Budget 2018 to aid growth, but with higher inflation, weaker fiscal balance

The inescapable inference is that govt now finds it extremely difficult to get the deficit down to 3%

With eight state elections in 2018 and the national election to follow by spring 2019, Finance Minister Arun Jaitley’s fifth Budget had to balance economic priorities against political imperatives. As a result (as Amartya Sen once commented on a paper decades ago), it has some good points and some not-so-good points. Given limited space and my inborn worrying tendencies, here I will focus mostly on the latter category. In doing so, I will deploy my standard four-part framework for Budget assessment: Overall fiscal stance, tax policies, expenditure policies, and reform initiatives.

Fiscal deficit

Given the over Rs 500 billion shortfall in non-tax revenues (comparing Revised Estimate to Budget Estimate) and the over Rs 1 trillion overshooting on revenue expenditure in 2017-18, it was no surprise that the fiscal deficit target of 3.2 per cent of gross domestic product (GDP) was exceeded by 0.3 per cent point. With private investment and exports sluggish during the year, this modest overshooting was not all bad from a short-run macroeconomic viewpoint. However, in a longer perspective of the four years since 2013-14, the less than one percentage point decline in the deficit from 4.4 per cent of GDP in 2013-14 to 3.5 per cent in 2017-18 (RE), clearly indicates a weak record of fiscal consolidation, especially in contrast with the 2 percentage points reduction recorded by the previous government, from 4.5 per cent of GDP down to 2.5 per cent, between 2003-4 and 2007-8.  What’s more, the revenue deficit reduction achieved between 2013-14 and 2017-18 has been only 0.5 per cent of GDP.

Illustration: Binay Sinha

More worrying is the Budget target of 3.3 per cent of GDP for 2018-19 (even higher than the original target for the present year) and the further postponement of the 3 per cent goal to 2020-21. If some fiscal laxity in 2018-19 is excusable on account of multiple elections, surely the 3 per cent of GDP target could have been set for 2019-20? The inescapable inference is that the central government now finds it extremely difficult to get the deficit down to 3 per cent. At a time when states are running deficits of another 3 per cent of GDP (or higher), we seem stuck with combined fiscal deficits of around 6.5-7 per cent of GDP, which does not augur well for the trajectory of medium- and long-term real interest rates. 

Tax policies

Media and analyst reactions have mostly focused (negatively) on the proposed resurrection of the long-term capital gains (LTCG) tax from listed equities and equity mutual funds at the modest rate of 10 per cent. In my view, this proposal is entirely justifiable on grounds of revenue, equity, and similar treatment of different asset classes. The recent sell-off in stocks has more to do with a global correction of over-heated bull markets than the tax proposal.

Far more significant (though less commented upon) is the Budget’s retrograde proposal to increase import tariffs on a wide range of commodities, including: Automobiles and components, mobile phones and parts, some processed foods and edible oils, a range of cosmetic products, footwear, furniture, watches and clocks, various toys and sporting equipment. As Mr Jaitley himself noted, this will constitute a reversal of more than 20 years of import tariff reductions, which he justified to promote “Make in India”. In fact, many decades of global experience and our own economic history has amply demonstrated the ill effects of tariff protection. As in the past, these steps are likely to increase inefficiency, raise domestic prices, hurt exports, encourage more tariff hikes in other areas, invite retaliation from trading partners and generally weaken the development of an efficient and competitive manufacturing sector. They are not consistent with the prime minister’s strong criticism of protectionism at Davos and could well undermine our recently reaffirmed commitment to stronger trade and economic integration with Asean nations and others in the Regional Comprehensive Economic Partnership.

The goal of promoting “Make in India” would be far better served through reduction of the substantial overvaluation of the rupee.

Expenditure policies

The two most prominent expenditure-side initiatives in the Budget are the National Health Protection Scheme (NHPS) to provide hospitalisation coverage up to Rs 500,000 per family per year for 100 million poor families (about 500 million people), and the programme to extend and make effective, minimum support prices (MSPs) for nearly all crops to ensure “that farmers will get adequate price for their produce” (defined as 50 per cent more than their cost of production).

Both these major initiatives are unfunded in the Budget for 2018-19. Both also raise serious issues of design, feasibility, economic efficiency, accountability fiscal cost, implementation capacity and cooperation with States. For example, the NHPS, which seems to be a scheme for state-funded insurance for (mostly) private hospital services, will have to deal with mammoth nation-wide deficits in the availability of hospital infrastructure and trained medical personnel. If and when such a scheme actually does effectively serve 500 million poor patients, the annual costs are likely to be many times higher than the Rs 100 billion per year mentioned by official spokespersons.

From a fiscal viewpoint the main concern is not about the negligible funding provided in the current Budget, but the open-ended commitment to massive future expenditures (as the scheme matures to meet its targets), which could render overall fiscal consolidation and prudence highly problematic.

One other worry on expenditure allocations is the relatively low allotment for defence, at less than 1.6 per cent of GDP. As others, such as T N Ninan, have noted, this comes at a time when the threats on our northern and western borders, as well as in the Indian Ocean, are high and mounting.

Economic reforms

It is unrealistic to expect major reforms in the last full Budget before national elections. Nevertheless, the expansion of the facility for fixed-term employment to all sectors (from the earlier experiment in apparel and footwear) should help cope with India’s daunting employment challenges. Similarly, the extension of the current scheme, whereby government contributes 12 per cent of wages of new employees in textile, leather and footwear, enrolling in the Employment Provident Fund, for three years, to all sectors is also welcome. 

As for the Budget’s macroeconomic impact, it is likely to be modestly supportive of short-term growth, but at the expense of higher inflation and weaker fiscal and external balances. 

The writer is honorary professor at ICRIERP and former chief economic advisor to the Government of India. Views are personal