Borrowed Boom

BROKEN IMAGES, A PLAY, WRITTEN BY THE LATE Girish Karnad, is currently touring the national circuit. Starring the redoubtable Shabana Azmi, this one-woman show is a must see. Coincidentally, even as Karnad’s skilled exploration of the multiple, and often contradictory, persona any individual harbours within engages audiences, a collage of broken public images was presented in Parliament by another star: Nirmala Sitharaman, India’s new and first female Finance Minister. Indira Gandhi as Prime Minister was Finance Minister but only briefly and as an additional charge. Sitharaman tabled the Union Government’s Annual Financial Statement (AFS) —aka the Union Budget—for 2019-2020 on July 5th, as required byArticle 112 of the Constitution.

The Budget is usually a bundle of contradictions—hence the reference to broken images—as opposed to a perfectly aligned composition. Rhetoric rarely translates into capital allocations. Consider the rhetoric on nationalism around the Balakot targeted air attack, in response to the terror outrage in Pulwama, Kashmir, in February this year. The downstream product of nationalism is the economically sensible policy of Make in India. But when it comes to defence assets, Make in India militates against quick acquisition of the best technology. Also, buying the best off-the-shelf doesn’t come cheap—as the Rafale figher jet acquisition illustrates.

It is the Annual Financial Statement where rhetoric meets reality and the coat is cut per the cloth available. The Budget allocation for defence increased at less than one half of the average increase of 14 per cent for 2019-2020 over the previous year.

How well did the Finance Minister blend long-term priorities, such as rekindling growth, with short-term objectives like preserving jobs and manufacturing bottom lines by further reversing the open economy trend of declining import tariffs? Similarly, did she go too far in her short-term income distribution objectives, whilst ignoring the medium-term objective to keep the direct tax policy consistent and competitive for high- income earners and corporates, whom the Finance Minister called “wealth creators”?

How, for instance, do the incentives for attracting foreign debt and equity capital, helmed by a never-before sovereign bond issue by the Government which will likely keep the rupee strong, gel with the need to grow our merchandise exports which have been languishing for the past decade?

A strong rupee—an ideological choice of the BJP think-tankers— works against the policy of Make in India. It makes imports cheaper than domestic manufacturing. Also, can the high growth targets of well above a real rate of 8 per cent, implicit in becoming a $5-trillion economy in the near term, be achieved without an export boom? The Economic Survey 2019 doesn’t think so.

Finally, are household savers and prudent businesses being sacrificed to fuel the ravages of inefficient or corrupt business? Admittedly, high interest rates on commercial loans, between 9 per cent and 12 per cent per year, make investment uncompetitive. But they must not be lowered at the cost of household savings going below, even the low of 17 per cent of gross domestic product (GDP) in 2017-2018.

Publicly owned banks, which dominate the capital markets as investors, must become more efficient to reduce the intermediation cost between the Reserve Bank of India’s (RBI) repo rate and the final borrower. This is partly an off-Budget plumbing task since all publicly owned corporates dance to the tune of the Government. But fresh plumbing must be accompanied by cash to restructure and recapitalise banks transparently and quickly. The proposed Rs 70,000 crore in 2019-2020 will help, including to revive growth. Admittedly, it will help if the RBI lowers the repo rate to 5.75 per cent. But it is a slow cook till financial sector balance sheets improve. It is here that foreign direct investment (FDI) inflows can help enforce financial discipline into the banking sector.

The Annual Financial Statement remains a slim document, just 14 pages long. It is, however, accompanied by additional documents weighing an arm-wrenching 4 kg! Digital versions are available on the internet. But the obscure practice of tabling hard copies, even for the select group of less than 600 Members of Parliament, has evaded Digital India.

One such ‘long form’ is the 113-page-long Finance Bill which defines the revenue envelope for taxes proposed to be levied by the Government. Once approved by Parliament, it allows the Government to collect taxes at the new higher surcharge rates from the super-rich, those with taxable income of Rs 2 crore per year or more; enable those earning less than Rs 5 lakh a year to pay no income tax at all; further enlarge the benefit of a lower corporate tax rate of 25 per cent, currently applicable only to companies with turnover not exceeding Rs 250 crore, to those with a turnover up to Rs 400 crore, thereby benefiting 99.3 per cent of companies. It will increase the excise duty and cess on petrol and diesel by Rs 2 per litre. It will also allow Customs duty to be charged at higher rates on a range of products including an increase of Rs 1 per tonne of crude oil imported.

