Sustainable magic requires that the magician remain credible.
There is a heady feeling to being India’s finance minister. Finance is fungible, unlike other factors of production — including the ubiquitous “ahlu” in North Indian cuisine — which gives it the centrality others lack.
This unique status of the FM also forces her to perform magic tricks — like balancing the budget without raising any red flags on the macro-metrics of debt, borrowings, sequestering just enough and not more of individual incomes via tax and prioritising expenditure to achieve a golden mean between equity (pro-poor spending) and investment for sustainable (green) growth.
Sustainable magic requires that the magician remain credible. The Interim Budget FY 2020 has dented the reputation of credibility, acquired over the first three years of Modi 1.0. Every magician is only as good as her last performance. On the flip side, a single flawless performance can make the world sit up and take notice.
The FM starts with a handicap of GDP in Fiscal 2019 — the base year — being lower by Rs 1.7 trillion than was estimated in the Interim Budget. But teamwork can come to the rescue — economic pundits within the party and, most important, the FinMin bureaucracy. The latter has, ahead of the stakeholder consultations starting this week — already subtly defined the budget envelope as limited to what already exists in the Interim Budget presented on February 1, 2019 — an outlay of Rs 27.8 trillion, of which 21 per cent is for transfers to the state governments in addition to the share of the states in Central taxes, which is constitutionally mandated.
The spending ambitions of the Modi 1.0 government rested on unrealistic assumptions of double-digit growth. Average growth over the last 25 years, till 2017-18, has been seven per cent. Add to that, the truism that our spending is derived from how we behave. Modi 1.0 was focused on the international outreach of India’s “strength”. Strong men need to be big spenders — like China’s President Xi Jinping — to win friends and influence people. This is tough if you are walking on a fiscal tightrope, as we have always done. “Feel good” must give way to “pocket light” tactics.
Three fiscal benchmarks can restore credibility. First, Fiscal 2020 is not supportive for growth because the foundations were not laid earlier. Nominal growth assumptions should be set conservatively at 10.7 per cent — four per cent inflation plus 6.7 per cent growth. This aligns with the outcomes in Fiscal 2019, which ended with 5.8 per cent real growth in the last quarter and 6.8 per cent through the year. All the other assumptions — tax revenues, sustainable borrowings and expenditure limits — are driven by this one single assumption.
Second, finance minister Nirmala Sitharaman will need to slash extravaganzas on the revenue account, to make space for the pro-poor schemes announced by the Prime Minister during the election campaign. In addition, she can choose to convey a loud, implicit signal about re-establishing fiscal prudence by marginally reducing the budgeted revenue deficit of 2.2 in the Interim Budget to two per cent of GDP. Credibility is mostly about being seen to establish virtuous trends. The FM should stoke the “fiscal austerity” fires. After all, a foundational belief in austerity is central to the RSS — the mother lode of the BJP.
Third, credibility can be enhanced by implicitly recognising that we have strayed from the path of fiscal prudence using “dodgy magic” tricks amounting to around Rs 1.4 trillion, or 0.8 per cent of GDP. Enlarging current liabilities — unprocessed bills, including for the publicly owned enterprises — whilst expanding the debt of these entities to fund current expenditure, is one such.
The revised fiscal deficit (FD) for FY 2019 of 3.4 per cent of GDP masks the actual of 4.2 per cent of GDP. Recognising the spillover pressure that such tricks create and revising the budgeted FD upwards to 3.8 per cent of GDP — it was at 3.9 per cent in 2015-16 — will lend credence to any plan she reveals for bringing FD down to the targeted 2.5 per cent of GDP.
None of this is easy. It means shunning the opportunity for making new friends. Industry will look for tax breaks. They should not get any. Arun Jaitley had, in FY 2018, offered industry the option of a lower 25 per cent (as opposed to 30 per cent) corporate tax rate if they gave up all the tax exemptions they enjoyed. There were no takers. The virtuous intention to reduce the nominal tax burden, particularly of cess and surcharge — which are not shared with state governments — can only come on the back of better tax compliance by trade and industry. Convincing the “big boys” that the government has a growth facilitating plan for deregulation of the financial, labour and product markets, is more important than tax breaks.
The Reserve Bank has already played its growth card. Three successive reductions in the repo rate from 6.5 to 5.75 per cent, with more to come, can help stressed banks restore their balance sheets — far more important than passing it through to spur consumers to splurge. Business — including in agriculture — must adjust to a low inflation regime and look for frugal, export competitive investments, rather than relying on inflation to write down the real cost of their imprudent investments, as previously.
Some realism about rationalising the GST tax rates is necessary. It can only be done over the next four years, on the back of the fiscal space created by frozen revenue expenditure. Any future increase in revenue must be applied to growth-spurring investments and to fund any enhanced devolution proposed by the Finance Commission.
The FM should resist the temptation to bask in the approving desk thumping in Parliament on Budget day or frothy elevations in the stock market levels. More important is to risk public displeasure whilst restoring fiscal stability.
It is instructive to compare the declining credibility of the Budget speech with the growing credibility of the Monetary Policy Committee (MPC) of the Reserve Bank since 2016, when it was established. Admittedly, the MPC is only lightly political unlike the Union Budget. But we must recognise that the Union Budget is a role model for the fiscal behaviour of state governments, where fiscal profligacy has grown. The Centre, rightly, sets the gold standard for fiscal prudence and stability. It cannot afford to join the fiscal-fun party.