Did Finance Minister Nirmala Sitharaman present a “feel-good” Budget or did she show up empty-handed? Will this Budget provide the necessary impetus to spur economic growth in India, or is it bereft of any cogent strategy to lead an economic recovery? Why didn’t the government simply break free from the so-called fiscal responsibility norms and spend heavily, as many have demanded, to boost growth? If the government is not spending by itself, then what is the central idea of the Budget?
As she rose to present her second Union Budget in the space of seven months, the Finance Minister had an unenviable task. That is because India’s economic growth rate, which was the fastest in the world until about 2017, has since slowed significantly.
What was the context of the Budget?
In 2019-20, which is the current financial year, the real gross domestic product (GDP) growth is expected to touch a six-year low of 5 per cent. The situation is worse if one looks at nominal GDP growth, which is expected to fall to a 42-year low of just 7.5 per cent. Real GDP is nothing but the nominal GDP minus the rate of inflation.
If this was just a momentary dip in the growth rate, possibly because of strife in one sector of the economy, the worry may not have been too much. But the fact, despite the government’s strenuous denials, is that the Indian economy has been losing power in one engine of growth after another — and that during the past 12 months, the slowdown has intensified rapidly. It has, in the process, also exposed weaknesses of the Indian economy, which are generally hidden when times are good.
Slower economic activity has led to a scenario where even existing jobs are being lost — not to mention the millions that were never created. The resultant decline in incomes has been compounded by a sudden, unexpected, and sharp rise in food inflation towards the end of 2019.
What is the problem with the economy?
Broadly, there are four engines that provide the power to drive GDP growth in an economy. These are: Consumption of private individuals (C), Demand for goods from the government (G), Investments from businesses (I) and the net demand from exports and imports (NX).
GDP = C + G + I + NX
As mentioned earlier, with each passing year, the Indian economy has been losing its engines of growth.
The corporate investments (I) engine has been slowing sharply since 2011. This has happened because most businesses that took loans in the preceding decade, when the going was good, found their bets failing in the aftermath of the global financial crisis. As such, most businesses that could be expected to invest in the economy were hamstrung as they were severely over-leveraged.
The new businesses found that the financiers to the economy, that is the banks (especially the public sector banks, which accounted for 70 per cent to 80 per cent of all lending), were themselves struggling with non-performing assets. Many of these NPAs were the same loans that they had extended to the big businesses who were now hamstrung.
Thanks to domestic bottlenecks and a middling global demand, net exports (NX) were struggling. This trend was not helped by a renewed wave of trade protectionism across the world — reflected in events like Brexit in Europe and the trade war between the United States and China.
That left only C and G — that is private consumption and government expenditure — as the engines of growth.
Private consumption demand was first hurt in the rural areas with poor commodity prices. While this meant that retail inflation was under control, the purchasing power of farmers declined. This weakness in rural demand was compounded by a collapse in urban demand after credit flow from the non-banking financial sector companies stopped following the meltdown in IL&FS.
This is being witnessed in the sales slump across the board — from cars to shampoo sachets.
Government demand carried the day for a considerable time. But with a sharp fall in revenues, thanks to a slowing growth, there is no way the government can spend without massively flouting the Fiscal Responsibility and Budget Management (FRBM) Act targets.
What were the options before the government?
In the Indian context, C or private consumption demand accounts for roughly 57 per cent of total GDP. Investments (I) are the next big chunk, accounting for 32 per cent. Government spending (G) is the smallest contributor, with net exports (NX) being negative for India.
Under normal circumstances, it would have been natural for the government to increase its expenditure and thereby provide a strong growth impulse to the economy. That is because what the government spends turns into someone’s personal income. This income when spent again, say on buying a car or a bar of soap, generates more economic activity, and further incomes.
In the run-up to the Budget, many had argued that this is what the government should do. But these are not “normal” circumstances.
A slowing economy has upset the government’s tax collections. As such, because the nominal GDP grew by just 7.5 per cent in 2019-20 instead of the Budgeted growth of 12 per cent, the gross tax revenues of the government fell from Rs 24,61,195 crore to Rs 21,63,423 crore — that is a shortfall of Rs 3 lakh crore.
The government could have still gone ahead and borrowed more money from the market, but here too there was a problem of supply. In other words, there weren’t enough savings in the market to fuel government demand.
As such, the total expenditure of the government is slated to go up by just over 9 per cent over FY20’s budgeted figure.
The other option was to boost investments.
To a great extent, the government had already tried to do this outside the Budget, when it announced a sharp cut in corporate income tax last year. The tax cut cost the government over Rs 1.5 lakh crore in 2019-20, with little to show in terms of new investment activity. To be sure, investment decisions are not taken in a hurry and even though the corporate tax cut was a welcome decision, and one that is likely to benefit the Indian economy in the medium to long term, at present, in the immediate term, it has been ineffectual.
