governance, political economy, institutional development and economic regulation

Posts tagged ‘Revenue Deficit’

Recapturing growth with stability

jaitley make believe

All governments game their performance metrics. Smart governments guard against falling for the make-believe themselves. The BJP stumbled in believing that India had earned an entitlement to grow, faster than China, at eight per cent per year. Well-intentioned measures — to end black money, resolve the stressed bank loans and reform indirect taxes added to the crowded agenda and disrupted entrenched business interests. Growth was bound to suffer because India depends significantly on private entrepreneurship and capital.

Look for low hanging fruit

The government does not have the luxury to cry over spilt milk. It needs to keep delivering public services. Implementing structural reforms — making labour markets less rigid, reducing the regulatory overburden on business and improving poor infrastructure, cannot be done within this year. We must, instead, look for the low-hanging fruit to maintain macro-economic stability this year in the hope of higher, even possibly eight per cent growth, in 2018-19.

Depreciate the INR to real levels to boost exports

suresh prabhu 2

Suresh Prabhu, the new minister for commerce, just days into his job, is already evaluating possible incentives to kickstart export growth, which has languished since 2014. Realigning the Indian rupee to more realistic levels could be his best bet. INR was at Rs 63.90 per US dollar four years ago, in September 2013. Since then higher inflation in India versus the United States has eroded the real value of the rupee. The overvalued INR not only makes exports uncompetitive, it also makes imports cheap, which hurts domestic manufacturing, constrains new investment, inhibits growth and job creation.

Low inflation & oil prices mitigate the risk of imported inflation

Of course, there are negative consequences of depreciating the rupee. A weaker INR and a higher than targeted fiscal deficit might induce a flight of foreign, hot money, anticipating higher inflation. But with inflation at historically low levels — the consumer price index below two per cent — and oil prices relatively stable, high inflation does not appear to be a near-term risk. More important, any slack due to the flight of foreign hot money can be mitigated by domestic investors with idle savings, desperately in search for rewarding investments. A cheaper rupee also has the virtue of discouraging gold imports, which have surged in recent months, by making gold more expensive, relative to the returns on financial investments.

Imported oil and defence purchases will become more expensive

Another downside is that depreciating the rupee by nine per cent makes oil imports, consumed domestically, more expensive by around Rs 30,000 crores. Allowing this additional expense to pass through to retail prices can spur inflation. This means reducing the royalties, taxes and cess on petroleum.

Low growth will also reduce tax revenues

Also with slower GDP growth, the increase in the aggregate tax revenue will be lower. Growth was budgeted at 11.75 per cent (7.5 per cent real growth and 4.25 per cent inflation). The actual nominal growth may not exceed nine per cent (six per cent real growth and three per cent inflation). The shortfall against the target would be of around Rs 30,000 crores. This makes the total revenue shortfall around Rs 60,000 crores.

Wisely, GST glitches already factored into the budget

An additional uncertainty this year is that the Goods and Services Tax might reduce the net tax levels due to the new facility of netting-off taxes paid on inputs. This has caused a flutter in the first two month of July and August with 65 per cent of the GST revenue recorded being set off against input tax credit on pre-GST stock of goods. But fortunately, this possibility had been anticipated and factored into the rather conservatively targeted increase of 6.9 per cent for excise and service tax, whereas customs and income-tax revenue were budgeted to grow by 11 per cent and 20 per cent respectively over the previous year’s collections.  Consequently, the risk of GST collecting less than the targeted amount is minimal.

Relax marco indicators Revenue Deficit & Fiscal Deficit sparingly

The targeted revenue deficit (RD) is already 1.9 per cent of GDP versus the maximum permissible under the Fiscal Responsibility and Budget Management Act of 2 per cent of GDP. This limit reduces the scope for borrowing, to fill the revenue shortfall, to around Rs 16,000 crores. It would increase the fiscal deficit (FD) from the targeted 3.2 per cent of GDP to 3.3 per cent of GDP — not a very significant departure and still considerably better than the FD in 2014-15 of 4.1 per cent of GDP. Also, there is no shortage of liquidity in the domestic market, so the government can borrow without crowding out the private sector. But it would be unwise to waste the hard work of Arun Jaitley, Finance Minister to reign in the FD to 3.9 of GDP in 2015-16; 3.5 of GDP in 2016-17.

Find the money – cut non merit subsidy & fat revenue budgets, not additional debt.

