With its own set of disappointments, Budget 2019 has also set some things right. The process of reform is not limited to it, measures have to be taken from outside, too
One of the great mistakes is to judge policies and programmes by their intentions rather than their results — Milton Friedman (1975).
Earlier today, Finance Minister Nirmala Sitharaman presented the Union Budget for FY 2019-20. The Budget comes at a time when the economy seems to be slowing and, therefore, most people argue that this budget is critical towards the revival of economic activity.
The quote by Milton Friedman assumes much significance as we evaluate the likely impact of this Budget on economic revival. Mere intentions are unlikely to fix what went wrong over the last three quarters, so the critical question to ask is if this Budget managed to fix it? The short answer is ‘yes’ and there are multiple reasons behind this.
Before we explore the impact that the Budget is likely to have on the country’s growth, we need to understand that a bulk of reforms occur outside the ambit of Budget and, therefore, we should not expect the process of reforms to be limited to just what was announced today. A good example of this is the reduction in small savings interest rates by the Government earlier last week.
While this reduction was too small to have an impact, it was in the right direction. The Finance Minister mentioned high cost of capital in her Budget speech. So, we should expect the Reserve Bank of India (RBI) to cut repo rates. Simultaneously, the Government should reduce small savings interest rates to ensure low cost of capital.
Low cost of capital is important given that the Government has put a lot of focus on the revival of investments in this Budget. It has been argued for a while that investments as a percentage of the Gross Domestic Product (GDP) have to revive to ensure sustained long-term economic growth. Given constraints on the Government’s capacity to lend, the private sector must take the lead and drive up investments.
Budget 2019 looks at the revival of growth rates and of the private investment cycle, which slowed post 2011, but recovering since 2016. What is required is to ensure that we surpass peak investment rates that we achieved in 2011 and sustain them over the next five years.
In this regard, we should welcome the lowering in corporate tax rate to 25 per cent for firms with up to Rs 400 crore turnover. This reduction will ensure greater retained earnings with private firms, which can subsequently be invested in the economy. Combined with lower cost of capital, this cut will have a definite impact on investments. However, given that India has one of the highest corporate tax rates in the world, an across-the-board reduction in corporate taxes would have made one happier.
Corporate tax rate reduction, which leaves out 0.7 per cent of the firms at a time when the country already has one of the highest corporate tax rates in the world, makes little sense. Any revenue loss by including them would be compensated by greater revenue realisation through economic growth caused by such a stimulus.
As a matter of fact, recent revenue shortfalls are largely due to the slowdown in the economy and, therefore, we need to rethink our taxation policy based on global evidence of resource mobilisation through such tax breaks.
On demand slowdown, part of the problem in sectors such as the automobile is due to liquidity concerns in Non Banking Financial Companies (NBFCs). The Government has tried to address these issues through a slew of measures. However, the impact of the same will only be felt a couple of months down the line.
It is reassuring though to see the Government commit itself to strategic disinvestments, not just of Air India but of other Central Public Sector Undertakings, too. Public Sector Units (PSUs) such as BSNL, should be considered for the purpose of such disinvestments over FY2020-21. The decision to allow public-private partnerships (PPP) for investments in the Railways is yet another bold decision that has the potential to augment India’s rail network, thereby creating a vibrant, efficient and modern railway system.
The focus on infrastructure is encouraging given that we need to create a conducive road, rail and water networks to encourage private investments. Such spending will have a positive impact on the economy and it is likely to have no significant impact on inflation. Despite the additional expenditure, the Government believes that fiscal deficit would stand at 3.3 per cent, down from 3.4 per cent.
I am a bit sceptical on the possibility of meeting this target, but in my view, it shouldn’t matter given that the economy needs a stimulus.
Another positive move was to see the Finance Minister Sitharaman accept and acknowledge the opportunity that India has in terms of integrating itself with the global value chain. In this regard, the Budget is very progressive in terms of easing norms and allowing foreign capital flows into the country. The relaxation in local sourcing norms for single brand retail is a progressive move that will catch the interest of many firms that were reluctant to enter India solely because of such rules.
But let us not stop just yet as such norms should be further relaxed for certain sectors for a period of five to eight years in order to encourage foreign firms to move to India. We’ve taken a small step in this direction; we should hope for more such steps over the next couple of months and hopefully, the next Budget.
Budget 2019 has its own share of disappointments but then again, which Budget doesn’t? For instance, the surcharge on rich taxpayers could have been avoided. Nobody is against taxing the rich more, but from a fiscal standpoint, we want to have more people in the tax net at higher tax slabs.
By such high tax rates and surcharges, we disincentivise tax compliance at high-income levels. Luckily, the Government has decided to tap foreign markets to borrow in the future and this will reduce interest burden on our borrowings. So, we should expect reduced pressure on taxpayers as the fiscal situation improves.
Overall, we have witnessed that tax rates have reduced for individuals and for corporations. This reduction has come with an improvement in tax compliance, which has made it possible for the Government to reduce rates while revenue increases. The direct tax to GDP ratio at present is at an all-time high. Therefore, it makes little sense for the Government to impose such a surcharge, especially when we want to improve revenue realisation from greater compliance at the high tax slabs.
Another missing link has been the reduction of profit tax for limited liability partnerships, which is yet to happen. While today we’ve reduced corporate tax rates for a major proportion of the firms, we are yet to extend such tax benefits to small private partnerships. This is something that the Government should consider over the next couple of months.
One announcement that has got public attention and is likely to make people a bit “unhappy” with the Budget is the increase of cess on petrol and diesel. This must be evaluated with what’s likely to happen in the international crude oil market. Oil prices are likely to be subdued over the next couple of months and it is likely that the prices may fall further in foreseeable future. Therefore, the introduction of this cess (or rather reversal of the petrol price cut that the Government announced a couple of months back) signals that the Government will.
Finally, while the Budget gets a lot of things right and we’ve witnessed what can be termed as “baby steps”, most reforms come outside of the Budget and another one is due within six months. So, we should expect more such measures. Budget 2019-20 will revive growth but revival should be expected from the third quarter of the 2018-19 financial year onwards.
(The writer is a New Delhi-based policy researcher)
Saturday, 06 July 2019 | Karan Bhasin | in Analysis