Budget 2017 comes against heightened uncertainty
The Budget for FY18 would be presented against the backdrop of heightened uncertainty both locally and globally. Although global growth picked up somewhat in the second half of 2016, after weakening in the first half, the global economic landscape has changed considerably through the year in view of events like Brexit, Donald Trump becoming President elect of US and Referendum defeat of Mr Renzi in Italy. These events have created substantial geopolitical uncertainty and expectations are that these will persist, with little indication as to what Mr Trump’s policy priorities would be once he assumes office in January 2017. However, one thing is nearly certain that protectionism which is on the rise will get a leg up. Not a good news for the Indian economy. Also with crude price inching up, US Fed raising the rates by 25bp as of now and likely to raise it further means reversal in capital flows and weakening of rupee. Simultaneous movement in crude prices and weakening of rupee will have an adverse impact on domestic inflation.
Demonetisation will adversely affect the economy in short term
Amidst this uncertain global scenario, the Indian economy was cruising well and was expected to clock a GDP growth higher than FY16 on the back of a good monsoon till the tsunami of demonetisation of high denomination currency hit the country. The sudden decision of cancelling the legal tender of Rs 500 and Rs 1,000 notes and the chaos created thereafter due to limited availability of new currency has caused significant disruption in the economy. The government’s idea of moving towards a less cash economy may be a laudable move and it is likely to pay dividend in the medium- to long-run. However, in the short-run it has affected economy adversely. India Ratings believes, GDP growth in FY17 is likely to decline to 6.8% (earlier estimate: 7.8%). Various sectors of the economy have been impacted differentially. In agriculture it ranges from farmers not getting the right price for their Kharif produce to rabi sowing being affected by inability/low ability of farmers to purchase seeds and fertilizer. Even if finally there is no significant drop in the rabi sowing acreage, the output could still be lower on account of inadequate post sowing activities which mostly happens in cash.
As nearly 90% of the transactions in the country are executed in cash, this move has impacted the cash economy. The key segments of the economy where cash transactions play a vital role are real estate/construction, gold, and the informal sector. Although the role of cash transactions related to real estate and gold are mostly dubious, it is the lifeline in case of the informal sector. Also, by no means it could be assumed that all the cash transactions happening in the informal sector are black. Further, informal sector is not a standalone sector and has strong to weak linkages with the formal sector, depending on the nature of goods/services dealt in. Therefore, where business in the informal sector has come to a grinding halt or down by 30%-40% and beyond, it has resulted in either ‘nil’ or lower income generation.
Therefore, the ripple effect of demonetisation is proving to be quite disruptive for the overall economic activity and employment. As the days associated with the loss of liquidity are getting longer, the impact is becoming severe and more pronounced in the informal sector. This in turn has the potential to push the default rate higher in both the formal and informal markets. Media, both print and electronic is full of stories about the breakdowns in payment systems choking trading activities across the board, and loss of liquidity leading to job losses. Disruption in trade in majority of the cases has permeated to the level of small vendors and street hawkers. Based on present situation, it is expected that the adverse impact may flow in FY18 also.
Headroom for consumption / investment stimulus is limited
Against this broad domestic and global economic backdrop, one of the major challenges for the government will be to firstly hold on to the growth momentum, and secondly, to accelerate it. However, demonetisation of high denomination currency notes has put a question mark on this. Therefore, as the government embarks on preparing the FY18 budget, the central question before it is – whether a fresh round of fiscal stimulus is required to offset some of the ill effects of currency demonetisation. Indian public finances (central, state and local bodies) suffer from committed expenditure syndrome as a large part of current expenditure is inflexible and cannot be reduced/curtailed in the short-run.
Therefore the fiscal room for stepped expenditure has either come from higher revenue collection or higher fiscal deficit. With growth expected to fall not only in FY17 but also in FY18, government is clearly staring at lower tax collection.
For FY17, if we combine this with: i) lower revenue collection than was budgeted from telecom spectrum auction, and ii) likely shortfall in disinvestment, then government finances do not appear to be heading towards budgeted numbers. However, government may still be able to cap the fiscal deficit at 3.5% of GDP due to a combination of i) higher growth in indirect tax collection than budgeted during 1HFY17, and ii) expected tax revenue garnered from Income Declaration Scheme 2016 and the proposed Pradhan Mantri Garib Kalyan Yojana (PMGKY) 2016.
Therefore, the headroom for the government to give stimulus either from the consumption side or investment side is quite limited and if it happens then perhaps it will require compromising fiscal deficit target and fiscal consolidation process. Any move in this direction will have its consequences. Moreover, unlike 2008, the slowdown in growth this time around is of our own making and the rationale for relaxing fiscal deficit target / consolidation process will not be viewed positively.
Further, rising commodity prices may also affect government’s fiscal arithmetic. In case crude oil prices increase further and the same is fully passed on to consumers, it will make RBI’s task of achieving 5% inflation target by March 2017 and 4% in the medium term very difficult. The government needs to be ready with alternate duty structure and move from ad-valorem duty to specific duty to maintain a fine balance between consumer inflation and tax revenue. In all likelihood, the GST will miss 1 April 2017 implementation deadline. The budget should have some proposals from the government to bridge the trust deficit arisen between central and state governments especially after de-legalisation of currency. In nutshell, we expect government’s budget focus this year on:
- Growth enhancing policies
- Steps towards implementation of GST
- Steps to attract investment
- Steps to improve quality of education
- Steps to boost revenue
- Improve ease of doing business
- Steps to improve capital inflows