Indian Budget 2019-20: Nirmala Sitharaman’s Maiden touch

Nirmala Sitharaman -India’s first female full time finance minister - presented her maiden budget, on 5^th July – faced with headwinds on the economic growth & job fronts impressed  with some new thoughts despite taking over the Ministry only 5 weeks ago. Some of them follow:

Zero Emission Mobility: The auto sector slowdown courtesy the NBFC (Non-Banking Financial Companies) crisis & trickling of credit to buyers thereof was addressed vide:

(a) a one time, six month, partial credit guarantee for PSU (Public Sector Undertakings) banks of first loss of up to 10% of Rs. 1 lakh crore for buying highly rated pooled assets of financially sound NBFCs, this financial year. The IL&FS crisis has triggered a crisis in the “shadow banking” sector & the RBI did not open any special window to handle the liquidity concerns of NBFCs; the govt. vide this announcement  has  “signalled” its intent to help financially sound NBFCs by nudging the “risk averse” PSU bankers & allowing the rest to be subsumed by market forces. An Asset Quality Review (AQR), of NBFCs, if announced will accelerate the inevitable.

Proposal for strengthening the regulatory authority of the RBI over NBFCs has been introduced in the finance bill.

(b)a Rs. 1.5 lakh tax deduction for buyers of EVs (Electrical vehicles) to spur this sunrise non-polluting segment to achieve economies of scale & perhaps, to make India into the EV factory of the world, by 2030; this is over & above the announcement of no custom duties, on some parts used in EVs, that are imported apart from the proposal before the GST council to reduce Indirect Taxes on EVs from 12% to 5%.

(c)Special Additional Excise duty & Road & Infrastructure cess of Rs. 1/- each per litre on diesel & petrol, perhaps, an attempt at “behavioural nudge” on consumers towards EVs; this also means that the demand for including oil under GST is unlikely to be met, immediately; states too would not complain, gaining as they too are due to the oil tax bonanza. This measure could net the Govt. about Rs. 20,000 crores this year.

Since Indian oil imports were $114 billion, in 2018-19, (~22.5%) of the total merchandise imports of $507 billion & India imports 83.5% of its oil needs there is a need to reduce import dependence by focussing on environmental friendly EVs. However, since the no. of moving parts in an EV are less than an IC (Internal combustion) engine vehicles, a shift to the former would induce stress in the auto component industry in the next decade or two & plans need to be initiated to manage the same. .

Stimulus to Housing: To manage the job crisis, a stimulus to the housing segment – the 2^nd largest absorber of labour after agriculture - vide:

(1)Allowing for an additional deduction of Rs. 1.5 lakhs, over & above the Rs. 2 lakhs already available, for availing of housing loans, upto 45 lakhs, till 31/3/2020

There are a lot of stressed assets in realty & buyers had petitioned the govt. for some intervention in the form of interest holiday & creation of a stressed asset fund to complete the projects; the govt. appears to favour market forces to manage the situation. Considering the power differential between the real estate tycoons & the home buyers - many of whom spent their lifetime savings on the home asset - it might be prudent of the govt. to take over the land banks of the recalcitrant tycoons, arrange for sell off - a la Satyam - & use the proceeds thereof to complete & hand over to the consumers. Since realty is one of the sinks of black money, in India, apart from mining, quarrying & Jewellery sectors managed largely vide political patronage, cleaning up this sector augurs well for electoral politics in India.

The govt. had encouraged rental housing & REITs (Real Estate Investment Trusts) formation in its previous term but flows from pension funds, sovereign wealth funds etc. was lacking since REITs expect at least an 8% return while rental yields in India are a meagre 2%. Since the highest component of the housing cost is land & the govt. is the largest hoarder of this scarce asset, Industry has been demanding social capital of free land from the govt. to promote affordable housing which is still unmet; the other suggestion by industry is “Negative Gearing” - where losses on investment by renting out house property is tax deductible & attracts only 50% (say) of capital gains in eventual sale. Real estate players too, instead of making supernormal profits, by keeping prices high, should cut prices to encourage buyers instead of being a cry baby year after year.

