Arvind Subramanian

10 things the Modi govt should do in the next budget

narendra_modi

Vivek Kaul


The finance minister Arun Jaitley will be presenting Narendra Modi government’s second budget next month in February 2015. The budget other than being a revenue and expenditure statement of the government is also the time when governments tend to announce their policy stance on various issues. It is also the time around which major economic reforms tend to be announced.
Keeping these factors in mind, here are 10 things that I would like to see Jaitley do in his second budget.

1) The assumptions of revenue growth need to be more realistic. In the budget for this financial year Jaitley had assumed that the government revenue receipts would grow by 15.6%. The total revenue receipts for the period April to November 2014 have grown by half that rate at 7.8%. The tax growth had been assumed to grow at 16.9%, whereas the actual growth in tax collections between April to November 2014 has been around one-fourth of that at 4.3%.
The Indian economy has been growing at the rate of around 5% per year. There haven’t been any major changes that tell us that the economy will grow at a significantly faster rate in the next financial year. Keeping these factors in mind Jaitley should keep his revenue projections realistic, unlike this year. Between April to November 2014, the fiscal deficit was already at 99% of the annual target, making Jaitley’s projections look totally ridiculous. Such a situation can be avoided next year.

2) Over the last few years, the government has assumed that disinvestment of its holdings in public sector units will bring in a lot of money. But that hasn’t turned out to be the case. Take the case of the last financial year when it was assumed that the government will raise Rs 54,000 crore through disinvestment. It actually managed to raise only Rs 19,027 crore.
For this financial year, Jaitley has projected that the government will raise Rs 58,425 crore through disinvestment. But only Rs 1,700 crore has been raised so far, with only around 11 weeks left for the financial year to end.
News-reports now suggest that the government is really trying hard to push disinvestment through. Instead of waking up at the end of the financial year, the government along with a big disinvestment target also needs to have an annual plan where they go about disinvestment all through the year. This is a better way of approaching the issue and Jaitley should look at it seriously in the next budget.

3) The fiscal deficit number needs to be correctly stated. In the last financial year, the then finance minister P Chidambaram managed to meet the fiscal deficit target that he had set through accounting shenanigans like postponing the payment of expenditure that had already happened and forcing public sector companies like Coal India to pay up huge dividends.
From the looks of it, Jaitley might want to do the same thing this year as well, in order to meet the fiscal deficit target of 4.1% of GDP that he had set when he presented the budget in July 2014. As mentioned earlier, the fiscal deficit for the first eight months of the financial year was already at 99% of the annual target. And the only way that Jaitley can now meet the fiscal deficit target is by doing the same things that Chidamarbam did last year. The finance minister should not fall for this temptation and come up with the “real” fiscal deficit number. My bet is he won’t.

4) In the Mid Year Economic Analysis, the Chief Economic Adviser to the finance ministry Arvind Subramanian wrote that: “Over-indebtedness in the corporate sector with median debt-equity ratios at 70 percent is amongst the highest in the world. The ripples from the corporate sector have extended to the banking sector where restructured assets are estimated at about 11-12 percent of total assets. Displaying risk aversion, the banking sector is increasingly unable and unwilling to lend to the real sector.” This has led to a situation where banks aren’t interested in lending and corporates aren’t interesting in investing.
In order to get around this problem Subramanian suggested that: “it seems imperative to consider the case for reviving public investment as one of the key engines of growth going forward, not to replace private investment but to revive and complement it.”
In simple words, the government should increase its capital expenditure to “pump-prime” the economy and get the investment and growth going again, feels Subramanian. It would make huge sense to have a dedicated revenue stream to finance this expenditure, instead of financing it all through borrowing. This could be through a massive disinvestment programme, a cess on petrol/diesel etc. This will make great accounting sense as well, where sale of public assets will finance the creation of newer public assets instead of financing regular expenditure of the government.

