As Finance Minister Arun Jaitley readies the fourth Budget of Narendra Modi-led NDA government, the single most important economic disruption that he needs to consider is the government's decision to demonetise 86 percent of India's currency in November last year. Anecdotal ev idence suggests that the surprise move to reduce the availability of cash in the economy has badly hit the informal sector that accounts for about half of India's $ 2 trillion GDP and employs almost 80 percent of the country's workforce. An economic slowdown, even if temporary, is majority forecast. Statistical proof is yet to back up anecdotal evidence, but the ruling front, which is well into the third of its five year term and faces five state elections including one in India's most populous state Uttar Pradesh in weeks from now can hardly take any chances. Hence, it was only natural that demonetisation, and possible budgetary interventions to mitigate its negative fallouts, dominated the pre-budget panel discussion hosted by Business Today. The discussants, including BT Editor Prosenjit Datta, the moderator, and six economic and political stalwarts - Shubhashis Gangopadhyay, Research Director, India Development Foundation; D.K. Srivastava, Chief Policy Advisor at Ernst & Young; D.K. Joshi, Chief Economist, Crisil; Mukesh Butani, Non Executive Chairman and Managing Partner BMR Legal; Abhijit Sen, former Planning Commission member and Bhupender Yadav, Rajya Sabha MP, BJP - were near unanimous in their opinion that Union Budget 2017/18, to be presented on February 1, 2017, will have the "demonetisation" imprint all over. Excerpts:
Prosenjit Datta: What do the macroeconomic numbers presented so far by India's Chief Statistician T.C.A. Anant tell us about the Indian economy?
Dharmakirti Joshi: The numbers that have come out don't capture the post-demonetisation impact clearly. Since this is a year of good monsoon and since we have a mild push to demand from the increase in salaries of government employees and the veterans and monetary policy also has a lagged impact on growth, the general expectation was that some of it might start filtering in. So that was expected to lift growth in the second half. Now demonetisation has clearly offset that, more than offset. So clearly growth is going to slow down in the second half of this fiscal year and not increase as was expected earlier. So, I think clearly what we should expect is a downward revision of these numbers.
Mukesh Butani: To some extent I agree with Mr. Joshi that many of the numbers really did not factor in the impact of demonetisation and I'm not sure that even if today you want to sit and assess the impact you can do it with some reasonable degree of accuracy or deploy some scientific tools to be able to do that. I would imagine that in order for people to even assess the impact, we will have to see this fiscal year pass and hence it becomes a challenge of sorts for Mr. Jaitley in deciding what kind of Budget he is going to present, which would be a mix of fiscal measures, easing restrictions on cash withdrawals, so on and so forth.
Shubhashsis Gangopadhyay: I am not surprised by the figures that indicate a slowing down of the economy. I think much of what the economy of the country now needs is state level activity and the central government can do very little. It can create an ethos but the actual things on the ground have to be done by the state governments. And there I'm afraid that while some states are doing very well, there are many which are still caught up in the pre-90s mindset. So I'm not surprised by these figures. If you observe that investment has really not done what it should have done so it's not surprising that our growth rates are slowing down. Plus there was some discussion on the GST and I think Indian businesses are not very good at risk taking. I'm sure everybody is waiting and watching to figure out how this GST system pans out before they take long term decisions. So I think this year was not a surprise for me, the fact that the GST has been pushed back or seems to have been pushed back creates uncertainty for next year too. But I was looking at this year, as just a readjustment year even before demonetisation.
D.K. Srivastava: I see the macro fiscal news pre-demonetisation spelling out a major policy challenge to the government. If you look at the output side, except for agriculture and public administration, all sectors show a lowering of growth. If you look at the demand side, then you would notice that the rate of gross fixed capital formation has been falling successively for three quarters and the fall has been increasing in terms of the magnitude, and therefore there is a major investment contraction that had already set in even before demonetisation impact came up on the scene. Demonetisation for all its pluses and minuses implies a kind of consumption contraction. So, you have a macro situation where investment contraction is being followed by consumption contraction and therefore if this is the major policy challenge then there has to be a clear route for the government to let the economy emerge out of this kind of macro fiscal problem. In fact, it is in some ways bad news because all the time we were thinking that pre-demonetisation at least we would have the old budget estimates of 7.6 per cent of GDP and 7.4 per cent at least for GVA (Gross Value Added). But now post-demonetisation it has come to 7.1 and 7 and therefore whatever is to be added is further bad news on this. Therefore the policy challenge is really how aggressive the government can be in order to stimulate the economy and what should be the sequence of thought, that is whether fiscal or monetary. Now added to this is the challenge that is coming from the way the world economy is shaping up. Now you know that Mr. Trump has promised that he will reduce the corporate income tax rate all the way from something like 34-35 to 15 per cent and the interest rate in the US is slated to go up and therefore a lot of FDI and FII would start flowing out not only from India but all emerging economies. So, you would need to stimulate the economy precisely at the time when a good amount of investible potential, investible resources, would be difficult to attract and therefore it is a major policy challenge and I'm talking about the macro fiscal picture only.
