By Invitation. How can Budget revive demand?

Fiscal policy can be utilised to revive demand through lower taxes, higher spending or targeted policy interventions for specific sectors. The questions that need to be addressed include, what type of demand needs to be stimulated, consumption or investment? Is there adequate fiscal space to adopt stimulative policies? Lastly, what are the consequences of exceeding fiscal targets?

GDP data from FY2013 to FY2018 (based on estimates released by the Central Statistics Office) indicates that private consumption has grown by 6.7 per cent per year in this period, at par with the pace of overall economic expansion (6.8 per cent).

However, the average growth of gross fixed capital formation has been subdued at 3.9 per cent in these years. Clearly, stimulating investment demand should be prioritised over consumption demand, particularly since demographic changes will anyway drive the latter.

On the expenditure side, there are a plethora of options to stimulate demand in various sectors, based on the priorities of the government and the needs of the economy. In our view, the Government is likely to augment spending on urban and rural infrastructure, and social security in FY2019.

Higher allocation toward affordable housing, roads, renewable energy, railways and ports would spur investment and boost job creation. Government spending on infrastructure would also trigger investment by the private sector.

Nevertheless, the latter may remain subdued in the next 2-3 quarters, given moderate capacity utilisation, availability of brownfield distressed assets, high leverage levels of various corporates and the stressed balance sheets of public sector banks (PSBs). Importantly, the PSBs must be adequately capitalised to fund the investment recovery that is expected to materialise after H2 FY2019.

Additionally, larger allocations for existing schemes related to crop insurance, NREGA, and other social security measures, and infrastructure related to cold chains, etc., boost the agricultural sector and the rural economy.

After the implementation of the Goods and Services Tax (GST), indirect tax rates on few items remain under the control of the Government of India (GoI). Therefore, major tax changes that the GoI may introduce in the Budget for FY2019 would be limited to direct taxes. However, the lack of clarity related to the revenue buoyancy post-GST may not allow for a meaningful reduction in corporate or private income tax rates.

Nevertheless, some tinkering is likely in the income threshold and deductions for the latter, which may provide a mild support to small-ticket consumption. Reduction in the corporate tax rate would have to be accompanied by removal of exemptions, to remain revenue-neutral.

Policy interventions may be introduced to aid specific sectors, such as the rural sector, exporters or SMEs. For instance, easing of infrastructural and other bottlenecks for exporters, which dampen their competitiveness, as well as the procedural constraints being highlighted by SMEs after the GST, could be addressed. However, these need not be dovetailed with the Budget, which is essentially setting revenues and expenditures for the year ahead.

The GoI had previously committed to reducing its fiscal deficit from 3.5 per cent of GDP in FY2017 to 3.2 per cent of GDP in FY2018 and 3.0 per cent of GDP in FY2019. This limits the fiscal space that it has, to stimulate investment by increasing expenditure or cutting taxes, without deviating from its announced fiscal consolidation path.

Every 10 bps of rise in the GoI’s fiscal deficit to GDP ratio would permit additional spending of around ₹185 billion in FY2019, which is modest relative to the size of its overall expenditure. Therefore, budgetary allocations would need to be supplemented through extra-budgetary resources such as market borrowings of the central PSUs.

A deviation from the fiscal consolidation path would dent the credibility of the GoI’s commitment to reducing its fiscal deficit. Moreover, it may further harden bond yields, which have gone up by around 65 bps over the last eight months. This would bloat the Government’s interest payments, and prevent higher outlays towards other sectors in the coming years.

To sum up, the upcoming Budget is likely to focus on higher spending on infrastructure and social security to stimulate demand. Cutting taxes appears challenging in the current situation as revenue collections are yet to stabilise after the switchover to the GST.

The writer is Principal Economist, ICRA

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