Enhance public Float from 25% to 25%: SEBI has been advised to initiate consultations to explore public shareholding increase from 25% to 35% that would enhance free float, allow for better price discovery & allow minority shareholders to own a greater slice of value stocks - the biggest potential wealth shifting announcement. This also takes away the promoters ability to unilaterally pass special resolutions & hence improve governance.  According to Centrum Broking’s research 1174 listed companies (~25%), of the total listed company universe of about 4700 companies, will be affected. These include companies like TCS (Rs. 59500 cr.), Avenue Supermarts (Rs.14000cr.), Wipro (Rs. 15000cr.) & they might have to divest stake or delist. There is a legitimate argument, however, that there is merit in having promoters of small caps & mid-caps have greater skin in the game.

India’s weight in MSCI (Morgan Stanley Capital Index) or other indices, though, could rise leading to benefits over medium term. FPI (Foreign Portfolio Investors) investment upto sectorial limits announced would ensure more inflow of foreign funds. Introduction of tax on dividends, of 10% plus surcharge, for individuals/HUF (Hindu Undivided Family)/partnerships/private trusts, over Rs10 lakhs, in last budget, over & above the DDT (Dividend Distribution Tax), of 20% (including surcharge & cess), charged on the companies, incentivized many promoters to opt for buyback of shares. The loophole is now closed with buybacks on listed companies too, like unlisted ones, attracting a 20% tax.

While the timeline to fulfil the 35% public holding is not spelt out, this has the potential to net the govt. substantial revenues ~20% on about 4 lakh crores or Rs. 0.8 lakh crores. However, Finance secretary, Subhash Chandra Garg, has clarified that a decision has not been taken yet & hence “unfortunate” that the market has prematurely reacted strongly against the “proposal” before SEBI coming out with a “considered recommendation,” on “whether & to what extent & which kind of companies” shall be subjected to the order.

Addressing the Job crisis: Capital adequacy of banks is being addressed vide a promise to infuse Rs. 70,000 crores; the time line of infusion is however unclear – this year or over a 3-5 year tenure. With capacity utilization under 80%, it is unlikely that fresh greenfield investments will be undertaken by industry especially when cheaper assets are available vide IBC (Insolvency & bankruptcy code). Breather on Angel tax, though, is welcome.

Easing of sourcing norms for single brand retail announced could bring in FDI but not help “Make in India”.

Announcement on a TV channel run by start-ups, for start-ups, to discuss on issues affecting their growth, matchmaking with VCs (Venture Capitalists), funding & tax planning, under DD (Doordarshan) bouquet of channels  & willingness to ensure greater dispersion of foreign languages is a signal to job seekers either to make provisions for self-employment or seek avenues abroad; the govt., though, should push for greater labour mobility in WTO (World Trade Organization), FTA (Free Trade agreements)  or in trade block negotiations.

Raising Foreign debt for Sovereign: Indian debt in foreign currency is a low 5% & India’s primary deficit is nearly zero i.e. entire fiscal deficit is used to fund the interest cost on debt. CAE (Chief Economic Advisor) Krishnamurty Subramanian, has argued that since the global interest rates are low there is a case for raising more of sovereign debt abroad in foreign currency. It must however be remembered that the Latin American crisis was caused due to high levels of foreign currency debt & former Governors’ of the RBI, like YV Reddy, resisted the pressure, of the then Govt., on a similar proposal raising the spectre of additional exchange rate risks & the consequent rating downgrade fears.

Zero Budget Farming: A pithy statement was made on zero budget farming which is another name for organic farming – without the use of fertilizers & pesticides & using cow dung, urine, organic waste etc. instead – & using intercrops as a way to supplement income over the main crop as a solution to the farm crisis; obviously, doubling of farmer incomes promised, by 2022, sounds utopian.

Taxing Rich Indians: A surcharge amounting to 3% extra & 7% extra tax was introduced on personal income tax slabs of 2 - 5 cr. & greater than 5 cr. respectively. Despite the Oxfam report, indicating that 1% of Indians hold 51.5% of wealth, no measures on Estate tax were announced.