Hefty cuts in revenue expenditure amounting to a Rs 60,000 crore will be needed to maintain the RD at two per cent of GDP.  A targeted approach could be to reduce non-merit subsidies. These include LPG and kerosene subsidy in urban areas. The differential between rural and urban wages should enable urban residents to pay for clean, commercial energy. Reducing the subsidy on urea (Rs 50,000 crores) is an environment-friendly option. The department of expenditure has expertise in identifying and cutting fat budgets. Barring defence, security, social protection, human development and infrastructure, significant reductions in budgeted revenue expenditure are possible to keep the revenue deficit at a maximum of two per cent of GDP.

Incentivise bureaucracy to be decisive & business friendly

tax admin

Balancing the budget judiciously merely manages the negative outcomes of low growth. Removing constraints on exports can add to growth. Similarly, addressing GST glitches and minimising the compliance burden can significantly improve business sentiment. Notwithstanding our administration being colonial in structure, it works quite well under stress with targeted, short-term deliverables. Achieving six per cent growth this year, with fiscal stability, is one such challenge.

Adapted from the authors article in The Asian Age, September 23, 2017 http://www.asianage.com/opinion/columnists/230917/recapturing-growth-what-govt-should-do.html

 

Navigating India’s “perfect storm”

BeltTight

(photo credit:www.webmd.com)

It’s final now. The run of good luck PM Modi enjoyed has tapered off.

The monsoon is likely to be deficient by 12%. This would be the second year in a row. True, agriculture only accounts for around 15% of the economy and didn’t grow much last year either. But when you target 7.8% growth every basis point, added or lost, counts.

Manufacturing and services growth is already slow. Companies are at best cautiously optimistic but the caution makes new investment sticky. The money and jobs spinning realty sector, driven earlier by negative interest rates, is in a slump.

To complete the “perfect storm” scenario there are two important state level elections around the corner-Bihar later this year and UP in 2017. Neither state has BJP governments currently, so doing well in these will inevitably be a metric of how strong the Modi magic remains.

The good news of course is that every threat is also an opportunity. This is PM Modi’s opportunity to show that he is the Lion we think him to be.

Fiscal stability disaster prone

First, more will need to be spent on drought relief; restructuring of bank loans for farmers and income support schemes for farm workers. Delhi, admittedly with a miniscule rural area, has already distributed Rs 50,000 per hectare as relief for the farmers hit by the April 2015 unseasonal rain. FM Jaitley is possibly right that the drought will be localized in North and Central India. But these regions account for around 45% of the farmers. Retaining the targeted revenue deficit at 2.8 % and public investment at 14% of the budget will consequently be tough.

Postponed subsidy reform

Second, it is unlikely that subsidy corrections will now be possible this fiscal. Cheap electricity, water and fertilizer are here to stay with a possible relaxation of the tight minimum support price policy of the last few years.

Higher wage cost

Third, a significant expansion in the wage bill looms. For the armed forces it is the One Rank One Pension promise of the PM.  For the Civil Service the recommendations of the 7th Pay Commission are to kick-in from 2016. Luckily the wage bill is low by international standards- 1.6% of GDP and 14% of the budget. But even small incremental increases, unless accompanied by efficiency enhancing restructuring, are not affordable this year.

This perfect storm of shocks cannot be wished away. Better to deal with it upfront. Here are five suggestions:

Winning the market perception battle

First, don’t be cowed down by stock market fluctuations or seek to pander to them. These are short term adjustments by speculators and not reflective of annual economic prospects. Consequently, rather than play down the “perfect storm” scenario it makes sense for the government to highlight the extreme shocks they are battling with to keep economic growth growing. Even in this David versus Goliath scenario, what is key is to share a plan of action on disaster management; income support; and realigning revenue expenditure to retain the revenue deficit and investment target.

Nothing much was heard about the recommendations of the Bimal Jalan, Expenditure Management Committee (August 2014). But it could provide some useful strategic, short term revenue expenditure rationalization measures.

Cut the Red Tape

Second, stressful times also create an environment conducive for administrative reform. PM Modi’s can quickly lick babudom into shape through positive strokes. He should consider setting up a lean but empowered “Decision Support Team” in his office, manned by ten senior Joint/Additional Secretary level officers selected for their expertise in key sectors; their ability to persuade and their flair for collaborative performance.

They would be mandated to speak for the PMO and be tasked to work with the key ministries and state governments to cut through red tape holding up investment decisions. Working against weekly targets with real time feedback to the PM, the mantra for this team should be “ANA- Achievement Not just Activity”.

