A Pre budget perspective for 2016-17

The budget 2016-17 has to solve the problem of depressed aggregate demand at a time of poor income growth of both individuals and firms and steadily falling exports.

The context:

On February 29, Finance Minister Arun Jaitley will present his third budget. The first one, in July 2014, disappointed those who had been expecting big reforms; the second in February 2015, was also more of the same, except for the announcement that the corporate would be reduced to 25 per cent from 30 per cent over five years.

Since then there has been a huge deterioration in both the domestic and the global economy. Proof of the slowdown in the Indian economy comes from the shortfall in railway freight targets and in the huge surplus of electricity now available.

The major economies of the world are also slowing down. The US, Europe and China have gone into a damage control mode, but to little avail. So world demand in 2016 is going to be depressed.

This has softened commodity prices, which is good news for India as it now has greater room for manoeuvre, especially because inflation is low, the current account deficit is the lowest in a decade at around 1 per cent. However, the reverse side is that India’s exports realisations have been going down for over a year and show no signs of reviving.

Our forex reserves are comfortable at over $350 billion but over 80 per cent are due to short term inflows which could go out very quickly if the FIIs start pulling out. At the same time rural demand has weakened massively because of two successive droughts and low commodity prices. Overall, these two factors have contributed to very depressed demand.

At the same time, stalled projects, especially in the private sector, are still high leading to poor demand for steel and cement. Non-oil and non-gold imports are also weak because of the industrial slowdown.

For taxpayers in India the budget expectation in 2016 is two-fold with a need to focus on growth as well as removal of barriers in case of tax litigation procedures.

The Goods and Services Tax roll out plan is the most important announcement India is expecting during the Budget session thus affecting the fiscal climate of the nation and Indian economy’s investment and expenditure climate. The challenge for the Finance Minister in this budget session would thus to be incorporate the stakeholders’ need keeping in mind the current investment climate of the economy. The integration of better institutional financial policy is another critical decision to be made in this year’s budget that encompasses the need of the declining manufacturing sector in India.

Even though there has been a global economic slowdown , India has been able to leverage its position financially and manage to develop into one of the fastest growing economies. Domestically India has been facing challenges from infrastructural funding of stalled projects and non performing assets in the banking industry. India, as an economy in the global system is to be able to keep up its position as an attractive investment destination will strongly to need to create a stable, predictable policy environment with single clearance windows for FDIs to flow in and retain business.

In short, the Budget for 2016-17 has to solve the problem of depressed aggregate demand at a time of poor income growth in India of both individuals and firms and falling exports.

The investment challenge:

For the finance minister, challenges are many. Amid weak private investments he has to find resources for higher public investment with a focus on roads, urban development and bank recapitalization. He has to boost growth sentiments, and win the confidence of foreign investors, while satisfying populist demands for more welfare spending.

He is also required to perform a well-nigh impossible task: of keeping the fiscal deficit down and increasing the rate of investment while maintaining inflation at its current low levels. Only a huge slice of luck can help him achieving these conflicting objectives. He has therefore talked about a ‘pause’ in fiscal consolidation which is so necessary to reassure foreign investors that all is well.

Last year the minister had promised that the fiscal deficit of 3.9 per cent in 2015-16 would be reduced to 3.5 per cent in the coming financial year.

Can he now increase this? By how much? To 3.7 per cent or 3.8 per cent? What will be the impact on inflation and foreign confidence?

Such a ‘pause’ may give the government around Rs 40,000 crore for investing in infrastructure which would then spur the demand for steel and cement. But since this extra would have to come of fresh government borrowing, two problems come up: would the new debt incurred for investment not make the fragile balance unsustainable and what is the guarantee that it will spur industrial demand?

Also, there are other claimants for funds like the Ujwal DISCOM Assurance Yojana, designed to improve the financial health of the power utilities. That also requires massive borrowing. Can the market absorb both?

If raising resources is one side of the fiscal problem, controlling expenditure is the other. The costs of the Seventh Pay Commission and One Rank One Pension pay-outs is going to take its toll.

One way out would be to rely on non-tax revenue via disinvestment but the valuations are low and it may not make commercial sense to sell equity in the public sector firms now without charges of corruption.

The government also promises to overhaul the tax regime. Budget has to tackle the bold pledges into action while stimulating consumption at the same time.

The banks problem:

The government owned banks are in dire straits. They need to be recapitalised as many of them have, over the last eight years, eaten away their capital. They need around one or 1.5 lakh crore over the next three years and only the government can provide this money because private savers unlikely to invest in them as long as they have huge band loans and are owned by the government.

Finding the money for this is another very important priority for this year’s Budget because otherwise the banks cannot start lending when economic activity begins to revive. But there is no obvious source from where the money can be taken. A certain amount of fiscal jugglery therefore seems certain, especially since the government also has to make a show of raising outlays for alleviating rural distress.

Then there are the bad loans, euphemistically, called non-performing assets. These are probably in excess of Rs 7 lakh crore and perhaps even more. This is the elephant in the room. The ideal solution would be for them to sell their bad loans to an asset reconstruction company but without a formal order in writing from the government, it is unlikely that bank chairmen will adopt this route for fear of attracting charges of corruption.

This means the loans may have to written off and that is further bad news for the banks. Their share prices could fall even further.

To sum up:

The Budget of 2016-2017 is critical for not only for India but for the global economic stakeholders. Domestically the resource and monetary allocation of the budget affects the three most critical sectors of Indian Economy i.e Infrastructure, Manufacturing and Banking making the decisions and budget allocation significant for global investment into India as well as domestic distribution of monetary resources, defining the industry sentiment.

Radhika Shapoorjee
President – India & South Asia

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