Having wasted 2 out of 5 years, Jaitley must pull up his socks
When the general budget for this year was presented on February 28, 2015, it showed a government and its finance minister firmly in control. It was assumed that a few deft policy touches here and there and bingo, an 8 per cent-plus growth rate was there for the taking.
There was a good reason for this optimism, driven as it was by revision in the way national income is estimated. The revisions pulled up the growth for 2013-14 to 6.3 per cent from 4.7 per cent. For 2014-15, 7.4 per cent growth was estimated.
So if by the new method, the worst year for the economy in a decade, 2013-14 could return over 6 per cent growth, then with a little more effort the economy could be helped to grow even above 8 per cent.
“When other economies are facing serious challenges, India is about to take-off on a faster growth trajectory once again,” was how finance minister Arun Jaitley started his budget speech last year.
So for the full financial year, growth target was pegged at 8 to 8.5 per cent. Markets also cheered a confident government with the benchmark BSE Sensex sitting at a dizzy 30024.74 points during trading on March 4, 2015, a day which coincided with the Reserve Bank also cutting policy rates.
However, the reality check came even before the budget could be passed. The equity market began to correct as foreign institutional investors (FIIs), who had been pumping money for months, felt that required reforms, or at least a vision of it, which they expected on the big day, was missing.
The meteorological department predicted in April that 2015 would see below normal rains. This was for the second year running that the country would face a drought. Many in the government put up a brave face — and a facile economic logic — saying that contribution of agriculture to the overall economy stood at just 13 per cent. In addition, there were enough food grains in stocks to deal with the shortages and inflation would be in check. But the drought impacted the economy and the first quarter growth came down to 7 per cent from 7.5 per cent in the January-March quarter.
Interestingly, some economists hold a view different from government officials and the finance minister. As chairman of the National Statistical Commission, Pranab Sen told Financial Chronicle in a recent interview not to measure agriculture’s contribution to the economy just by the size of its share in economic output.
Agriculture supports a whole range of rural services like transportation and trade that will be impacted by the drought, he had said.
The other spillover of the drought is on consumer products as farmers’ incomes take a hit, Sen pointed out. The impact of drought showed. The growth numbers for the first two quarters showed no major lift-off for the economy. The revised numbers issued later showed that the economy’s performance was slightly better than what was assumed earlier, but had slowed down as compared to two quarters in October-December. This slowdown, which comes when capacity utilisation is already low, adds to the woes of industry.
Apart from drought, the Indian economy faced global uncertainties; the crisis in Greece followed by the slowdown in China in the later part of the year. The other risk hovering on the horizon and the Indian economy was the fall out of the increase in interest rates by US Federal Reserve. These events, spread around the year, caused massive volatility in stock markets. This was no small volatility either, as it effectively derailed the central government’s disinvestment programme.
Of the total Rs 69,500 crore revenue target envisaged from privatisation of state-owned firms and selling small stakes, only Rs 13,344 has been raised so far. Of this, Rs 9,369 crore has come only from the sale of 10 per cent of Indian Oil shares.
The Indian Oil share auction would have been a huge embarrassment for the government, but for the Life Insurance Corporation’s (LICs) intervention. The government-owned insurer scooped up to 90 per cent of the shares that were on offer.
After that debacle in August, the disinvestment process came to a standstill. Only Rs 634 crore has been raised after that by selling stake in Engineers India last month. Trouble with divestment was waiting to happen, as most PSU companies primed for the purpose were commodity companies. Therefore the moment troubles began for China, it was clear that the divestment programme would be in a soup because demand for commodity paper globally was expected to come down sharply.
Given the past underperformance in actual divestment receipts vis a vis target, there is need to stress that the government could be forced to take up a more realistic estimate for revenues.
However, the one positive outcome of the global crises was that it brought down commodity prices even further, which in turn helped bring down inflation. RBI governor Raghuram Rajan credits the central government for efficient management that kept food prices in control, despite the drought.
Low inflation also helped RBI get slightly aggressive with interest rate cuts. In 2015-16, the RBI has brought down policy rates by 75 basis points to 6.75 per cent thus enabling a monetary stimulus to the economy.
Despite the fact that RBI cut rates, except a few banks, the majority of lenders did not pass on the rate cut to customer in full. The other bother was that with stingy banks unwilling to give loans despite the rate cut, did not help credit off take the way it was imagined, adding to the slower pace of recovery.
But it was not all downhill. While drought was bad news, the government got lucky on the petroleum front.
Crude oil prices, which started coming down from October 2014, had by March 2015 touched $55.18 a barrel. Using the available headroom, the government raised excise on auto fuels in the budget to mobilise resources for infrastructure spending. Low crude prices also brought in savings on oil subsidies. The Union budget had envisaged an increase in spending by Rs 70,000 crore on infrastructure, but actual spending could be higher as the government’s coffers have been full.