5) Every year along with the budget the government releases a revenue foregone statement. The revenue foregone for the government during the year 2013-2014 has been estimated to be at Rs 5,72,923.3 crore. “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the statement of revenue foregone points out.
The following table shows the exact breakdown of the revenue foregone by the government under various kinds of taxes. It is clear from the table that Indian businesses benefit the most with corporate income tax, excise duty and customs duty foregone, forming a bulk of the revenue foregone by the government.

Table


It needs to be stated here that the revenue foregone is based on certain assumptions. As the statement points out “ The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures….The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.”
While there are many assumptions behind the revenue foregone number, it is too big a number not to be taken seriously. It is even greater than this financial year’s projected fiscal deficit of Rs 5,31,177 crore. The government needs to go through these exemptions carefully and figure out are they really needed. This maybe too big an exercise to be carried out along with the budget, but it can be announced along with the budget and can be carried out over a longer period of time.

6) One of the ticking time bombs in India is the amount of money that needs to be pumped into public sector banks in the years to come. The Report of The Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak committee) released in May 2014, estimates that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”
Where is this money going to come from? The government needs to start thinking about the issue seriously. It is not in a position to pump in so much money into public sector banks. So it should start seriously looking at either selling out some of these banks or simply shutting down the poor performing ones. The government does not need to own so many banks. Again, the finance minister needs to tell us what he is thinking about this and the budget would be a great time to do this.

7) Jaitley needs to come up with a time frame and a plan around how soon the government will start paying out all subsidies in bank accounts of citizens directly. This will go a long way in ensuring that subsidies actually reach citizens and do not get siphoned off by the system.

8) Since coming to power the BJP government has made a lot of noise about getting back all the black money that has left the shores of the country. But what about all the black money that is still there in the country? Why not try to recover that? It will be significantly easier to do that. It is time that the government came up with a plan to recover black money within the country as well. The budget would be a great time to announce such a plan.

9) In the previous budget Arun Jaitley came up with 29 new schemes to which he allocated Rs 100 crore each. It is very tempting for the government to try and do everything and in the process spread itself too thin. The government cannot be a part of everything, simply because neither does it have the expertise nor the money. It would be better if it concentrated on a few big things(or ideas) in the budget. But there is no point in being absolutely all over the place.

10) The government expenditure is categorised into two categories—plan and non-plan. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure. As is obvious a lot of non-plan expenditure is largely regular expenditure.
Plan expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government. It is asset creating expenditure.
Nevertheless, what seems to be happening is that plan expenditure gets held back and is only released in the latter months of the year. Take the case of the current financial year. Between April to November 2014, the total plan expenditure of the government stood at Rs 2,93,651 crore or around 51.1% of the annual target of Rs 5,75,000 crore. The ratio was 52.8% for the period between April to November 2013.
The main reason why the government goes slow on plan expenditure and stacks it up towards the end of the year is that it has become the balancing factor in the budget. If the revenue projections go wrong, then the government slashes plan expenditure in order to meet the fiscal deficit target. This is what Chidambaram did in the last two financial years. In 2012-2013, he had budgeted Rs 5,21,025 crore towards plan expenditure. The final expenditure came in 20.6% lower at Rs 4,13,625 crore. In 2013-2014, the plan expenditure was budgeted at Rs 5,55,322 crore. The final expenditure came in 14.4% lower at Rs 4,75,532 crore.
Jaitley is looking to do the same in this financial year as well. He had budgeted Rs 5,75,000 crore for plan expenditure but my guess is that he will have to slash it by Rs 1,00, 000 crore to meet the fiscal deficit target. This practice needs to be done away with and it can only happen if the government works with more realistic projections of both revenue as well as expenditure. The next financial year is a good time to start.

These are the 10 things that I strongly feel the government should be trying to do in the next budget. Let’s see how many of these things happen.

The column originally appeared on www.Firstpost.com on Jan 9, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek) 

Has the Chief Economic Adviser ever read George Orwell?

george orwell

Vivek Kaul

The writer George Orwell in his dystopian novel 1984 came up with the concept of “doublethink”. He defined this as a situation where people hold “simultaneously two opinions which cancelled out, knowing them to be contradictory and believing in both of them”. Arvind Subramanian, the chief economic adviser to the ministry of finance, seems to be in a similar situation these days. While speaking to the press after the Mid Year Economic Analysis was presented to the Parliament, Subramanian said that the government should consider increasing public sector spending in the medium term to revive economic growth . At the same time Subramanian said that the government was committed to meeting the fiscal deficit target of 4.1% of GDP during the current financial year. Fiscal deficit is the difference between what a government earns and what it spends. How is it possible to stand for two absolutely opposite ideas at the same time? How can there be a commitment to increased government spending and maintaining the fiscal deficit at the same time? If the government spends more without earning more, its fiscal deficit is bound to go up. Nevertheless, before getting into this issue in detail let’s try and understand why Subramanian makes a case for increased public investment. In the Mid Year Economic Analysis Subramanian suggests that the public private partnership (PPP) model for infrastructure development hasn’t really worked. “There are stalled projects to the tune of Rs 18 lakh crore (about 13 percent of GDP) of which an estimated 60 percent are in infrastructure. In turn, this reflects low and declining corporate profitability as more than one-third firms have an interest coverage ratio of less than one (borrowing is used to cover interest payments). Over-indebtedness in the corporate sector with median debt-equity ratios at 70 percent is amongst the highest in the world. The ripples from the corporate sector have extended to the banking sector where restructured assets are estimated at about 11-12 percent of total assets. Displaying risk aversion, the banking sector is increasingly unable and unwilling to lend to the real sector,” the Mid Year Economic Analysis points out. What this means is that over the last few years corporates have borrowed more than what they can hope to repay. This has led to them defaulting and banks ending up in a mess. Currently the corporates are not willing to invest and banks are not ready to lend. In the process projects worth Rs 18 lakh crore (which is slightly more than the annual budget of the government of India) have been stalled. So what is the way out of this mess? “First, the backlog of stalled projects needs to be cleared more expeditiously, a process that has already begun. Where bottlenecks are due to coal and gas supplies, the planned reforms of the coal sector and the auctioning of coal blocks de-allocated by the Supreme Court as well as the increase in the price of gas which should boost gas supply, will help. Speedier environmental clearances, reforming land and labour laws will also be critical,” the analysis points out. But even this will not be enough, given that the PPP model hasn’t really delivered. In this scenario Subramanian suggests that “it seems imperative to consider the case for reviving public investment as one of the key engines of growth going forward, not to replace private investment but to revive and complement it.” The question that crops up here is on what should the government be spending money on? Subramanian suggests “there may well be projects for example roads, public irrigation, and basic connectivity–that the private sector might be hesitant to embrace.” He further suggests that one of the main lessons from PPP not working is that “India’s weak institutions there are serious costs to requiring the private sector taking on project implementation risks.” Hence, risks like “delays in land acquisition and environmental clearances, and variability of input supplies (all of which have led to stalled projects) are more effectively handled by the public sector.” And above all weak infrastructure (lack of power supply and poor connectivity) remains a major reason as to why the manufacturing sector hasn’t taken off in India. Increased spending by the government could address all these issues. The reasons presented by Subramanian for increased government spending make sense. One cannot argue against them. Nevertheless, he doesn’t address the most important question, which is, where is the money for all this going to come from? All he says in Mid Year Economic Analysis is that: “consideration should be given to address the neglect of public investment in the recent past and also review medium term fiscal policy to find the fiscal space for it(Italics in the original).” What he means here is that the government will have to somehow figure out how to finance the increased spending in the budgets to come. A document which runs into 148 pages could have done slightly better than that. So, let’s look at the options that the government has? It is not in a position to raise the tax rates, given the economic scenario that we are in. The other possible option is to cut down on non-plan expenditure which makes up for around 68% of the total expenditure of the government and use the money saved to increase public spending. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure. As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. Hence, slashing this expenditure is easier said than done. Another option for the government is to sell its assets, put that money into some sort of an infrastructure fund and use that money to finance higher public spending. But as we have seen over the last few years the disinvestment process has been a non starter. Now that leaves the government with only one option i.e. to finance the higher expenditure by borrowing more. This will lead to several other issues. As T N Ninan writes in the Business Standard: “The government could borrow more and invest, but the history of public sector investment is that, outside of sectors like oil marketing, the return on capital employed is lower than the government’s cost of borrowing.” While return on capital employed is not the best way to judge increased public spending, there are other issues that need to thought through as well. The government of India had managed to push its fiscal deficit down to 2.7% of GDP in 2007-2008. In 2008-2009, it decided to start increasing its expenditure to finance social schemes like NREGA and to give out subsidies as well. This pushed up the fiscal deficit to 6.4% of the GDP in 2009-10. This increased spending by the government helped the country grow at greater than 8% during a time when growth was collapsing all around the world in the aftermath of the financial crisis which started in September 2008. But it also led to a scenario of high interest rates and inflation, and a huge fall in household financial savings. The household financial savings have fallen dramatically over the last few years. The household financial savings rate was at 7.2% of the gross domestic product in 2013-2014, against 7.1% of GDP in 2012-2013 and 7% in 2011-2012. It had stood at 12% in 2009-2010. Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. A fall in these savings led to high interest rates. The government was not creating any physical infrastructure through this increased spending. It was basically doling out money to asection of the population. As this money chased the same amount of goods and services it led to high inflation. Subramanian’s plan on the other hand is to use the increased government spending to create some physical infrastructure. Hence, increased government spending will not directly translate into inflation, as was previously the case. Nevertheless, all government spending in India has leakages and these leakages are likely to lead to some inflation. Further, there has been sharp fall in productivity over the last couple of years. As Swaminathan Aiyar puts it in his today’s column in The Economic Times: “After 2012, the investment needed to produce one unit of output has gone up from four to seven units.” Long story short—these issues need to be thought through. Further, an increase in spending can push up fiscal deficit again to a level, which the international rating agencies as well as foreign investors may not like. If the rating agencies downgrade India or even threaten to downgrade India that will lead to a huge amount of foreign money leaving the debt and the equity market. If the foreign investors see the Indian fiscal deficit going out of control they can also choose to exit India. This will lead to the rupee falling to levels which are not health for the Indian economy. And since we import more than we export any fall in the value of the rupee tends to hurt us more. This is something that the country went through only last year, and it should not be so forgotten so quickly. Even if a part of the money invested in the debt market starts to leave the country, the rupee will crash against the dollar. This is precisely what happened between June and November 2013, when foreign institutional investors sold debt worth Rs 78,382.2 crore. The rupee crashed to almost 69 to a dollar. Over the last five years economists and columnists have been complaining about a high fiscal deficit, high interest rates and high inflation. A major part of this came out because of the huge jump in government spending starting in mid 2008. Ironically, the same guys are now recommending that the government needs to increase its spending to create economic growth. In fact, this noise is only going to get louder in the new year. What this tells us is that economists and columnists (who also fancy themselves as economists) basically have two ides: cut interest rates (an idea which came from Milton Friedman) and increase government spending (an idea which came from John Maynard Keynes). These two ideas keep repeating themselves in cycles. And now that Raghuram Rajan hasn’t obliged with an interest rate cut, the economists have jumped on to the increasing public spending idea. A version of the second idea is when the government decides to increase spending through printing money. The conspiracy theory going around is that is exactly what the government may be planning. Meanwhile, I am waiting for the day when an economist comes up with a third idea. The column appeared on www.equitymaster.com as a part of The Daily Reckoning, on December 23, 2014