Criticism on the Budget

Former Finance Minister, P Chidamabaram, called the budget an “unusually opaque exercise” which did not disclose “the total revenue, total expenditure, Revenue deficit, fiscal deficit, the additional revenue mobilizations or financial concessions”. He called the budget “protectionist” for increasing custom duties, “exploitative” for increasing taxes, on petrol & diesel & lamented no “structural reforms” in Part A of the budget speech. He reminded that FPI (Foreign Portfolio Investment) is not FDI (Foreign Direct Investment) & critiqued the increase in FPI limit from 24% to the sectorial cap, perhaps, because the former is more volatile. He found the idea of a Credit Guarantee Enhancement Corporation, National Gas & Water grids interesting but bereft of details.

TT Ram Mohan, Prof IIM (A), lamented the absence of any reference to the fiscal glide path.

Indian exports are stagnating; exports, in 2013-14, were $312 billion which dropped sequentially till 2016-17 & rose to $303 billion in 2017-18 & $328 in 2018-19. One would have expected the broad contours of a revival plan to be laid out with the Commerce Minister spelling out the details later. Indian exporters face structural issues including delayed refunds & high power & logistics costs; decongestion of ports, roads, railways & waterways are solutions apart from removing roadblocks in customs While 50 Lakh crore investment, till 2030, in Railways, was proposed, Rs. 0.64 lakh crores only, in capital budget was allocated for this year in the budget; the budget for roads & highways too is 0.68 lakh crores only. Monetization of railway land & NHAI (National Highway Authority of India) completed road projects & PPP partnerships might be the way ahead.

While the govt. awarded the regulation of HFC (Housing Finance Companies) to RBI from HDB (Housing Development Board), it would have been prudent to announce the institution of a super regulator combining SEBI, PFRDA, IRDA, RBI etc. to avoid both turf wars & prevent regulators from escaping responsibility, post inaction on issues, by claiming them to be beyond their remit.  

Surprisingly, the budget documents, presented, have not been updated with the actual figs of FY 2018-19 but have retained the Revised Estimates (RE) of 2018-19 - the same as presented by Piyush Goel, in Feb 2019; it is obvious that the revenue growth estimates projected by the govt. are more a sleight of hand - an attempt to project a Fiscal deficit of 3.3%.

Conclusion

Nirmala Sitharaman’s maiden budget was a grand statement of Modi 2.0 intent which covered elements of Indian foreign policy too; fresh thoughts like the one of EVs for “Zero Emission Mobility” are welcome while lack of clarity on issues like “Zero Budget Farming” is a concern. Prudent that going forward, hopefully while presenting her first full year budget, for FY 21, in Feb next year, she speaks numbers, for greater clarity, to differentiate between statements of intent & well-crafted fully baked policy. To borrow Arnab Goswami’s famous words: “India wants to know”.

Budget Expectations: July 2019

The euphoria is palpable as Nirmala Sitharaman - the first female, Finance Minister of independent India, if one discounts Indira Gandhi, who handled the finance portfolio, in 1970-71, while being Prime Minister – rises to present the budget on July 5^th; the question on everyone’s lips: will she make history by announcing a “dream budget”?

Challenges:

Growth & Employment: The NDA govt. is faced with the twin challenges of decreasing growth & rising unemployment. GDP growth figs fell to 5.8%, in Q4 2019, the lowest in the last 20 quarters while unemployment is at a 45 year high-7.9% as per CMIE, in June 2019 & 6.1% for 2018 as per the periodic labour force survey (PLFS),  released by NSSO (National Sample Survey organization).

Lower growth means that the revenue estimates announced in the interim budget - such as GST revenue growth of 21%, which was anyway too ambitious, is likely to fall further short even while demands for a stimulus to pump prime the economy, to counter slowdown, inevitably rise. Prudent to revise the tax nos. downwards & increase the non-tax revenue targets.

The auto sector – generally seen as a proxy of the national manufacturing economy - is sputtering during the last few months; however, that could be attributed to the NBFC crisis & the weakening of disbursal of credit, to buyers, thereof. Bring shadow banking under greater ambit of the RBI & release a liquidity lifeline.

