Insights into Editorial: Will Budget 2020 work in getting the Indian economy back on track?
Union Budget of India is the country’s comprehensive Annual Financial Statement.
The Union Budget consists of a detailed account of the government’s finances, its revenues from various sources and expenditures to be incurred on different activities that it will incur.
As mentioned in the Article 112 of the Indian Constitution, the Union Government lays a statement of its estimated receipts and expenditure for that year, From April 1 to March 31, before both the Houses of Parliament.
Finance Minister has an unenviable task ahead as she rises to present the Union Budget for the financial year 2020-21 (FY21).
That’s because the Indian economy has been decelerating fast, the government cut the GDP growth rate for 2018-19 from 6.8% to 6.1%. The growth rate in the current year is already expected to be at a six-year low.
What is the problem with the economy?
Broadly, there are four engines that provide the power to drive GDP growth in an economy.
These are: Consumption of private individuals (C), Demand for goods from the government (G), Investments from businesses (I) and the net demand from exports and imports (NX).
GDP = C + G + I + NX
With each passing year, the Indian economy has been losing its engines of growth.
The corporate investments (I) engine has been slowing sharply since 2011.
The new businesses found that the financiers to the economy, that is the banks (especially the public sector banks, which accounted for 70 per cent to 80 per cent of all lending), were themselves struggling with non-performing assets.
- Many of these NPAs were the same loans that they had extended to the big businesses who were now hamstrung.
- Private consumption demand was first hurt in the rural areas with poor commodity prices.
- While this meant that retail inflation was under control, the purchasing power of farmers declined.
- This weakness in rural demand was compounded by a collapse in urban demand after credit flow from the non-banking financial sector companies stopped following the meltdown in IL&FS.
- This is being witnessed in the sales slump across the board — from cars to shampoo sachets.
- Government demand carried the day for a considerable time. But with a sharp fall in revenues, thanks to a slowing growth, there is no way the government can spend without massively flouting the Fiscal Responsibility and Budget Management (FRBM) Act targets.
What were the options before the government?
- In the Indian context, C or private consumption demand accounts for roughly 57 per cent of total GDP.
- Investments (I) are the next big chunk, accounting for 32 per cent. Government spending (G) is the smallest contributor, with net exports (NX) being negative for India.
- Under normal circumstances, it would have been natural for the government to increase its expenditure and thereby provide a strong growth impulse to the economy. That is because what the government spends turns into someone’s personal income.
- This income when spent again, say on buying a car or a bar of soap, generates more economic activity, and further incomes.
- In the run-up to the Budget, many had argued that this is what the government should do. But these are not “normal” circumstances.
- A slowing economy has upset the government’s tax collections. As such, because the nominal GDP grew by just 7.5 per cent in 2019-20 instead of the Budgeted growth of 12 per cent, the gross tax revenues of the government fell from Rs 24,61,195 crore to Rs 21,63,423 crore that is a shortfall of Rs 3 lakh crore.
- The government could have still gone ahead and borrowed more money from the market, but here too there was a problem of supply.
- In other words, there weren’t enough savings in the market to fuel government demand.
- As such, the total expenditure of the government is slated to go up by just over 9 per cent over FY20’s budgeted figure.
- The other option was to boost investments.
- To a great extent, the government had already tried to do this outside the Budget, when it announced a sharp cut in corporate income tax last year.
- The tax cut cost the government over Rs 1.5 lakh crore in 2019-20, with little to show in terms of new investment activity.
Private Consumption demand requires more Investments:
- To be sure, investment decisions are not taken in a hurry and even though the corporate tax cut was a welcome decision, and one that is likely to benefit the Indian economy in the medium to long term, at present, in the immediate term, it has been ineffectual.
- That is because investments follow demand, and consumer demand has been declining sharply. This has resulted in high unsold inventories, and is reflected in capacity utilisation falling to an all-time low late last year.
- Still, the Finance Minister announced that there will soon be a scheme to encourage investments for the manufacturing of mobile phones, electronic equipment, and semi-conductor packaging.
- Similarly, she has allowed the electricity generating companies to benefit from the corporate tax cut.
- That left the biggest driver private consumption demand and by the looks of it, the government has tried its best to nudge people to consume more and, by that route, kickstart a virtuous cycle.
- The government has tried to do this by providing people with some options that enhance their disposable income. However, in the process, it has disincentivised savings.
- The best example of this is the option of a new Income Tax regime, which removes all exemptions and deductions, but also cuts the tax rates.
- The government likely hopes that taxpayers will be enthused to opt for this structure because it is likely to leave them with more money in hand.
- This is likely to be especially true for those taxpayers who are young and lie towards the lower end of the income brackets.
- That is because in that age and income brackets, the so-called marginal propensity to consume is higher. The richer and higher-salaried workers tend to save most of their income.
How does the government expect this strategy to work?
The government’s strategy, or hope at least, is that leaving people with more money will help boost their consumption levels, which are at present quite subdued, as witnessed in the slump in sales of goods and services across the board.
Higher consumption will bring down the inventories in the economy and incentivise businesses to invest again.
The ground has been prepared to make investments attractive for businesses as the government has already cut the corporate tax rate last year.
Once the business activity recovers, the government would have more taxes coming to it and would be in a better position in the coming years to spend more prolifically.
What are five things to watch out for in the Union Budget 2020?
- Nominal GDP growth:
This is the most important number in a Budget and it forms the base of all other variables.
In the last full Budget that was presented in July 2019, the government expected nominal GDP to grow by 12% in 2019-20. As it turns out, the actual number is likely to be 7.5% or even lower.
This dip completely alters the likely real GDP for 2019-20; real GDP is derived after subtracting the annual inflation (roughly 4% for the year) from nominal GDP.
2 and 3: Fiscal and Revenue Deficit
Given that there are no engines of growth left in the economy, many have argued that the government must not sit back under pressure from the fiscal hawks, and should instead spend more to boost the overall demand and rekindle the animal spirits in the economy.
However, a crucial thing, if the government decides to relax or postpone fiscal responsibility norms, would be if the government refocuses on revenue deficit as well.
In 2018, the government had dropped targeting revenue deficit. This had meant that India increasingly borrowed money to finance its everyday consumption at the cost of funding capital expenditure.
Typically, Rs 100 spent on capital expenditure by the government results in Rs 250 being added to the overall economy.
If the government spends on revenue such as salaries the overall impact on the economy is less than Rs 100.
So, the crucial thing is not whether the fiscal deficit target is flouted or not, the crucial thing is what is the revenue deficit and whether the government intends to reduce it to 0% in the next few years.
4.An income tax cut:
There are two reasons why the government may want to cut the personal income tax rates or at least rejig its slabs.
- For one, the corporate income tax rates or the corporate tax rates have been cut sharply last year. It makes sense to offer that relief to the taxpayers in the economy.
- Two, people have been hoping for an income tax cut for long, and it may be one way to allay the concerns of the middle class in India.
The Prime Minister has been reiterating that the country cannot go forward without people looking at “wealth creators” with respect.
The Economic Survey has already outlined the policies that need to be tweaked.
A good way for the government to get out of the way of businesses in the country, and raise significant resources of its own in the process, is by divesting its stake in many public sector enterprises.
Union Budget also empowers the government to carry out its constitutional duties such as providing social justice and equality for all.
Resource allocation in the best interest of the society and the country and allocating resources optimally for public welfare.
Union Budget need to take steps to control inflation, deflation and economic fluctuations thus ensuring economic stability in the country. The Union Budget of any country is crucial as it has widespread implications on that country’s economic stability and general life as such.