The massive dose of stimulus in the form of public spending on infrastructure has ensured that the country might still grow at 7.6 per cent in 2015-16, Central Statistical Office estimates suggest. But after a point, the government instead of passing the cut in oil prices to the consumer, started to increase excise duty on petrol and diesel. This extra money, which the government is collecting through hikes, could turn out to be its potential saviour.
With the Seventh Pay Commission recommending wage hikes for central government employees to be implemented from January 2016, the government’s wage bill is likely to go up.
Add to it, implementation of the one-rank-one-pension scheme for defence personnel. Accepting the recommendations in full is certain to create a strain on government finances. It’s quite possible that the government, facing mounting spending pressures such as a higher wage bill, may choose to sign up for a wider deficit of GDP in the forthcoming Budget.
On other macroeconomic parameters like fiscal deficit and current account deficit (CAD), the government is expected to meet the targets for the fiscal. Despite massive contraction seen in merchandise exports during the year, CAD reduction will be aided by low commodity prices, especially crude oil.
High indirect tax collections will ensure that even the fiscal deficit targets will be met, at least in rupee terms, even if not as a percentage of GDP. Low inflation has ensured that growth in the economy at current prices will be lower than what was assumed during the budget making.
To meet the ratio of fiscal deficit of 3.9 per cent of GDP, revenue collections will have to be slightly higher.
Higher tax collections from auto fuels and forecasts that crude oil prices will remain low for next few years, have made the government ambitious. It announced a massive programme to restructure state electricity boards and provide a large dose of equity to state-run banks in an effort to beef up their lending capacity. While there has been some progress on this front, it remains far below what was being expected at the time when this restructuring was announced.
Electricity board and banks with robust balance sheets will be growth multipliers. If revamped electricity boards reach a situation where they can supply reliable power, it will be a big boost to small and medium industrial units, Pranab Sen had said earlier.
Experts, however, opine that the August ramp in equity support of state-run banks, pegged at Rs 70,000 crore in the next four years after providing a measly Rs 7,940 crore in the budget, is still inadequate.
State-run banks need at least twice that amount, associate director and co-head, banks and financial institutions at India Ratings & Research, Abhishek Bhattacharya points out.
Estimates show that banks might have to suffer a loss of around Rs 1 lakh crore on loans that have already been classified as non-performing assets (NPAs). Taken this together with lack of investors in tier 1 bonds of banks, the total amount required will be Rs 2.8 lakh crore, he says.
By the end of September last year, NPAs of state-run banks had risen to 6.21 per cent from 6.03 per cent at end of the June quarter.
Taking gross NPAs and restructured loans together, the stress on state-run banks stood at 14.20 per cent of total advances at the end of July-September quarter as against 14.12 per cent by the end of June.
Bhattacharaya believes if banks would have to continue to lend at the rate at which economy is growing, the demand for funds would be huge. If not, they would have to reduce their balance sheet size and credit needs would have to be met by other vehicles.
The drive by banks’ to clean up their balance sheets on RBI’s directive will increase their capital requirement even further. The central bank has set a deadline of March 2017 for the job and indications are that in the 2016-17 budget, the recapitalisation amount would be substantially higher than Rs 25,000 crore that has been announced.
The 2015 budget also saw a new round of tug-of-war between government and the Reserve Bank of India.
Buoyed by hopes of better times and high growth, the government tried to speed up changes in the way its debt is managed by inserting an entirely new point in the finance bill. The Public Debt Management Agency that the bill seeks to create would have directly impinged on the powers of RBI as a manager of public debt.
Talk about setting up an independent public debt manager has been going on for several years, but the haste with which Jaitley decided to push it, put the government and RBI in opposite camps. By making the PDMA a part of the finance bill, the government was trying to get it converted into a law faster, without sending it for scrutiny of troublesome parliamentary committees.
As the finance bill is a money bill and Rajya Sabha has no power to reject or delay its passage, even the problem of lack of numbers in the Rajya Sabha or the upper house, was taken care of by this move.
The fight back by the RBI was swift. Many letters and visits were exchanged, though RBI governor Raghuram Rajan sought to play down the exchange saying it was not part of the finance minister’s budget speech that normally flags most important issues. Importantly, he said that even if PDMA was set up, it would have a substantial RBI presence.
When the time for actual passage of the finance bill came, Jaitley withdrew the PDMA proposal. Some reports suggested that prime minister’s intervention clinched the issue in RBI’s favour. While stepping back, the finance minister said that work towards an independent public debt management agency would continue, regardless.
