What is the defining legacy of the Indian budget 2015-16?

Examining the budget for its revenue and expenditure projections and other announcements.

Analysing and Indian budget is a tricky job. At its core, it is a statement of government revenue and expenditure. At another level, it is a statement of economic policies of the government. Governments, over the years, have used the occasion of the presentation of the budget to announce a slew of economic initiatives. Hence, budget presentation days have become a day of policies with budget being one of the announcements.


The government looks set to meet its fiscal deficit target of 4.1 percent for the year ending March 2015. In July 2014, the NDA government presented its first budget, for the financial year ending March 2015. They only had nine months left in the financial year. Yet, they announced ambitious targets for tax revenues – both direct and indirect. Second, the budget documents had imported text, wholesale, from the interim budget presented by the outgoing UPA government. The budget was lacking both in focus and structure. However, the poorly made budget did not cause much damage to the government. The monsoon did not turn out to be as deficient as originally feared. The collapse in the price of crude oil was a big bonanza.

How did the government meet 4.1 percent deficit target?
For the year ending March 2015, the revised estimate for the fiscal deficit of the Union Government is INR5.126trn against the budgeted fiscal deficit of INR5.312trn. So, in rupee terms, the fiscal deficit will be lower by about INR186bn. The deficit ratio should have been lower than 4.1 percent had the government’s GDP estimate been realised. That was not to be. The nominal GDP now projected for 2014-15 is INR126.538trn versus the budget estimate of INR128.767trn. This is about INR2.229trn short. Therefore, the growth rate of nominal GDP in 2014-15 now projected to be achieved over the new GDP estimate of INR113.451trn for 2013-14 is 11.5 percent versus the budget estimate of 13.5 percent.

In part, the GDP performance has been disappointing because of the tight fiscal compression that a deficit target of 4.1 percent entailed. The mid-year (2014-15) economic analysis of the government, released in December 2014, argued and demonstrated that the target budget deficit ratio of 4.1 percent was tighter by about 1.1 percent to 1.8 percent of GDP over what was realistically feasible. The previous government had projected an unrealistic deficit compression just to stave off a credit rating downgrade. That compression was to be achieved through a severe squeeze in capital expenditure, postponement of expenditure and wildly optimistic assumptions on revenue growth. Those assumptions could be met only if GDP growth wildly exceeded expectations. Alternatively, the tax administration became extortionist to squeeze out tax rupees from all taxpayers. Tax litigation became the norm and India’s reputation for doing business took a hit. Finance Ministers would promise a friendly investment and tax regime to foreigners. Yet, at home, they exerted and exhorted the tax department to go after taxpayers. The hypocrisy hurt the country.

The new NDA government that came to office, unfortunately, accepted the target of 4.1 percent. It looks to have met the target chiefly through expenditure compression. It was also helped by the collapse in crude oil price that saved the government several hundred billion rupees in petroleum subsidies. There were savings in both non-plan expenditure (mostly from capital expenditure) and plan expenditure (both revenue and capital expenditure). No surprises therefore that the GDP growth rate was 2 percentage points lower.

Further, with the private corporate sector maxed out on debt and with the Indian banking system unwilling and unable to lend because of its huge backlog of non-performing debt, capital formation and infrastructure spending in the last several years have stagnated. India’s potential GDP growth has either stagnated or even declined in the last several years. That has implications for inflation in the years ahead. If economic growth revives mostly through demand growth, then higher inflation and current account deficits will return. India’s current benign inflation environment is mostly due to external and one-off factors rather than due to intrinsic improvements on the supply side.

At this stage, one has to mention that the sooner the government got rid of the distinction between non-Plan and Plan expenditure the better. The Planning Commission itself is gone. Hence, this distinction becomes meaningless. Second, most non-Plan expenditure is revenue expenditure except for Defence Capital Expenditure and some miscellaneous capital items.