Abhijit Sen: I had expected a much better first half for this year than what we got. The reason was that the world economy was looking up rather than down as now. The first half also happens to be when everybody thought that Clinton was going to win rather than Trump, and the world economy was supposed to be going on a certain trajectory. Domestically, the two big news about this particular fiscal was that we're going to have a normal monsoon after two very bad ones, I personally expected agriculture to grow at about 8 per cent this year and you had a bounce back not only because of that but also because of the Pay Commission impact on consumption spending. Added to that, the government actually managed to clear two very important Acts, GST and Bankruptcy, which I had hoped would give investors reason to actually become optimistic; none of that happened. Essentially what has happened is investment has gone on its way downwards and that's the main reason for the lack of demand that you see. I don't think we're seeing in first half any real supply side contraction, it's mainly demand side contraction. I had really expected 7.7 - 7.8 per cent sort of GDP growth, but what we may get is 7.1. So I think really it's disappointing to start with and mainly disappointing on the investment side.
Prosenjit Datta: Can there be a comprehensive assessment of the impact of demonetisation?
Bhupender Yadav: Sometimes we discuss demonetisation as a single act. It is not. It is the latest among a series of events which shows the commitment of the government towards stable and long term development of India. The government did work for social inclusion by providing credit facility to the small scale sector through schemes like Mudra Bank and others. It made so many legislative changes, and made executive orders to move towards better social security, economic inclusion and transparent administration. Tax simplification is one of the main objectives of the government. GST Bill, Bankruptcy and Insolvency law, Sarfaesi Act, Benami Act or an amendment in Prevention of Corruption Act were all meant to change the system of governance. The synchronisation of the rail budget and the general Budget also shows the commitment of the government to not go by mere populist measures, but to stand for the stable development of this country. I think even after demonetisation there has been a good growth in the agriculture sector, especially in the Rabi sowing season. I think demonetisation is one such measure that will give a push for future growth.
Abhijit Sen: The one thing demonetisation has almost certainly done is induce a contraction in consumption demand. We already had a demand side problem that would have got multiplied. So, if the news was bad pre-demonetisation, it's going to be even worse in the next six months. As far as the supply side constraints are concerned, I think this is new and this is big because, as a result of demonetisation, there is a major obstacle to working capital, especially in the unregistered sectors. The working capital flow that has worked here so far has hit a huge road block. It will take time not just for working capital to revive even after currency comes back but for even new arrangements to be found, new definitions of trust to be formed for that sector to rebound back. There are also liquidity constraints which will affect the working capital arrangements particularly for the non-registered sectors. Taken together, I would be very surprised if we touch 5 per cent GDP growth in the next two quarters. Well, for the whole year it's an average of 5 and 7 so it's near about 6.
D.K. Srivastava: There is no controversy about the fact that there is a contraction in the economy and it is consumption led. The effect of demonetisation is to add a consumption-led contraction on a pre-existing investment contraction. The question is only about the magnitude and extent of this contraction. And it is of course very difficult to summarise what it would eventually turn out to be in the final analysis. But I think there are two or three clues that we can talk about. One is the effective currency availability related to GDP in the demonetisation period. While there is a lot of data around, we notice that the effective currency to GDP ratio, which in India pre-demonetisation or at the point of demonetisation was about 12.5 or so, has been halved effectively for these last two months. That's a massive contraction of available currency in the system and therefore it is going to have a sharp effect.
The second clue is the sectoral clues. Which were the relatively more cash intensive sectors. For example, agriculture, construction, and we also talk about some retail trade and some of the services that are cash intensive. Obviously those sectors will have a heavy load to bear as a result of contraction. Now, some of these service sectors actually do have a high, relatively large, weightage in the GDP. Some of these things could have been avoided, but because of this, the fall in the GDP growth would be in the range of 1 per cent at least.
Prosenjit Datta: About 50 per cent of the currency is back in circulation and SBI chief has said that it is very likely that by February end the bulk of the cash which is required will be back. What will be its effect?
D.K. Srivastava: In a monetary policy context, we have entered into what some policy makers call a dark corner. It is because of the fact that the inclination of people to hold on to currency has gone up to a very large extent, almost infinity, that is to say when people get hold of currency, they just hold on to it. The normal process used to be that you get currency, you use it in exchange, it goes back into the banking system and it gets circulated. But now it's almost two months now and people are not putting their currency back into the system and therefore every time when you go to withdraw it's a new currency note that you're getting hold of and therefore this is a very unpredictable phase that we have entered. So although remonetisation may exceed let us say about 70 per cent or so by mid-March, the habit of people has changed. It will take time for them to normalise.
Bhupender Yadav: One definite impact of demonetisation will be an increase in India's tax base. The major threat to our economy is the parallel economy. With this move, we are bringing in more people into the formal economic system. Hence, we will get a fair GDP in future. In the short term, there is an absence of any certain data. We ourselves say that certain data is available only up to October 15. Given this fact, how can you predict any other thing? Let us hope that this decision will have a good impact.
Prosenjit Datta: We have seen some increase in tax revenue data shared by the finance minister. We have also simultaneously seen a credit shortage, a credit drop, a credit demand drop. Post demonetisation, how do you see these things play out?
Subhashis Gangopadhyay: Regardless of whether money is coming into banks or not, I don't think there was ever a discussion of investment going down, there was ever a discussion about people not being able to get hold of funds because banks were unwilling to lend. So the fact that the banks had no money did not change things. I don't think it will have any impact unless there is any real reason for investment to pick up. The fact that banks have money is not going to help. Just because they have money they are not going to lend to projects that they would not have otherwise funded. I don't think the rate of interest is the issue here, the rate of interest for long term investment, especially when you're talking of major changes in the economy and we are going through a transformation. The interest rate I don't think affects the investment that much, especially in a changing economy like ours. It's investors' confidence that is more important. But I think to be able to understand the impact of demonetisation, yes, it will have a negative impact, I'm not denying that, how much I don't know. But I think one thing we have to understand, and this we have to acknowledge, that the informal sector, a large part of our economy as opposed to the parallel economy, is a large absorber of the so-called "black money" and hence, we see what we observe. The black economy was squeezed, and the moment it was squeezed the informal sector was squeezed and hence we hear about people losing jobs, much of the jobs were actually funded with resources from this parallel economy. I wouldn't call it parallel because it is not parallel as it was quite integrated to the actual economy in this field, to the informal sector. So, for us the important thing is how quickly we can make the informal sector into a formal sector. All the good things about demonetisation that we're talking about will have an impact if we can reduce the informal sector and increase the formal sector.
Prosenjit Datta: What should the Finance Minister ideally do in the current Budget?
Abhijit Sen: If the Finance Minister basically says that these are problems we are facing in the economy, much like what we've said, and emphasises that we need to have a government led recovery, it needs to spend more. On the other hand much of this depends upon all the parties agreeing to major reforms like GST. Also we're going to get the recommendation from the FRBM committee on fiscal discipline. In order to pass things like GST (this discussion was conducted before the GST council agreed on modalities) and others, you will need the other parties to come on board. That is unlikely until the state elections are over. So Jaitley should perhaps postpone the vital part of the Budget (expenditure side)except an intent on larger government expenditure to a later date. Once all the political tamasha is over, you can get back to the serious business of actually making a Budget and taking into account both better information and a political climate more suitable for a Budget.
Bhupender Yadav: Definitely, after demonetisation, people expect more tax reforms, people expect more social inclusion, people expect more investment in infrastructure, people expect more job growth and more growth for the rural sector. In the last Budget, you had seen consistency in and continuity of the steps taken by the NDA government in power. I think it will reflect in a people friendly Budget.
Mukesh Butani: If I was supposed to give just one recommendation that he should get passed, which is going to lay down the framework for the economy regaining its strength, I think it would be consensus on the GST. If a consensus on the GST is achieved, I have no doubt in my mind, that you're really looking at entering a phase of a different kind of tax compliance altogether. And in a way, if you're saying that your income disclosure scheme coupled with PMGKY (Pradhan Mantri Garib Kalyan Yojana) is going to add more tax payers, then that coupled with GST is going to give to the government a fairly sustainable set of a revenue tax payer base. To some extent I also agree, that we don't need to be prisoners of FRBM, if a flexibility in the FRBM targets is going to lead to a situation where the economy can go back to its original growth path, I think it would be worth the gamble. But having said that kindly bear in mind the level of mistrust between the states and the government. Let us take for instance the compensation formula. What is compensation formula at the end of the day. The states are saying please make good my loss or give me the necessary fiscal leeway to tamper with my FRBM targets, because the entire debate on compensation loss for GST is that. So I think once you get past the GST you possibly will be able to build that minimum level of trust with the state government and in a way simultaneously kind of formalise the fiscal room, additional fiscal room that is available to the states. I think one can do that.
Dharmakirti Joshi: I would say that I agree consumption needs to be given a push but there are ways of doing it. One method which has been tested is that you can create infrastructure and also give a boost to consumption. We've seen it during Vajpayee's time also, so that momentum should be further increased. And the second thing is, through the tax reforms. We have already done demonetisation, we are also getting more tax payers into the net, now simplify the tax system so that you can reap the benefits of it.
Prosenjit Datta: Most limits in IT even deductions like medical, insurance premium and all that, was set 10-15 years ago ...
Dharmakirti Joshi: So fixing that and reforming direct taxes will give a boost to consumption demand and I think together with simpler and fairer tax system and with more people into the net, I think your buoyancy will only increase. We've already seen it when we reduced direct tax rates, direct tax collection actually increased revenue, and did not fall as a percentage of GDP.
Shubhashis Gangopadhyay: There are a few things he has to do when he presents the Budget to increase the trust in demonetisation and all of that. One is that he had made a commitment to reduce corporate tax and get rid of exemptions. Unfortunately in the last Budget he announced many more exemptions, so he has to correct that. It's already two years down the road. I think that should be done. The other thing, though I don't think it is within the finance ministry's ambit to do that, since the Budget has become a policy statement and doesn't really depend on or is not restricted to finance only, there is something I wish to see as an economist: Since demonetisation was a bold decision and the government wants to take bold decisions, it should get rid of this small versus large mentality. The support to start-ups is necessary. We're also embarrassed of failing, hence we don't take risk, so therefore the support to start-ups is a good one, but this distinction, between small and large is the root of corruption. The moment you put in thresholds, and unfortunately the government keeps putting in thresholds, every policy that it does, there isno change from the UPA. Every policy comes with a threshold, and the moment you have put in a threshold after demonetisation and digitisation you're just giving more opportunities for corruption. So I sincerely hope, that given the path that they have promised to follow, that they really follow it. Get rid of exemptions, reduce the corporate tax and get rid of these thresholds.
Prosenjit Datta: Now, that we have gone past the ideal, what are the things we can realistically expect given the political backdrop. Will he actually touch taxes at all, what are the expectations, or will it just be more spends on social sector and other areas?
Abhijit Sen: What he has to do, if this is taken to be the final Budget, there is nothing more to come, then one of the things that he has to do is to show some sympathy for people who have suffered. The people who had to go back from Delhi, the poor, there has to be something slightly more perhaps than the Prime Minister has already announced. I don't know what their expectation is, because the expectation is very high on the ground. The second thing is the middle class who are essentially watching for tax cuts or at least exemption limits going up. So these two are the demands coming from the middle class and the class which matters more politically. But if he does that and he doesn't have the FRBM thing, he's got precious little to do for the investment side and in which case you've precious little to show as a Budget.