This was the government’s first run-in with the RBI. Another battle of attrition between the two was fought over how the country’s monetary policy needs to be run.
Just as the budget was presented, the RBI and the government finalised the monetary policy framework that enjoined the central bank to bring down inflation to 4 per cent by 2018 — and keep it pinned there. For that, the RBI had been given full freedom to choose the kind of tools it wanted to use.
Then in August 2015, the government put out for comments the second version of the Indian Financial Code drafted by the Financial Sector Legislative Reforms Commission. The code proposed that a monetary policy committee (MPC), which gave greater role to government functionaries, should decide policy rates. Again, protests followed. The government went on the back foot disclaiming those views.
The composition of the monetary policy committee that has been agreed for now tilts heavily in favour of the RBI. The cabinet clearance to RBI amendments, which would lead to setting up of the MPC, is now up for inter-ministerial consultation. The issue of differences between the RBI and finance ministry is not new; the good part is that on MPC at least, both sides agree.
The cleaning up of the banking system and faster introduction of bankruptcy code are key ideas needed today. RBI has started the cleaning up of banks. The bankruptcy code is important because it will not only help businesses, which fail due to genuine reasons, but would assist banks to recover depositors’ money in an organised manner.
In effect, PDMA and MPCs were the first stumbling blocks for the finance minister in his quest to move quickly on the ‘reforms path’.
Before the 2015-16 budget was presented, tax officials woke up the ghost of retrospective taxation by sending notices to FIIs asking them to pay minimum alternate tax (MAT) for income earned in 2011-12 onwards.
Later, notices were also issued for 2009-10 and 2010-11. This sparked a sell-off in the share markets. For damage control, the budget announced that henceforth, FIIs would be exempt from MAT. To exorcise the ghosts of the past, the government announced formation of a panel headed by Law Commission chairman justice A P Shah to suggest a way out of dealing with the problems of previous cases.
The Shah panel’s report came in September and going by its recommendations, the government dropped the demand of MAT from FIIs.
Since coming to power, the government has been quick to address any issue that may portray it as a hawk and unfriendly to business.
Even on the tricky issue tax demand on Vodafone for the gains Hutch made when it sold its mobile telephony unit, the government has begun talks for settlement with the company. However, this week’s ‘reminder’ by taxman on Vodafone’s over $2 billion tax bill has triggered fresh alarm and complicated the situation.
A panel has been set up to re-examine the entire income tax taxation process to make it simpler. The panel has since then submitted its first report. To reduce tax litigation, the government has raised the monetary threshold for filing appeals in a higher legal forum, if the verdict of a lower body has gone against it in a tax case.
Revenue secretary Hasmukh Adhia said this week that this move alone would halve 75,000 such cases going on the moment. While promising a stable tax policy and non-adversarial tax administration, the finance minister had also announced tabling of a bill to deal with unaccounted assets held by Indians abroad.
The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 was passed in the budget session itself. The act gave a three-month compliance window to those holding untaxed assets abroad to declare them, and another three months to pay taxes on them.
After the compliance window opened, then revenue secretary Shaktikanta Das and chairperson of Central Board of Direct Taxes Anita Kapur spoke at many meetings organised by business chambers and taxation professionals so that compliance with the Act was high.
However, after the extensive exercise only 644 entities disclosed Rs 4,164 crore. The tax collected from them stood at a none-too-impressive Rs 2,428 crore.
Tough provisions of the Act also made it clear that if after the closure of the compliance window, the government gets information about any unaccounted money held abroad from other sources, beneficiaries of those assets would lose all their money and might be even sent behind bars.
Taxation professionals say high tax and penalty on disclosure of black money that totaled 60 per cent, deterred many other disclosures.
For dealing with overseas black money, the government also entered into an agreement with the US automatic exchange of financial information. Under this pact, US will provide information about Indian citizens and India will exchange financial data that it has on American citizens.
The government also signed an international pact, which is being piloted by OECD. Countries becoming part of the automatic exchange of information will start sharing financial information about foreign residents with their home countries. Around 97 countries have already signed the pact and exchange of information will begin in 2017. For dealing with domestic black money, a new benami transactions (prohibition) bill was introduced where quoting of permanent account number (PAN) has been made mandatory for all sale and purchase of over Rs 2 lakh. Now, PAN will also be required for opening bank accounts and holding term deposits of over Rs 50,000 in post offices as well.
Says Rakesh Nangia, managing partner at tax advisory firm Nangia and Co: “The Black Money Act has taken incremental steps and widened the net against black money, but a more serious problem is to address the issue of domestic black money where the battle will be long, considering that there are no estimates available.”
