Budget 2015: Main Themes

Finance Minister, Arun Jaitley’s 2^nd Union budget, was crisper & definitely better thought out than the one presented last year. While Prime Minister, Modi’s imprint on the budget, is visible, the man who seems to have done the heavy lifting, perhaps, living in the shadows, is Jayant Sinha, the MOS Finance. Expectedly Chidambaram opined that the budget “fails the tests of fiscal consolidation & equity” while Modi called it “a budget that will further reignite our growth engine, signalling the dawn of a prosperous future”. The truth shall lie somewhere in between the two assertions.

The BJP govt. was lucky to be welcomed into the saddle with a dramatic drop in the international commodity prices - including oil - that translated into an automatic saving in subsidy. The unexpected flare-up in Ukraine has reduced the attractiveness of Russia as an investment destination while other emerging economies continue to remain “fragile”; India, therefore, is a default gainer. The tapering off of QE (quantitative easing) in the US coincides magically with the introduction of one in Europe & Japan that shall sustain FII flows into India. Apart from the benign international environment, the RBI, too, has chipped in by taming inflation & the rupee. The CSO (Central Statistical Organization) estimates -under the new methodology - project a GDP growth of 7.4% this year & 8.1 - 8.5% next year. India definitely is in a “sweet spot”.

The 14^th finance commission recommended devolution of 42% of the national divisible tax pool to the states, against 32% today, & advised pruning of 66 nationally sponsored schemes to 36; the govt. accepted the first recommendation – a tribute to co-operative federalism - & the second partially. Critics of the 42% devolution, cringing at the possibility of burly states & a supine centre, can seek comfort from the fact that total transfers from the centre - including centrally sponsored schemes & grants – still stands at 62%, roughly the same as last year; therefore, this increased financial freedom to the states is not an un-bridled one. The centre’s assertion of a lack of fiscal space post devolution is, therefore, untrue.

The budget has defined the long term vision of the govt. as construction of 6 crore houses by 2022 – to ensure a roof for every family – each house to have 24 hrs. power supply, clean drinking water, toilet, road connectivity, senior secondary school within 5 Kms. for each child, greater farm incomes & prices, enhanced telecom connectivity in rural & making India a manufacturing hub through “Make in India” & “Skill India”. None shall dispute the intent but 2022 is afar & yearly milestones would have been more comforting. Watch the budgets of subsequent years, carefully, if these promises are, indeed, fulfilled.

The main themes of the budget need to be analysed against this background.

Increase savings rate:

India’s gross fixed capital formation has fallen from 36.8% in 07-08 to about 29.8% now, effecting investment. Household savings - that account for a bulk of domestic savings - has seen a shift from financial products into physical assets, affecting the flow of finance into projects with a long gestation period, like infrastructure. The govt. instead of raising the income tax slabs – the traditional response - has, therefore, creatively tried to incentivize savings into infra bonds, health insurance & pension contribution which is welcome.

With an incremental capital to output ratio (ICOR) of 4, a savings rate of about 30% can translate into a GDP growth of about 7.5% only, much less than our need for a double digit growth rate to annihilate poverty. If productivity is kicked in & transaction costs lowered – read reduction in corruption & increasing labour productivity – an ICOR of 3 can be achieved & at a higher savings rate of 36% a GDP growth trajectory of 12% is possible indeed.  That seems to be the professed aim of this budget.

Provide a universal social security net:

Labour reform without an adequate safety net could lead to social chaos. Incidentally, social security is an important feature, both in the socialist & the capitalist blocks. Surprisingly, however, Indian political leaders have paid only lip service to the concept of a “welfare state”, The Jan Dhan Yogana - with 12.5 crore bank accounts - apart from providing a banking account to the unbanked has a Rs 1 lakh accident insurance & Rs 0.3 lakh life insurance cover. This is the first attempt by GOI at creating a truly nationwide safety net. The specifics: accident insurance & life insurance of Rs 2 lakhs each  on a premium of Rs 12/- per annum & Rs 330/- per annum respectively for people between 18-50; pension plan at a contribution of Rs 1000/- for senior citizens above 60 years; & a senior citizen welfare fund with a Rs 9000 cr. corpus.  

The budget builds on this concept, further, through additional tax breaks for contributions to medical insurance by Rs 10,000/- & New pension scheme (NPS) by Rs 50,000/-. This could enthuse some of the 5 cr subscribers of EPFO (Employee Provident Fund Organization) – guided by conservative investment principles - to shift a portion of the 6 lakh crore corpus into the NPS – with 0.8 crore subscribers & 0.75 lakh crores corpus & a more liberal investment philosophy of investing into equity. 