Drop in Investment Rate: Investment rate, in the country, is trending around 28-30% which means that with an incremental capital to output ratio of 4, India can theoretically grow at 7-7.5% unless assisted by productivity gains which can, perhaps, add another 0.5% extra. Prime Minister, Modi’s  target of moving India to a $5 trillion economy, by 2024, against the $2.74 trillion in 2018, demands a growth of 12.8% per annum; alternatively, the economy can grow at a slightly lower rate but the rupee should appreciate against the dollar which would decrease the competitiveness of exports, which are already stagnating & hence a no go. Thus, unless the investment rate does not go up to 51% (12.8 X 4) achieving a $5 trillion target is unlikely. India is more likely to become a $4 trillion economy by 2024 growing at 8%. Household savings have dropped from 23% to 17% & private consumption contributes 59.5% to GDP growth even as exports stagnate; simultaneously, household indebtedness has grown in India  which means that while a higher household savings rate is desirable for higher investment rate, it is unachievable looking at the secular trend line. 

High Logistics & Power Costs: Responding to govt. requests for increasing investments, Industry bodies initially complained about “environmental hurdles”, in 2013, which Modi make an electoral issue under “Jayanti Tax” & later got his Minister, Prakash Javadekar, to accelerate clearances. Industry bodies then shifted goalposts to complain about the high cost of capital, which the current RBI Governor, Shaktikanta Das, has partially addressed vide three rate cuts, totalling 0.75%, this year, although transmission is tardy contingent as it is on systemic liquidity & higher interest rates offered on small savings. It might be prudent for the RBI to fix the repo rate at a real rate of 1.5% which combined with inflation of 4% (say) adds to 5.5%.  Industry's grouse on high logistics cost, in India, (14%  of GDP as per Economic Survey 2017-18) against less than 10%, for China & Western economies & the high cost of power - since industrial power subsidizes domestic power - are, however, legitimate. Removal of power subsidy is a delicate political issue but addressing T&D (Transmission & Distribution) losses, largely on account of “power theft”, should be taken head on. Increase of solar power capacity to 29GW (7.8% of the total installed power capacity of 356GW) & with planned capacity of 100GW, in solar by 2022, should ideally lower prices & the govt. should pass on the benefits to industry first to help in lowering costs & hopefully increasing exports. Reduction of logistics costs, though, is a medium term project since it needs investment in roads, railways, waterways & ports. With capacity utilization at 76%, large corporates might not increase investments in greenfield projects especially when cheaper assets are available vide IBC (Insolvency & Bankruptcy code). The govt. should therefore shift focus from cry baby large corporates to the MSME (Micro Small & Medium enterprises) sector which account for 29% of GDP, 45% of manufacturing, 50% of exports & 11 crore jobs; Minister, Nitin Gadkari has expressed an intention to increase export contribution  to 75% & increase employment to 15 crore people. The disproportionate focus we give to large corporates can be gauged from the fact that, as per the RBI, organized private sector jobs increased from 7.23 million, in 1978-79, to 11.97 million, in 2011-12, or 4.7 million in 33 years (or only 1.4 lakhs per annum) while the heavy lifting, on job creation & exports is being done by the MSME sector who are suffering because of lack of credit at reasonable interest rates.

NPA crisis: The “Twin Balance” sheet problem, as eloquently put by the former Chief Economic advisor – Arvind Subramanian – persists. While the IBC has done a yeoman's job on redressing the steel sector, stress in power, aviation, telecom sectors persist & watering down of the RBI's 12^th Feb circular can only provide cosmetic comfort.

The Bimal Jalan committee, which was entrusted with the task of recommending a formula for the transfer of RBI surplus to the govt., is yet to submit its report. It is possible, however, that this surplus could be used by the govt. to recapitalize banks.