“The implementation of the amended rules (on quoting of PAN on transactions) will generate significant financial data, which if processed with data analytics software, will assist the government to track down tax evaders and curb black money,” he explains.
The other major tax announcement was on corporate tax rates. The finance minister said rates would come down to 25 per cent from 30 per cent by 2019 and this gradual reduction would be tied up to removal of exemptions. A panel formed for this purpose has already recommended a roadmap for removal of exemptions that have been put in the public domain for comments.
For taxpayers, the government has also simplified procedures, scrutinised less intrusive tax returns and started issuing refunds faster during the year.
The speed, at which the government has responded to tax issues of the past and some that cropped up during the year, has got the vote of approval from experts.
“Overall, there has been a positive approach to address pending issues like MAT on FIIs and retrospective taxation with regard to cases like Vodafone. These things have been addressed pretty well. Overall, the approach remains positive,” says director at Grant Thornton Advisory Riaz Thingna. He believes that the biggest problem is the deadlock on goods and service tax (GST), which remains a bottleneck to beat all bottlenecks.
The failure to reach a consensus on GST has affected the sentiment in equity markets in a negative manner. A lot of money flowed into sectors like FMCG and logistics because implementation of GST was expected to help these companies. The moment it became clear that GST would not be implemented any time soon, the inflow to these sectors not only stopped, but even overall flows slowed down. Not surprising at all. Many are looking for a broad roadmap regarding the implementation of GST in the upcoming budget.
Thingna says going forward the government would have to balance its stated intention to withdraw all tax exemptions available to companies and support ‘Start Up India’ and ‘Make in India’.
‘Make in India’ would need concessions to balance out the disadvantages that the Indian manufacturing sector faces, like poor infrastructure and not-so- competitive wage costs, he avers.
Like targeted subsidies, the government should aim at targeted incentives to drive both these programmes, asserts Thingna.
Social sector schemes and supporting small entrepreneurs were also on the must-do list of the government at the start of the financial year. Schemes for government-subsidised insurance and pension were announced. The financial inclusion programme, which targets to open a bank account of at least one member in each family, was also given a boost. Another scheme was announced to provide loans to small entrepreneurs under the prime minister’s mudra scheme. The pradhan mantri jan dhan yojana, launched in August 2014, was given a booster dose in the budget. So far, 20.63 crore accounts have been opened under the scheme with 8.8 crore of them seeded with Aadhaar numbers.
Around 70 per cent of accounts opened under the scheme collectively hold Rs 31,399 crore. Only 30 per cent of the accounts do not hold any money. The massive financial inclusion programme with Aadhaar in the background, paves the way for better targeting of subsidies in the future as government plans direct benefits transfer even in the power sector.
The Atal pension yojana has so far enrolled over 2.05 million people. In the pradhan mantri jeevan bima yojana, 2.9 crore beneficiaries have joined while 9.3 crore subscribers have been added to the pradhan mantri suraksha bima yojana.
The government's plan to clamp down on the nation's gold lust has seen mixed results. Jaitley had announced a gold monetisation scheme and a sovereign gold bond scheme in his last Budget speech. The government then introduced gold bond and deposit plans to attract investors. Progress has been a tad slow, though it’s still early days.
The first slice of bonds attracted investment equal to 917 kg, while the second tranche pulled in an impressive 2.79 tonnes. The authorities are now fine-tuning the deposit plan, known as the monetisation scheme. The deposit scheme, which can prove to be a game-changer, may actually take three to five years to make a significant impact.
Even the rural employment guarantee programme was promised more funds in the Budget - despite the prime minister using it to mock at the Congress party.
Earlier this month, Jaitley said utilisation of funds provided for MGNREGS is going on as per plan and additional money would be provided for it. A battle royale between the Congress and the BJP to claim ownership of MGNREGS is currently the talk of town in the corridors of power. This exchange is taking place because MGNREGS is seen as an instrument to attract votes and with the UP election scheduled for 2017, there is bound to be increase in money which flows to MGNREGS. What needs to be watched is whether this money is spent on building rural infrastructure, as was being said when NDA government came to power, or is it being splurged in a manner similar to what was being done under the previous UPA regime.
As the budget day comes close, forecasters have offered their growth projections for the next financial year. The World Bank pegs the growth in 2016-17 to go up to 7.8 per cent. India Ratings, a Fitch affiliate, also puts the growth at the same level. For those struggling with the prospects of another poor monsoon, good news has just come in. The US government weather forecaster says that El Niño would weaken in the coming months and La Niña conditions are on the rise. This would mean better rains for India.
Jaitley will be now giving finishing touches to his budget proposals in the hope that monsoon will not fail the country this time and oil prices will remain low. A lot of what lies in store for the Indian economy will be determined by these two factors.
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