Having laid a safety net the govt. moves stealthily on labour reform. The budget makes contribution to EPF (Employee Provident Fund) optional for employees below a certain threshold of monthly income. Employees can, now,  choose the health insurance provided by either Employment State Insurance (ESI) or an insurance plan recognized by IRDA (Insurance Regulatory Development Authority). Manish Sabarwal, of Teamlease, has argued that this is the “most impactful labour reform since independence” since EPFO runs the “world’s most expensive government securities mutual fund (440 basis points)” & its “45 million dormant accounts do not offer backpack benefits that are easily portable between employers”. The ESI according to him “offers India’s health insurance programme with the worst claims ratio (45 per cent) & sits on cash reserves of Rs 32,000 crore”. He averred that this move shall enhance formal employment. The last assertion is arguable though.

Clearly, the govt. wants to create a safety net before it initiates massive labour reforms & at the same time wants to regulate savings into the equity market.

Creation of jobs:

12 million citizens enter into the workforce every year who need to be provided jobs; else, the demographic dividend shall get converted into a demographic curse.

Traditionally, an attempt was made to attract Industry through investment allowance, tax breaks et al leading to a “revenue forgone” of about 5.8 lakh crore, enough to wipe out the fiscal deficit of the country. Industry, when confronted with the demand of job creation, complained about the delay in clearances by the environment ministry & when the same was expedited through CCI (Cabinet Committee of Investment), shifted the goalposts to slow clearances in the states & labour law reforms. Truth be told: Industry is plagued by excess capacity & until the capacity utilization crosses the 90% mark is unlikely to invest further. The finance ministry therefore was forced to look at other avenues to create jobs. It seems to have identified MSME, knowledge economy & tourism as the focussed sectors.

India has 5.77 crore MSME scale enterprises, offering employment to 12.8 crore people – about 4 times higher than the employment provided by organized Industry - with a major share in exports. 93% of these enterprises do not have access to formal sources of finance & pick up debt from money lenders at usurious rates of interest. While the industry clamours for changes in labour laws - which are difficult to be implemented since they have not been changed for the last 65 years - these enterprises have no such demands. The govt. is right in its intent to accelerate credit to this sector.

The govt. has, therefore, decided to start MUDRA bank to provide credit access to this sector. It would have been more prudent, however, to task the existing banking network to achieve the objective by ordaining a lending target similar to the target of 8.5 lakh crore affected for the agricultural sector. Unfortunately, the UPA govt. launched a Mahila Bank when challenged on women emancipation, while the BJP govt. plans to launch a Mudra bank for ensuring credit flow to the MSME sector; both are sub-optimal solutions. Electronic trade receivables exchange proposed, though, Is a welcome measure to help the working capital needs of this sector

That leaves us with the knowledge economy & tourism. The govt. has hit the bulls eye in recognizing the transition to a knowledge economy based on innovation & has created an innovation fund which is welcome; however the concern: what happened to the 10000 crore promised last year for a similar purpose?.11% of jobs worldwide are generated in the tourism sector & the govt. attempt to increase visa on arrival facility from the existing 43 countries to 150 is to harness the potential of this segment.

Rationalize taxes:

While the corporate tax rate is 30%, the govt. realizes only 23% post deductions.  The Hindu, on Mar 2^nd – in an article - shared that the 263 companies in India with net profit greater than 500 cr PA, pay an effective tax of 20.68% while 2.78 lakh companies with a profit less than 1 cr PA, pay a tax of 26.89%. Clearly, a flat 25% rate, without deductions, is welcome, although the notice period of 4 year is too long; the transition should have started this year, instead of the next. GOI will also be under pressure from corporate lobbies not to tinker with deductions. Industry is, however, surreptitiously being pushed to accelerate investments through this measure; as an example the incentives for the power sector expire in 2017 & they are hence being prodded to quicken investments, which is welcome. Will the govt. have the gall to remove deductions would be interesting to watch. 

Countries worldwide have been using wealth tax as a route to shore up revenues The Govt., surprisingly, chose to do away with the same citing revenue receipt of only Rs 1000 crore & instead adding an additional 2% surcharge on individuals with an income over 1 crore, to net an additional Rs 9000 cr in taxes. Taxing rich farmers & Hi-Net worth individuals, outside the tax net, would have been a more equitable solution. This appears more a move to appease patrons of the party. Removal of MAT on FII inflows including PN (Participatory Notes) – disapproved by the Tarapore committee since it was largely a case of double tripping of unaccounted black money – is, perhaps, another attempt at incentivising the party funders.

Dropping of MAT on FII’s, though, shall increase capital inflows & perhaps lead to a current account surplus. Import duty on gold - increased to 10%  to contain CAD (Current  Account Deficit) earlier but has led to an increase in smuggling- needs to be revoked. The CEA (Chief Economic Advisor), however, is arguing for a weaker rupee to accelerate exports. Clearly, expect the rupee to weaken in the coming days.

