Tuesday, March 01, 2016

Definitely a Modi budget

The budget for 2016-17 bears the stamp of prime minister Modi. There is a philosophy and a political direction to it, which could have come only from the PM himself. 

There's a shift in focus- from industry to agriculture, from the urban middle classes to the rural poor. This is reflected in increased in allocations for a variety of rural schemes and the attempts to boost rural consumption. It also shows in a willingness to tax the rich (higher surcharge on incomes over a certain limit, taxation of dividend in the hands of the shareholder) and in the attempt to move PF contributions to EEE, that is, to tax withdrawals. (It appears this may be partially rolled back).
What has caused this shift? Several things, I guess:
  •  The realisation that not much can be done to boost private investment and industry at a time when the global crisis seems to be worsening, large Indian companies face a debt overhang and the banking sector is bogged down by high NPAs.
  • The recognition that if agriculture can be strengthened and made to grow faster, we can raise the overall growth rate without being dependent on the vagaries of the global economy. Also, that a turnaround in agriculture can translate into significant votes. That was Modi's achievement in Gujarat- to reach electricity and water to the rural areas. That was also Nitish Kumar's achievement in Bihar. 
  • Once agriculture is improved, a revival in the world economy will help push India's growth rate into the 8-9% range, perhaps in time for the 2019 elections.
At the same time, there is a concern not to rock the boat where foreign investors are concerned, to shore up badly won macro-economic stability at a time when investors are pulling out of emerging markets. Hence, the focus on achieving the fiscal deficit target of 3.5%. Modi doesn't want foreign investors to mess up things for India by fleeing at this time.

The big negative in this strategy is inadequate recapitalisation of public sector banks- Rs 25,000 crore just isn't enough. I am inclined to believe the government when it says this isn't the entire figure they have in mind- more could be forthcoming. Perhaps, the government will get a clearer view of the capital requirement once consolidation of some sort is firmed up. They can then top up the sum of Rs 25,000 crore later in the year. If international conditions are a little calmer, they can afford to give the fiscal deficit target of 3.5% a miss and settle for, say, 3.7%.

As commentators have pointed out, there is a contradiction between sticking to the fiscal consolidation roadmap and then seeking a review of FRBM targets. Perhaps, the FM hopes that the promise review will give him leeway to relax the deficit by the time he presents the next budget.

What could go wrong? Well, what we have is a continuation of fiscal compression along with a little monetary loosening. This won't do much for growth. It's no use bringing down interest rates when banks lack the capital to be able to lend. This means growth is likely to be closer to the lower end of 7-7.5% band indicated in the Economic Survey.

One can live with that - provided the global economy doesn't get into worse shape. If it does, then growth could slip below 7%, foreign investors might yet flee and the banking sector's situation will become perilous.

Secondly, the allocations for agriculture, while higher than in previous years, may not be adequate to dramatically change the situation on the ground. Politically, then, Modi may not reap the expected dividend.

Clearly, there are risks to the budgetary strategy that the Modi government is pursuing. But this is clearly the strategy of a consummate politician- I can't see that any economic advisor could have crafted a budget of this sort.

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