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January 09, 2017

Now to ease the demonetisation pain

Budget musings


When the Finance Minister Arun Jaitley rises to present the Union Budget for 2017-2018, he faces pretty much the same taskfor the third time: to ensure the economy pulls ahead on the crutches of budgetary support.


But for entirely different reasons, this time. The first two budgets of the Narendra Modi government were overcast by theshadow of poor monsoons. This year’s ‘drought’, on the contrary, was brought about by the adverse effects of demonetisation.The fiscal, in fact, saw normal and well-distributed monsoon, across geography and time.


Yet, Budget 2018 will have to play a greater effort in buttressing the economy compared with the previous two Budgets. Despitedeficient rains in fiscals 2015 and 2016, growth was gradually inching up. But this fiscal, the Central Statistical Organisationhas pegged GDP growth at 7.1%, knocking 50 basis points off last fiscal’s 7.6%.


To the government’s credit, the policy focus so far has been towards raising growth potential rather than stepping up the cycle.It has avoided using monetary and fiscal steroids to deflect global headwinds and absorb the adverse impact of twoconsecutive failed monsoons. Policy actions were focused on putting the house in order and initiating structural reformsnotably,the passage of Bankruptcy and Insolvency Act, and the push-through of the Goods and Services Tax (GST) closer toreality. These reforms may not have created an immediate upside to growth but have raised the potential and trend rate ofgrowth.


Will this stance continue in the forthcoming Budget? In my opinion, the Budget will focus on stemming the downturn.


First, in addition to the fall in overall growth, private consumption growth, one of the bulwarks of the economy, too, has fallen.The ability of the Budget to kick start the economy depends on the ‘fiscal space’ it has to maneuver. The debt/GDP ratio forthe Centre as well as the Centre and states together has been stubbornly sticky in the past few years, despite a conservativefiscal stance. Bringing this down is a key policy objective, as India has the highest debt ratio among similarly rated sovereigns.The second factor that constrains the ability of the government to spend aggressively is the commitment to reduce fiscaldeficit to 3% of GDP in fiscal 2018 from 3.5% in the current fiscal.


Some fiscal space for fiscal 2018 can be created through (1) relaxation of pre-committed fiscal deficit target of 3% of GDP (ifthe Fiscal Responsibility and Budget Management Committee recommends so) and (2) dividend payment to the government(from the Reserve Bank of India) equivalent to the value of the Rs 500 and Rs 1000 currency notes extinguished.This space can be used to push private consumption by relaxing personal income tax limits, support to housing, and increasedbudgetary allocations to the rural economy.


Second, revival of the investment cycle remains a key challenge. Even without demonetisation, private investment was fallingand could have taken a year to show signs of revival. On its part, the government has been trying to lift public investments soas to crowd-in private investments. In addition to budgetary allocation, bolstering the execution capability of ministries is alsocritical to ensure that the government’s investment plans see light at the end of the day. So far, the government’s efforts topush public investments have been more than offset by weakness in private corporate investment, leading to overall declinein investments in fiscal 2017. Within public investments, the government is likely to continue its focus on building roads andincentivising low cost housing, as the construction sector has high labour intensity, and this will generate employment as well.Unless the private sector returns with bigger investment plans, sustainable recovery will remain elusive. Budget 2018 willhave to be fairly creative in the use of limited fiscal space to support growth and cheer the private sector.