Those taking up such high tension assignments should expect to be on the fast track to become Secretaries to the GOI.  The PM is known to be cagey about trusting officers beyond a tiny circle familiar to him. This is not surprising given that he has never worked closely with the babudom in Delhi. But he should experiment by subjecting a larger group to the “agnipariksha” of performance. He will not be disappointed with the results.

Forget the optics of who gets the credit

Third, the knotty problem, particularly in Bihar and Uttar Pradesh, is how to be proactive in the face of state governments, which have the incentive to rebuff such support as being politically motivated.

The farmer does not distinguish between the state and the Union government (Lokniti Survey 2013) – 58% held both the state and the Union government responsible for the sorry plight of agriculture. If farmers fall through the gaps of political finger pointing, they will punish both the BJP and the SP-in Uttar Pradesh and the JD (U)-in Bihar. The beneficiaries of apathy will be Bhenji (Mayawati- the BSP supremo) in UP and Lalu Yadav in Bihar. Doing little is not an option for the Union government despite some of the shine rubbing off on the SP and the JD (U).

Don’t rattle the private sector

Fourth, it would be a big mistake to take too seriously the campaign to paint the BJP as a consort of the corporate sector. When stern action is warranted, it must be taken transparently and without rancor or bluster. But a “Preet Bharara type” of regulatory action is not what we need. Jobs are what the average citizen wants, which only the private sector can generate them.

Strong arm regulatory actions against foreign investors are bad optics- both for investment and for citizen sentiment. If our regulatory agencies are seen to be handmaidens of the government, they lose credibility. But the government also loses by devaluing an efficient instrument for regulating the private sector in a hands-off, technical manner.

Sticky revenues

Fifth, boost revenue. The tax receipt scenario is grim. First, projections for the year were over optimistic at Rs 14.5 lakh crores (US$ 230 billion) around 16% higher than the previous year. Tax receipts are bound to slide with slow external and domestic demand and lower corporate profits, despite the 15% increase in the rate of service tax. A tax receipt equal to last year’s estimate of Rs 13.7 lakh crores (US$217 billion) or 9% more than the actuals of last year is the best we can hope for- 5% points due to inflation and 4% points due to growth of the taxable base.

Getting more tax payers into the net is a worthwhile but effort intensive option with limited upsides. In 2013-14 there were 47 million direct tax assesses. New assesses have varied between 1 to 3 million per year since 2011. Even doubling the number of new assesses helps only marginally in additional revenue.

Transferring the crown jewels to citizens

There is more upside in fast tracking disinvestment. Listed Public Sector Undertakings (PSU) account for 13% of the valuation of the Bombay Stock Exchange or around Rs 13.6 lakh crores (US$ 215 billion). Of this, some equity is already held privately by minority investors. But an additional 10% can be sold without diluting government’s majority control. The problem is that, in the past, Institutional Investors have been the primary takers for such shares. Retail investor appetite has been largely absent from the tumultuous stock market for some years now and market momentum has been primarily provided by Foreign Institutional Investors.

Selling PSU shares in large volumes, without transferring majority control to the private sector, dampens the market price. Even the private IPO market is slow. Government is wary of inviting the charge of crony capitalism by selling shares to large institutional investors at cheap rates.

On the other hand, selling directly to retail investors is more defensible even if the price is low. After all the “Crown Jewels” really belong to citizens. Dispersing the ownership of PSUs widely also meets multiple objectives. Why not borrow a leaf from Dhirubhai Ambani’s 1982 market making strategy and incentivize the retail investor back into the market?

Link disinvestment, as a sweetener, to the issue of government debt for retail investors only – special convertible bonds – with a fixed return for three years at the prevailing Government Bond rate. 50% of the face value could be optionally convertible on termination in 2018-19, into a balanced bouquet of public sector equity at a 15% discount to the then prevailing market price.

A sequenced, mega issue of Rs 1 lakh crores (US$ 16 billion) of an asset backed government security can reduce the short term risk profile of PSU equity investments and pull in finance from an alternative source.

Government must come out with an evidenced strategy to deal with the “perfect storm” India faces. Of course, the PM is a “lucky General”. The drought may not materialize; the world economy may sort itself out and the opposition in Bihar and UP may self-destruct. But waiting for this to happen may be pushing the Gods too far.

Tag Cloud

%d bloggers like this: