Budget 2017: Modi & Jaitley’s Timely Prescription for the Economy

Reducing tax rate may not necessarily boost consumption as India grapples with the after-effects of demonetisation.

(Photo: Harsh Sahani/ The Quint)

The budget deals with allocating money towards areas where the government thinks it is essential to spend, and finding out ways such as taxes, to finance it. The government primarily requires money to spend on social infrastructure (such as schools, hospitals, water, sanitation, etc), physical infrastructure (such as railways, roads, airports, etc) and transferring funds to the poor and the deprived, so that distribution of income becomes more equal.

But how does one say whether a budget is good or bad? The general assumptions underlying a good budget are: It contains the fiscal deficit, carries on with the necessary reforms, and gives incentives to consumers and business.

Also Read: Budget 2017: After DEMON-etisation Damage, Allowing Time to Heal

Pessimistic Business Outlook

It is to be noted that India is the only large economy in the world which is growing at above 6.5 percent, and yet this growth rate is not supported by some fundamental micro and macro-economic indicators.

Importantly, in this phase of de-globalisation (read, the Trump factor), and disruption post-demonetisation, it will be a miracle if India can achieve a 7 percent growth. Market pundits and economists were, therefore, looking for an action plan from the Finance Minister (FM) that will sustain economic growth in a more equitable fashion.

To put things in perspective, after demonetisation, common man in the street and small and medium size entrepreneurs will vouch for a fall in overall demand. There has been a fall in car, two-wheeler, and cement production. In fact, service PMI (Purchasing Managers' Index) tracking sales, employment, inventories, and price data of private service sector companies have shown a sharp decline in recent months.

Service is the most important sector, contributing to 67 percent of India's national income. The pessimistic business outlook is also reflected by a fall in foreign direct investment (FDI). During the last five years, India saw an average inflow of $2,200 million worth of FDI every month. The corresponding figure for December 2016 was $2,034 million.

Challenge of Generating Consumer Demand

For the benefit of the reader, there are five components of demand, namely, consumption expenditure, investment expenditure, government expenditure, exports, and imports. The most important component of demand is consumption expenditure, explaining 70 percent of the national income in 2016.

To generate more consumer demand, the FM announced, persons with an annual income upto Rs 3 lakh will not have to pay income tax and those having income upto Rs 5 lakh will be charged income tax at 5 percent as opposed to the earlier 10 percent rate. This will generate an additional Rs 13,000 crore income in the hands of consumers.

Keeping an Eye on Expenditure

Government spending for the third quarter of 2016 stood at Rs 3,840 billion in comparison to five years’ average of Rs 2,790 billion. Government spending mostly comprises implementation of government programmes and maintaining various government departments.

Recent estimate shows GDP from public administration (Rs 3,861 billion) has now surpassed the GDP from the agriculture sector (Rs 3,095 billion). This increased government spending was able to keep India's growth story alive at around 7 percent.

However, to sustain this growth, focus needs to shift to the agriculture sector. With an effort to revive the agriculture sector, the total allocation for rural, agricultural and allied sectors has been increased by 24 percent and this now stands at Rs 1,872.23 billion. Likewise, farm insurance coverage under the Pradhan Mantri Fasal Bima Yojana has been increased to 40 percent from the existing 30 percent.

Not all aspects of government spending are bad. It makes sense to spend on infrastructure. ‘Make in India’ project, that is, incentivising manufacturing in India, will not be possible without having world class roads, ports and railways. And one has to give credit to the government for increasing fund for building infrastructure sector.

However, money spent on maintaining too many government departments is unworthy. For instance, department of sericulture can be merged with agriculture, higher education under science and technology and so on. At the time of e-governance, better delivery of public services can happen through a leaner, thinner and stronger (read, productive and transparent) government department. Also, ornate beautification of roads and public places without providing proper infrastructure facilities is uncalled for. The FM could have done with allocating lesser funds for public administration.

Decreasing Tax Rate Won’t Increase Consumption

Acknowledging instances of tax evasion, the FM stressed the need for digital economy and big data analytics to catch the evaders. There is also a massive reform in political funding, with maximum limit of anonymous cash payment now reduced to Rs 2,000 from an earlier Rs 20,000.

Data suggests that there are only 24 lakh Indians who have income above Rs 10 lakh. Ironically, Indians bought 25 lakh cars every year since 2011. Decreasing tax rates for sure will increase tax buoyancy but its immediate impact on raising consumption demand is questionable.

Although the consumer spending data has shown a tepid increase, the bug lies in agricultural income, supporting livelihood of around 60 percent population. Long-term trend suggests that India's growth story is kept alive through higher government expenditure.

Giving Boost to the MSME Sector

Sustaining this 6.5 percent plus growth and generating consumer demand will also require transferring funds to the poor and the deprived, so that the distribution of income becomes more equal. Richest 1 percent in India own 58 percent of country's wealth. Around 26.1 percent of its 1.27 billion population live below poverty line and 63 million people have been driven into poverty due to the high cost of healthcare and education.

In this age of 3D printer and data algorithms, when manufacturing process is increasingly becoming mechanised, there is a need to incentivise micro, small and medium enterprises (MSME) sector.

Problem with MSME sector is access to finance. A flourishing MSME sector is much needed for employment generation. India has a growing young population, with two-third of its population below 35 years. The FM has reduced income tax for firms (with a turnover of less than Rs 50 crore) to 25 percent from the earlier 30 percent. To increase accessibility to finance, the FM has doubled lending target to Rs 2.44 lakh crore under PM's Mudra Yojana.

Resisting Some Temptations

There was some talk about giving unconditional cash transfers to the poor. Although at present government budget deficit and inflation are both under control, direct cash transfer is not a good idea. Cash transfer can at most help to create a vote bank but not help the masses to sustain their income. The FM has desisted from this incentive and have kept the budgetary deficit under control, pegging the fiscal deficit at 3.2 percent of GDP for 2017-18.

In short, the outlook for this budget remains positive and much of the budgetary statements look realistic.

(The author is Professor, Bennett University and can be reached @banik_nilanjan. This is a personal blog and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)

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