Total Deficit of 9%: Former Finance Minister, Arun Jaitley, reduced fiscal deficit (FD) from 4.5% in 2013-14 to 3.4% in 2018-19. The BJP was handed an unexpected international oil price drop bonanza, in 2014, but kept domestic prices nearly flat, by increasing excise duties, on petroleum products, from an ad valorem rate to a fixed excise duty, thereby increasing the tax revenues from 0.88 Lakh crores, in 2014, to 2.6 lakh crores, in 2018-19, an increase of 1.72 lakh crores which is 0.9% of GDP of 187 lakh crores, in FY 19; thus if oil products are brought under GST the entire reduction in FD achieved would be reversed. Meanwhile, the NDA govt. launched the UDAY scheme, in 2014, as part of power sector reforms, under which NPAs of the state power sector companies were transferred to the books of the state govt. in lieu of which the FRBM limit of 3% of the states FD has been breached. The combined fiscal deficit of the centre & the states would actually be about 7%. Sajjid Chenoy, of JP Morgan, says that if “off balance sheet” financing vide state PSUs is added then FD is around 9%. Critics could argue that countries like South Korea sustained FD of 12% while countries like Egypt failed even at 3% since the former used it for creating capital assets giving returns higher than the cost of capital, a worthwhile sustainable investment, while the latter used it for consumption; however India is no South Korea & having seen the aftereffects of the stimulus between 2009-11, we need to tread carefully; the NK Singh committee has allowed an “escape clause” of 0.5% FD extra under specified circumstances; while sticking to the fiscal glide path is recommended, a  0.2-0.3% deviation might not invite the displeasure of international rating agencies aware as they are of the international headwinds.

It is against these structural challenges that the Finance Minister rises to present the budget on 5^th July.

Options:

Raise resources: The govt. can explore following opportunities to raise revenues

(a)Auction assets like spectrum, coal blocks etc.; however, with the telecom industry under stress & polluting resources like coal facing international approbation, there might not be many takers. Bringing in international mining majors like BHP Billiton & Rio Tinto, though, would help enhance competition & bring in the latest technology & management practices.

(b)Privatization: While Niti Aayog has prepared a report on 42 companies that can be privatized; their offer for sale might attract an interest similar to Air India.  A better proposition would be to sell the land assets of defunct companies, pay VRS to the employees & use the remaining money for infrastructure development. Against a disinvestment target of 0.8lakh crores, the govt. achieved 0.85 lakh crores, some vide the abominable practice of forcing another govt. entity to pick up the slack to bail the govt. out. It is time to target 1.5 lakh crores of genuine divestment as it happened under the Vajpayee regime.

(c)List Insurance companies: Merge General insurance companies-United India Insurance, National Insurance & Oriental Insurance); follow it up by divesting at least 10% each in the merged entity & Life Insurance corporation of India. The General insurance companies have a solvency of 150% against the industry trend of 230% (as per a Money control report) & these companies have taken losses in the recent floods & therefore divestment could be postponed. Listing LIC could easily net the govt. at least 50,000 crores this year.

(d)Sell Infra assets: NHAI can monetize completed assets to interested sovereign wealth funds, pension funds et all & use the proceeds to fund further infra assets. Corporatize all major ports & divest upto 49% & use the proceeds to decongest thereby aiding ease of business & exports. Manage likely trade union protests, at ports, by convincing them that the entire proceeds of divestment in a specific port would be used for expansion of that port only aiding creation of more jobs.

To avoid the accusation that the govt. is selling family silver, make a budgetary announcement that all the proceeds of the sale would flow into an infra fund & shall be used for building infra alone; in other words one asset is being sold to build another with the bonus of additional employment.

(e)Add an income tax slab of 40%:Prudent to tax rich tax payers with incomes over 5 crores at 40%; else keep the 3 tax slabs but add a surcharge to effectively create a 40% slab.

Increase MNREGA Spends: MNREGA spends increased from 30,000 crores in 2014 to about 52,000 crores in 2018. Since rainfall is delayed this year & a drought is likely, increasing MNREGA spends to 80,000 crores would be helpful. Since the BJP has promised to bring piped water to all households in the next 5 years, it might be prudent to use the MNREGA money to dig lakes on govt. wasteland on rural & urban outskirts & feed them with rainwater & storm-water drains & use the water so collected to provide piped water which is a low cost option to vanity announcements of bringing river water vide canals - with its attendant land acquisition challenges, ecological disasters & sub optimal  Relief & Rehabilitation measures due to a leaky machinery.

