Budget 2016-17: A mid term correction called for

The common person should be happy that the government has kept to the path of fiscal prudence and stuck to the fiscal deficit target of 3.5% of the GDP because this is one measure that will help keep prices stable. At the same time, Finance Minister Arun Jaitley has announced a plethora of plans for crop insurance, health insurance, LPG access, affordable housing, employment generation and more funds in hands of panchayats and urban local bodies, better roads and power in rural areas.

Hopefully, taken together and executed without hindrance and leakage, this will reverse the cut down in the social and rural sector budgetary allocations in the last two years and stimulate consumption demand, especially in rural areas. At the same time, improvement in rural connectivity and markets could keep prices of essential commodities under control. All of this, taken with the tax increases, like the one on high value cars, signals that the Budget is set to work in the nature of a course correction and favours the common man over the rich.

But the big question is, how would the government meet the expenditure for all these projects and plans without increasing the fiscal deficit? Is there some magical wand at play? The answer lies in the sources of receipts. Increased tax revenue accounts for around Rs 1 lakh crore, disinvestment proceeds account for Rs 31,000 crore and increase of Rs 40,000 crore is shown under communication (spectrum auctions?).

The receipts budget includes a huge profit transfer from the RBI as in the case of last year. From what the finance minister said, he has only made interim provision for meeting the obligations imposed by the Seventh Pay Commission and is setting up a committee to work out details. So, the impact of any additional provision for this outgo on the fiscal deficit is not clear.

In case the disinvestment, receipts from communication and tax revenues do not materialise as planned, adhering to the fiscal deficit figure for 2016-17 at 3.5% of GDP would be quite a feat, especially as the government will not have the headroom to increase excise and other duties on oil and petroleum products as in the last year when the fall in oil prices provided such a bonanza.

The initial sell off in the stock market, as Jaitley read out his speech, was on account of the disappointment with the re-capitalisation figure of Rs 25,000 crore for the public sector banks. Banks have huge loans that are bad or could go bad. Making provisions for these loans and writing them off would mean that banks would face problems of not having sufficient capital for increasing loans to various sectors of the economy that need such credit for growth.

Borrowers are already beginning to feel that banks are reluctant to lend. Various analysts have projected the increased capital needs of banks anywhere from Rs 1.5 lakh crore to Rs 4 lakh crore and the budget provides for only Rs 25,000 crore. Hence, the market was disappointed.

But equally, this would work as a blessing in disguise. The banks with larger NPAs can do fresh lending only if they are able to recover their loans or sell their bad loans and they will make renewed efforts for doing this rather than get comfortable that government capital will be forthcoming. This will also make them more careful in extending fresh loans especially to large borrowers. They may increase their exposure to retail and housing rather than expose their impaired balance sheet to the impaired balance sheet of corporates.

“Comatose” condition

Today, there is much more realism in assessing the extent of bad loans in banks’ balance sheet and rather than driving them to a “comatose” condition (as described by a noted banker), maybe the shock treatment will drive people into action from all sides – the borrowers, the banks, the auditors and the supervisors – which would be a very good thing.
Financial stability of the banking system is certainly not threatened at this stage, but if this exercise of diving deep into the asset quality had not been undertaken by the RBI, financial stability would surely have got threatened in the near future. The transparency in the system will bring in credibility and corrective action, which will be all for the good.

Also the proposal for single sponsors and 100% FDI proposal in Asset Reconstruction Companies will help clean the banks. Hopefully, the Bank Board Bureau under Vinod Rai will soon get cracking on its job for ensuring better governance and autonomy of banks.

Remaining on the path to fiscal consolidation also augurs well for the bond markets, interest on government securities and, in general, for interest rates in the economy. The benefits will pass on to the bank borrower as the worries of crowding out due to larger government borrowing ease. This was clearly noted in the response of the 10-year bond to the budget.
The new feature in the Budget is the tax on dividend income in hands of those who get more than Rs 10 lakh annually by way of dividend income, which is completely exempt currently. There is also a proposal to increase surcharge to 15% from 12% on those who earn over Rs 1 crore. While there are many who argue that the tax on dividend amounts to double taxation, the Dividend Distribution Tax is certainly a very regressive one, and in a developing economy, it is quite jarring that dividend income is not taxed in hands of the recipient.

The Economic Survey 2016 did a yeoman service by allocating a whole chapter on how government subsidises the well off. Given that the correctives to this subsidy regime will take quite a few years, the surcharge on income tax for the super rich and the tax on dividend can by no means be considered unfair or illogical. All in all, the signal is a focus on the India that is not doing too well, and the trick of making it work will lie in sticking to the numbers.

(The writer is former Deputy Governor, RBI)

(The Billion Press)