Oddly, the Budget process gives precedence to expenditure over revenue. This reduces the revenue proposals to being a residual, gap-filling measure rather than being the starting point—a defining limit beyond which the state can or should not proscribe private incomes and wealth. This skewed emphasis possibly originated as a device to fatten the goose before killing it. Soaking the rich, unmindful of their known ability to game the tax system to lower their effective tax rate, is bad economics but great public theatre.

The ‘Demand for Grants’ runs into 142 pages. Once approved, these demands will be converted into an Appropriations Bill to be passed by Parliament which will enable 145 million farmer households to get Rs 6,000 per year in their bank accounts; 50 million kids from minority communities to get scholarships; funding of public services like education, health and social protection; set up a new public sector company for space exploration; build road, air, marine and inland waterway connectivity; invest in high-speed data-transfer networks and sustainable habitats.

It will also enable consumers to use the special deduction of Rs 1.5 lakh from their income tax, allowed for interest paid on a loan to buy an electric vehicle. The list of programmes funded by the Union Government is astonishingly long at 122 schemes with a proposed outlay of Rs 11.4 lakh crore being 41 per cent of the total expenditure of Rs 27.9 lakh crore (13 per cent of projected GDP of Rs 2.11 crore crore) excluding Rs 6.6 lakh crore of interest payment (3 per cent of GDP).

The Constitution requires that the expenditure proposed distinguish between revenue and capital expenditure—a prescient requirement imposed on the executive early on, to red flag profligate spending without collecting sufficient revenue. The metric of revenue deficit identifies the excess of spending on other than investment over current receipts, which similarly exclude capital receipts, like the proceeds of disinvestment or from the sale of government land.

If we truly believe in the power of connectivity to lift all boats, we cannot remain isolated from the upsides and downsides of the global economy, as transmitted to us via external trade, capital and currency flows

Revenue has never exceeded current expenditure since 1951- 1952. India was an ‘unlikely’ democracy till recently—a ‘low- income economy (LIE)’ with high ambitions for universal empowerment. We escaped the pejorative LIE tag by transiting to a more respectable ‘lower-middle economy’ status, as per the World Bank 2018 definition, by crossing the Rubicon of gross national income (GNI) per capita of $995 only recently in 2008.

The next hurdle is to transit to the ‘upper-middle-income economy (UMIE)’ status—a bit like upgrading oneself from the economy to business class whilst travelling. But that is still some distance away. At $3,895, the floor income is almost double of our GNI per capita of $2,020 (2018). Note that the GNI per capita calculation deducts the rate of population growth. At a rate of 8 per cent real growth, it will take us 10 years, till 2028, to become a UMIE.

China, our bête noire, is at a GNI per capita of $9,470. Growth, in real terms, at even 5 per cent per year can take them to a GNI per capita of $12,055, making them a high-income economy by 2025. China’s growth story started a decade earlier than ours in 1979. Since 1996, its GNI per capita has grown in current dollar prices at 8.5 per cent per year. Our GNI per capita grew at an average rate of 7.1 per cent per year since economic liberalisation in 1992. Happily, since 2000, the growth of our GNI per capita accelerated to 8.8 per cent per year till 2018.

India has the potential to replicate China’s growth miracle, possibly more sustainably with respect to the environment and definitely in terms of political and social stability, whilst respecting all the covenants of a liberal democracy.

Since the end of planning in 2017-18, the final year of the 12th Five-Year Plan, we have relied on annual Budgets to take forward the enormous challenges of raising incomes of the bottom 40 per cent of our population and providing them the basic public services they have lacked thus far: work on public construction sites for the needy; a house for every family; access to electricity; access to clean cooking gas; sanitation facilities; access to clean water; quality education at least up to the secondary level with significant new-age skills for the digital world; access to healthcare for all and social protection for the marginalised, the aged and the specially enabled. This is the broad agenda for social and economic inclusion.

In theory, it can feed into growth and enhance the demand for private goods and services. But the distributional load is heavy. It competes for capital allocations with the capital demands of executing the sovereign functions allocated to the Union Government like infrastructure development and connectivity enhancement to reduce the transaction and transit cost of doing business, which is at least 5 per cent to 10 per cent higher than in comparable countries.