That is because investments follow demand, and consumer demand has been declining sharply. This has resulted in high unsold inventories, and is reflected in capacity utilisation falling to an all-time low late last year.
Still, the Finance Minister announced that there will soon be a scheme to encourage investments for the manufacturing of mobile phones, electronic equipment, and semi-conductor packaging. Similarly, she has allowed the electricity generating companies to benefit from the corporate tax cut.
That left the biggest driver — private consumption demand — and by the looks of it, the government has tried its best to nudge people to consume more and, by that route, kickstart a virtuous cycle. The government has tried to do this by providing people with some options that enhance their disposable income. However, in the process, it has disincentivised savings.
The best example of this is the option of a new Income Tax regime, which removes all exemptions and deductions, but also cuts the tax rates. The government likely hopes that taxpayers will be enthused to opt for this structure because it is likely to leave them with more money in hand.
This is likely to be especially true for those taxpayers who are young and lie towards the lower end of the income brackets. That is because in that age and income brackets, the so-called marginal propensity to consume is higher. The richer and higher-salaried workers tend to save most of their income.
What else has been done?
The Finance Minister has promised a lot of small but meaningful changes that may make it easier for the economic activity to happen, if they are implemented in right earnest. For instance, the Budget outlines several measures to incentivise start-ups in the country. Similarly, for MSMEs too, there was relief from the compliance burden as the Finance Minister raised the turnover threshold for auditing of accounts for small retailers, traders, shopkeepers etc. five times — from Rs 1 crore to Rs 5 crore.
Will this strategy boost growth?
This is not a big bang Budget by any measure. In essence, the government has tinkered with several different aspects of the economy. Even this tinkering has been made possible only after it has announced that it will stray from the FRBM Act path for two consecutive years — FY20 and FY21.
Essentially, the government is hoping that its belief — that the slowdown is “temporary”, and that it has bottomed out — is true, and that with a little nudge to consumers and businesses, the economy will dig itself out of the current trough, if not in FY21, then by FY22.
However, nothing can be said for certain. There is no way right now to estimate how far disposable incomes could or would increase. Or indeed if, when people do get some additional cash, they would spend it at all. A spurt in business activity is directly dependent on consumption demand increasing.
And that is where the threat to the bid for a recovery lies. There are many ways in which the plan can go wrong. What if private consumption demand doesn’t go up substantially? Or, what if the government is not able to raise the Budgeted revenues from tax and non-tax sources? This is especially true about disinvestment — the government hopes to raise Rs 2.1 lakh crore in FY21, but it raised just about Rs 66,000 crore in FY20.
Could the government have done something else?
At one level, this Budget has exposed the failings of the government when it comes to fiscal health. The fact is that the government seems to have run out of revenues just when it needed them the most — and it is a reflection of not doing more towards achieving fiscal rectitude when the economy was growing rapidly.
To be fair, this limited the government’s ability to do a lot. But there is one telling example of where the government missed out even under the current restrictions.
That’s in the data related to trends for fiscal deficit (or the net borrowings by the government from the market) and revenue deficits (the gap between revenue expenditure and revenue receipts) for FY20 and FY21. The Budget shows that over these two years, while the fiscal deficit is expected to decline, the revenue deficit is expected to increase.
What this essentially means is that the government will be increasingly using its borrowings to fund revenue expenditure, not capital expenditure.
There is a big difference between the two when it comes to how it pushes economic growth. Research has shown that in India, when government spends Rs 100 on building capital (such as roads and bridges) the economy gains Rs 250; however, when government spends Rs 100 on revenue (such as salaries), the economy gains just Rs 99. (Sukanya Bose and N R Bhanumurthy, National Institute of Public Finance and Policy, ‘Fiscal Multipliers of India’)
Similarly, the government could have created fiscal space by rationalising subsidies.
Key takeaways from Budget 2020
1. Deposit Insurance Coverage to increase from Rs 1 lakh to Rs 5 lakh per depositor
2. Concessional corporate tax rate of 15 per cent to new domestic companies in manufacturing and power sector
3. 100 more airports to be developed under UDAN
4. Tax concession for sovereign wealth fund of foreign governments and other foreign investments
5. Tax benefits to start-ups by way of deduction of 100 per cent of their profits are enhanced by increasing turnover limit and period of eligibility
6. Turnover threshold for an audit of MSMEs increased
7. Dividend Distribution Tax removed and the classical system of dividend taxation adopted
8. Simplified GST return shall be implemented from April 1, 2020. Refund process to be fully automated
9. PM KUSUM to cover 20 lakh farmers for standalone solar pumps, and another 15 lakh for grid-connected pumps
10. Viability gap funding for the creation of efficient warehouses on PPP mode
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