Geo-tag these assets to ensure that projects do not get completed only on paper.

Transfer Fertilizer & Food subsidy vide DBT: India spends about 75000 crores annually vide fertilizer subsidy. The subsidy is paid to the producers & not farmers directly leading to perverse incentives. Subsidies to producers, has remained unpaid effecting industry health. The govt. can announce removal of the fertilizer subsidy & transfer Rs 5000/- per farmer extra over & above the Rs 6000 promised under the PM KIsan scheme to remove leakages & stimulate the rural economy. This could invite criticism of not benefitting tenant farmers though.

India spends 1.84 Lakh crores as Food subsidy& the Food Legislation passed by parliament promises to benefit 2/3^rd of the population or about 18 crore families; prudent to transfer Rs 10,000/- per family to eliminate leakages vide the Public Distribution System (PDS)

Increase spends on Infrastructure: The interim budget promised a capital expenditure of 3.36 lakh crores predominantly in defence (1.03L crores), Roads& Bridges (0.68L crores) & Railways (0.64L crores). It might be prudent to enhance the spends on the latter two to at least 0.8 lakh crores each.

Others which could be addressed outside the Budget:

(a)Factor Market Reforms: While there is a demand for factor market reforms – land & labour- it is difficult to be implemented because of the impending state elections in 4 states; land is a state subject & we have witnessed the hasty retreat of the NDA govt., in the first year of their previous term, on the land ordinance. Industry would always demand a “hire & fire” policy which is a political hot potato; prudent to continue to manage demand cycles vide off roll accretions as is the current practice; one can add apprentices to strengthen the labour force. Showcasing the Rajasthan labour reform model to be emulated by other states is a better proposition.

(b)Focus on MSME: Jaitley had promised, in 2015, a road map of reducing corporate taxes from 30% to 25% & has struck to the commitment by progressively doing so for corporates up to a turnover of Rs 250 crores which accounts for 99% of the companies. The large companies (Turnover above 250 crores, courtesy, tax incentives, anyway pay an effective tax rate less than 25%.

Focussing on the credit needs, at reasonable interest rates, for the MSME sector, prudent, to create growth, jobs & exports. The recent announcement of increasing non-collateral loans to this sector from 10 lakhs to 50 lakhs is a recipe for disaster as it could buy growth in the short run only to turn into NPA’s in the medium term. With an efficient minister, Gadkari, handling MSME, expect him to make announcements on this sector outside the budget.

(c )Create a super regulator: India has multiple regulators – RBI for banking, SEBI for corporates, IRDA for Insurance, HDB for housing finance companies etc.; the govt. planned to clip the wings of the RBI by creating another regulator, for Fintech companies, which is regressive. Since many regulatory issues are falling in between the stools & leading to regulatory turf wars, prudent to combine all of these agencies & create a super regulator. Light touch regulation on NBFCs & chit funds have led to systemic risks; hence stronger regulation recommended.

(d)Entice supply chains from China to relocate: China became a manufacturing powerhouse, during the last 30 years, because of Western, South Korean, Taiwanese & Japanese investments while India became an IT superpower bypassing the manufacturing revolution.  The US-China trade war is a once in a lifetime opportunity to correct this historical wrong. Entice supply chains to relocate to India under the “China+1” policy instead of countries like Thailand & Vietnam- which otherwise offer the advantages of FTA (Free trade agreements) with attractive Western markets. It might be prudent to enter into a FTA with complementary economies like US & EU; however such announcements shall be made outside the budget.

Conclusion:

Indian GDP figs are under a cloud for some time & former Chief Economic advisor, Arvind Subramanian’s paper has accentuated the same; time to put MCA 21 database into the public domain along with the GDP calculation methodology & invite criticisms for correction & rectification in the next 6 months to avoid embracing the “fudged nos” reputation of China.

India faces structural challenges which can only be addressed in the long haul. India becoming a $5 trillion economy by 2024 is as ambitious as doubling farmer incomes by 2022. Rational estimation of targets supported by institutional strengthening & execution efficiency would be a saner alternative.