Capital expenditure is much lower than the expectations raised by the Vision Document of the Bharatiya Janata Party, which postulates a capital expenditure of Rs 20 lakh crore per year over the next five years. The average capital investment by the aggregate public sector, Budget allocation by the Government and capital investment by publicly owned enterprises, over the last two fiscal years 2018 and 2019 was Rs 8.3 lakh crore. The proposed capital expenditure in 2019-2020 is fairly low at Rs 8.78 lakh crore or 4.2 per cent of GDP. Adding likely investment by state governments and their commercial entities takes aggregate public investment to just above 8 per cent of GDP against 7.2 per cent in 2017-2018.

But private investment (22.4 per cent of GDP in 2017-2018) is flagging. The capacity of households to invest has declined owing to capital already tied up, giving no returns since 2014 in the realty market and the tapering-off in stock-market returns. Private corporate profitability is growing at a lower rate than nominal GDP. It is no surprise then that gross investment has decreased from 39 per cent of GDP in 2010-2011 to 32 per cent in 2017-2018.

The Economic Survey 2019 flags investment as a primary driver of growth and cites the example of China where, at its peak, investment was 47 per cent of GDP. But investment comes on the back of domestic savings.

Households are the biggest savers. But their savings have fallen from 23.6 per cent of GDP in 2010-2011 to 17.2 per cent in 2017-2018—a fall of 6.4 percentage points of GDP. Total savings, including that of the corporate private sector and the aggregate public sector, fell by 4.1 percentage points from 34.6 per cent of GDP in 2010-2011 to 30.5 per cent in 2017-2018 despite an improvement of 2.3 percentage points of GDP in public and private institutional savings.

It is in this context that the bold Budget announcement that India will enter the international bond markets for the first time to boost investment capacity should be viewed. India already has a sovereign investment grade rating from Moody’s. Indian public and private corporates have been accessing international capital markets since 1996. In 2015, the International Financing Corporation of the World Bank group issued masala bonds, denominated in rupees. Lower borrowing rates in the international markets are an attraction, as are the depth and maturity of these capital markets.

Reservations on account of ‘exposing’ sovereign debt to the scrutiny of international credit rating agencies and investors are overblown. If we truly believe in the power of connectivity to lift all boats, we cannot remain isolated from the upsides and the downsides of the international economy, as transmitted to us via external trade, capital and currency flows.

ALSO, THE GOVERNMENT CANNOT possibly borrow more from domestic capital markets without crowding out private borrowers or increasing their cost of debt. The RBI has been very proactive is reducing the rate at which it lends to domestic banks by 0.75 percentage points, bringing the repo rate down to 5.75 per cent after inflation remained below the 4 per cent level mandated by its Memorandum of Agreement with the Government. Our rather iffy record with managing inflation is the context within which the cautious approach of the RBI to reducing interest rates should be viewed.

In the nature of quick fixes, the Government has proposed to provide publicly owned banks a partial sovereign guarantee for up to 10 per cent loss on pooled assets of non-banking finance companies (NBFC) of up to Rs 1 lakh crore, against loans to better performing NBFCs suffering from collateral contagion due to the debt-servicing problems of a few NBFCs.

Therefore, the new Finance Minister faced a dilemma, not unlike Manjula in Karnad’s play. Should she come clean and piece the broken images together or play the game regardless? For the moment, like Manjula, the Finance Minister has chosen to play along using as her bookends the baggage inherited from the past including hugely exaggerated revenue projections targets prescribed by the Fiscal Responsibility and Budget Management Act 2003 (see my piece ‘Budget data snafu: No answers in sight’, The Asian Age, July 10th), ostensibly employing the former to notionally meet the latter. Both the fiscal deficit of 3 per cent of GDP (the Finance Minister’s 2020 target is 3.3 per cent) and Union Government debt-to-GDP ratio of 40 per cent (actual was 48 per cent in fiscal year 2019) have become moving targets. It is unlikely we will reach either target any time soon.

Prudent fiscal management is an increasingly dynamic equilibrium. It’s a game learned economists play, trading off among keeping inflation in check, growing a private investment-fed economy and enlarging the tax space for improving income distribution and public services for the poor and those left behind. The real question is do we have the skills to play this risky, knife- edge game or might we end up like the hapless Yudhishthira of Mahabharata?

About The Author

Sanjeev Ahluwalia

Sanjeev Ahluwalia is Adviser, Observer Research Foundation, New Delhi

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