to be employed in manufacturing and the services sector, and for this, skillsets will be required. So it is not just about building a factory. You have to be employable. There is enough infrastructure deficit in India – if we just build on that, then a sufficient number of jobs can be created. But government has to go full-on to push the infrastructure front, because manufacturing is not just a capacity issue, but you are seeing capital-intensive manufacturing, and automation is happening – so need for physical labour is also going down. Skills is an issue that has to be resolved if you want to jump from agriculture to services.
Looking at India from here in Singapore, and the way demonetisation has been handled, do you see an RBI that has lost credibility, and what is it that the institution can do to rebuild trust?
There is no such discussion outside India on RBI’s credibility, and such talk is all local noise. If demonetisation is about cracking down on black money, then we cannot stop here, because other hoarding vehicles also have to be attacked. Second, you have to minimize the pain for the economy – the cash shortage due to the limits of printing capacity – this has to be addressed faster. Pace of remonetisation has been slower than expected.
How do you see the Indian markets in 2017? Will the volatility continue?
It goes without saying that volatility will continue as we have a lot of uncertainty. Our view in general for Asia, in the backdrop of what we are seeing in the US, is more caution, because a lot of Asia has built leverage over the years, and is therefore more vulnerable to a faster pace of US rate hikes.
China has become an integral part of the supply chain for most countries here, and given the debt buildup there, and we expect growth (in China) to be around 6.5% - but if that growth is supported by more credit creation, basically financial risks rise simultaneously. The region in general has an ageing population. A US that is a lot more protectionist, has more restrictions on trade deals, has tariffs, immigration restrictions – then medium-term for US is inflationary, and that backdrop for Asia is one where we are a lot more cautious in terms of the economic outlook for the whole region.
Your outlook for the rupee.
Outperformer on a relative basis. Within the region, in terms of domestic parameters - exposure to China, and exposure to US - is low, and so on a relative basis, the rupee will be an outperformer, and on an absolute basis, our view is that the US dollar will continue to strengthen this year, and so we are looking to mild depreciation vis-à-vis the US$.
If there is a setback in the UP elections, do you see the government changing track?
This is a standard expectation everyone has in the run-up to the general election, but I would say we have been positively surprised by their policies. If the end objective is to get the rural economy to do better, what strategy do you use? Do you outright throw cash, which is populism, or do you give more irrigation, investments, increase spending in rural infrastructure, to make them more productive? End objective is the same—routes that you choose can be different. It is difficult to say if the Modi-led government will take a populist approach—there have been instances like the UP elections now, and Bihar elections last year, and every chance where we thought they would become populist, they did not. They have stuck to policies that are prudent, despite being geared to sectors that are election-oriented. While the UP elections are very important, every party has a DNA, and you don’t throw everything away and become populist. We had similar fears after Bihar, but they did not come through. Their policies have been long-term—even demonetisation was a huge political move pulled off before the UP elections.
Outside the budget, when you look at India, what are the concerns?
Generally, the view on India is very positive... it looks strong because the government is undertaking reforms. It may not show up in growth numbers, or investments picking up immediately, but they have been prudent in reforms and in policy steps; in general, the view from outside is therefore positive.