D.K. Srivastava: Well, I agree with this fact that the Finance Minister has to bring the mood of the nation a little more on the positive side. The nation is sulking in silence. Therefore there has to be something that sets the mood of the people right and this in the Budget making context generally results into the numerous listing of concessions. We got a sample from the speech of the Prime Minister, so I think one part of the budgetary exercise is going to be about additional concessions. In my view that is, the less important point. This is symbolic, this is going to be framed in a way in which heavy magnitudes will not be involved, but the number of concessions could be quite large. But what is really going to affect the economy and what is really going to push the economy, and therefore in the medium to large term make the mood of the nation actually right, is what happens immediately after the Budget, and by that I mean is that the case for bringing the Budget forward. There is only one reason for which it is being forwarded and that is the government would be able to spend almost immediately after the March. And the complaint has been, that if you have a Budget, which is actually passed in May or so, then you'll lose the monsoon months and you'll start your expenditure programmes sometime in September, which is what happened last year and for all these successive years. So the case for bringing forward the Budget is to actually, as soon as you have the approvals, gain additional three to four months of spending and that expenditure has to be large. So, I come back to the issue of how are you going to finance this. I think the government would gain fiscal windfall out of demonetisation, both because of extinguishment of money and because of additional tax revenue, one time IDS 2 (Income Disclosure Scheme), in addition to IDS 1, and therefore let us say that would give the government a short term push of about 0.75 per cent of GDP. And that must be immediately spent. Now you should cap capital expenditure related to the GDP of the central and the state governments, the budgeted was 4.5 which is less than what should be ideal but actual is not going to be more than 3%. So you are actually starting with a deficiency in capital spending.
The whole point of achieving revenue cum balance was that, all that you are borrowing must be spent on capital spending, it's not happening. That is what has got to happen. But this must also be counterbalanced by one major disadvantage to which Abhijit referred to earlier, which is to say that we're making Budget also blindfolded, in terms of information availability. Now, look at the seasonality of the way tax revenues are actually gathered. You would find that there is seasonality, which is June, September, December and March, these are the peak months when revenues actually very sharply increase. And we are going to miss the December and March peak, because we are going to really look at what is the data available for two peaks. The June peak is a very mild one, September is a more meaningful peak and that's all we're going to get put in the December peak. A good amount of data that is presently shown in terms of tax revenue is actually advance payment in November itself. So, I think that the advantage of advancing expenditure can be really realised only when you spend. But if you get the Budget approvals and don't spend, then of course that advantage would be lost, but at the same time the quality of Budget making is going to suffer unless we change the ways in which revenues are collected.
Shubhashis Gangopadhyay: I am not a good economist, so I don't predict. Really, as I said, I expect him to commit to do what he had committed to, since it's the second opportunity you will have, last time he ducked, but this time he should?Yes, but he had the opportunity to do something last year, which he did not, he ducked, this year he should move towards what he had committed to and I do hope that he gets rid of the exemption. That's all.
Bhupender Yadav: I conclude only this, that as far as the functioning of our government is concerned, definitely our Prime Minister is working very hard for the elimination of poverty in our country. So I hope, that it will be for the economic inclusion of all poor sections, it will provide an opportunity to the aspirational Bharat.
Mukesh Butani: I think he will take a bold step in terms of rejigging the tax rates. Because I think he recognizes that lower tax rates have a spill-over impact because there is only so much that the government can do by increasing the spend on infrastructure. So I think, whereas common man's objective will be in his mind from a political standpoint, but I don't think he is going to ignore business. I also anticipate that there will be some bold tax regulatory reforms for political parties. I think the Prime Minister indicated that in his speech. "If Trusts are taxed on anonymous donations, why shouldn't political parties be". We keep on talking about the parallel economy, but we don't talk about the parallel economy that gets generated because of our political systems, so I would expect reforms. Maybe there is something on the land side, land reform side as well; I don't know whether the current Benami Act is good enough for him to address the menace of parallel economy that enters the real estate sector. In the past along with the Benami Law, specifically with respect to land laws, we have been talking about national registry. The implementation of some of those bold reforms will lie with the states but I think somewhere in the Prime Minister's mind, he knows that these two sectors have to be dealt with if his larger agenda of curbing the black economy is to be fulfilled. If you look at the impact of demonetisation, I think he recognizes that a substantial part of the parallel economy is hidden in these two sectors so how do you really deal with those two sectors.
Dharmakirti Joshi: On the direct tax front, I would expect changes in slabs, etc. and some rationalisation as far as corporate taxes are concerned. So I think that is one expectation that I have and second I think, we have not talked about employment generation. I think you look at the sectors, construction is the most labour intensive sector and it has slowed down. So I think there has to be a boost to that sector, whether it is through real estate or whatever. Real estate is down so I think there would be some measures to push construction activity whether it is roads, whether it is houses. I expect measures which generates employment because it has been a casualty in the last few years. ~
For Dharmakirti Joshis exclusive column on rupee volatility go to businesstoday.in/D.K.JoshiFor Mukesh Butanis exclusive pre-budget column, go to businesstoday.in/MukeshButani