Public sector Investments

The Economic Survey indicated that stalled projects – due to delay in environment, land, fuel clearances, lack of demand or funds – is at 8.8 lakh crores or 7% of GDP. Most of the private infra firms are suffering from bloated balance sheets & delayed projects which have contributed to the increase in NPA’s of banks – currently at 4.5%. There is no way that any PPP projects, even if announced, would have found takers. Public investment, therefore, was the only solution which shall neither “crowd out’ the private sector nor cause inflation.

The budgets promises a spent of 3.17 lakh crore - Rs 80000 crore higher than last year – by the PSU’s & an additional Rs 70000 crore spent by the govt. to pump prime the economy. 5 UMPP (Ultra Mega Power Projects) of 4000MW each, with a plug & play feature – with a potential of 1 lakh crore investments -, corporatization of ports to attract investors as well as monetization of their land holdings, & 1lakh Kms of extra roads are additional such measures. However, this shall be a slow burn due to a time lag between the announcements & actual executions due to bureaucratic play.

Black Money

As an electronic trail shall help in controlling the domestic parallel black economy the govt. has promised to incentivize use of plastic – read credit/ debit cards. PAN is made mandatory for all transactions above Rs 1 lakh & cash transactions exceeding Rs 20000/- for immovable property are banned. The Black Money Act, promises punishment of false reporting or non-disclosure of foreign assets & incomes with upto10 years rigorous imprisonment & 300% penalty. Plans are also afoot to control domestic black money through the Benami transactions (Prohibition) bill. While the govt. plans a window for compliance without an amnesty scheme, there might not be many

takers. Money shall continue to flow either through the PN  or AIF (Alternate investment Fund) route. The budget announcement is more an attempt by the govt. to signal seriousness & warm the cockles of the citizens who have become frustrated with the govt. pronunciations on the HSBC accounts - which sounds much like the previous UPA govt.

Cashless transactions have another advantage. It shall help banks do away with large manpower deployed in handling cash, reduce the fixed costs of deploying ATMs, opportunity cost of holding cash & soiling of notes. Banks' can reduce their manpower in the long run thereby helping bottom-lines.

Protect local Industry & drive “Make in India”

Manufacturing accounts for 18% of India’s GDP as compared to 33% in China & 24% each in Indonesia & Malaysia. A CRISIL report laments that 11.1% of GDP is capital intensive manufacturing while we should be concentrating on labour intensive manufacturing – a view subscribed to by the Chief Economic Advisor. A Mckinsey report avers that manufacturing at 25% of GDP by 2025 shall create a 1 trillion industry & provide 60-90 million new jobs. The solution therefore is to encourage “Make in India” through subtle protectionism, well within the WTO guidelines which seems to be the govt.’s intent too.

Therefore, it has increased custom duties:  commercial vehicles from 10% to 20% which shall help companies like Tata Motors & Ashok Leyland; & on Iron & steel from 10% to 15% to counter cheap imports effecting local industry players like Tata Steel, SAIL, Jindal et al. Removal of the inverted duty structure – courtesy FTA (Free Trade Agreement) with Japan, South Korea & ASEAN - for 22 items shall help local manufacture. The list goes on.

Apart from incentivizing local manufacture the govt. is keen on quicker redeployment of assets for greater productivity in the economy through reduction in bank NPA's. SICA (Sick Industrial companies Act) & BIFR (Bureau for Industrial & Financial Reconstruction) are proposed to be replaced with a bankruptcy code & NBFC’s with a net worth above 500 cr are being brought under SARFAESI to ensures better investor protection.  This is, however, WIP (work in progress).

Reduction of tax on royalty & fees for technical services from 25% to 10% shall hopefully attract new technology in the pharmaceuticals, electronics & engineering areas. 

With GST expected to be implemented next year unification of excise & service tax rates would have been more prudent; however excise at 12.5% & service tax at 14% has left people confused. This seems to be more of an attempt to balance the account books.

Conclusion

The economic survey gave an impression that a “Big Bang” budget shall be unveiled but what has emerged are a series of small measures that when taken together could translate into a “Big Idea”. While critics have argued that a 15.8% growth in revenues against 9.9% last year is ambitious, what perhaps has been overlooked is that the additional Rs 4/- per litre cess on petrol & diesel shall generate an additional revenue Rs 40,000cr & the increase in excise & service tax rates that shall pool in additional revenues. The expense increase of only 5.7%, 2% less than last year is a surprise, though, & shall, unfortunately, be breached. Expect therefore drop in capital spending to balance the fisc. 

Implementation of the pay commission recommendations & GST, next year, would result in additional outflows to employees & compensation to states respectively. Therefore adherence to the fiscal deficit target of 3.6% this year & seeking a deviation next year, would have been more prudent. Revenue deficit at 2.8% - only 0.1% less than last year - is a sure sign of fiscal profligacy. 

The only consolation is that India is in a “sweet spot” & even if the animal spirits of the economy are not unleashed by the govt., the country shall still be amongst the fastest growing economies in the world, attracting investments on its own accord. The rise of India is inevitable.