On the deficit target for 2015-16
The government has projected a fiscal deficit ratio of 3.9 percent for the financial year ending March 2016. It is slightly higher than the deficit ratio of 3.6 percent projected last year for 2015-16. But, this is more realistic. To reiterate, India needs fiscal deficit to come down. But, India needs to do it in a realistic fashion. The previous government has left a big, bad legacy of huge deficit that hardly contributed to economic growth. If anything, they have damaged India’s growth prospects too. That is a double whammy. The new government has still not informed the country about the economic legacy of the 10-years of UPA misrule. It risks Indians blaming it for not delivering on economic growth and foreigners finding it guilty of not delivering on deficit reduction pledges, while the blame should rightfully be assigned to the previous government. [1] Policies – good or bad – affect economies with a lag.

Given this backdrop, a deficit ratio of 3.9 percent vs. 3.6 percent is slightly better for growth but not by much. The good thing, however, is that the government is boosting capital expenditure while letting revenue expenditure rise only modestly in the next financial year. Plan Capital Expenditure goes up by 33.9 percent and Non-Plan Capital Expenditure goes up by 16.3 percent. Plan Revenue Expenditure drops by 10.1 percent mainly because of reduced central assistance for States and Union Territories. Revenue Expenditure under the Central Plan raises, however, by 36.8 percent. Non-plan revenue expenditure goes up by 7.5 percent mainly because the government has budgeted a higher interest payment, assuming a conservative interest rate of 10 percent on the incremental (net) borrowing.

On the revenue side, the government’s assumptions are realistic. First, the nominal GDP growth is 11.5 percent, unchanged from the growth rate projected for 2014-15. Estimates of growth in various sources of tax revenues – direct and indirect – are realistic because they are well below the average annual growth rates seen in the last five years. Of course, excise duty is higher but that is due to the hikes in excise duty on specific products and the rise in the central excise duty from 12.36 percent to 12.5 percent by subsuming the education cess into it. Service tax goes up from 12.36 percent to 14.0 percent for the same reason. While wealth tax was removed, it was replaced with an additional 2 percent income tax surcharge on incomes above INR1.0 crore. In sum, the revenue estimates are not wildly optimistic but reasonable overall and may even be conservative in some instances.[2]

The government has assumed a big receipt from sale of stake in public sector enterprises (INR695.0bn) including strategic disinvestment (INR285.0bn). The word privatisation is taboo in India but that is what it means. That is a welcome development. But, given the massive amounts expected from asset sales, it has to be very efficiently executed and with single-minded focus as soon as the new financial year begins. Towards this end, the Finance Minister has sought to befriend the foreign institutional investor who is the mainstay of Indian stock markets, for the better or worse. He has clubbed FII and FDI limits for calculating the maximum foreigner holding in an Indian enterprise. [3] Second, if an offshore India-centric fund chose to place its fund manager in India, the Fund would not be deemed to have maintained a permanent establishment in India and be subject to tax on the Fund income and capital gains, etc.

One final point on public sector asset sale. We do not necessarily agree that receipt from asset sale should be excluded in calculating the true fiscal deficit, since it is a form of financing. That is a plausible argument but since government creates capital assets with its expenditure, it is reasonable to count asset sale receipts as a source of income. [4]

Macro-economic policies
In contrast to the budget that was presented in July 2014, the budget that the Finance Minister presented on 28 February 2015 was confident, purposeful and coherent. Talking of the 75th anniversary of Indian Independence in 2022 and the goals to be attained by that year reflects vision combined with shrewd political signalling.

Additionally, political sensitivity was amply evident in the announcement of insurance schemes – Pradhan Mantri Jan Dhan Yojana and Pradhan Mantri Jeevan Jyoti Bima Yojana – for the poorer sections of the population and in the announcement of the scheme for minority youth to obtain a school-leaving certificate. Health and Accident cover are very important for the poor. One bad crop and one bad illness or accident can and do tip many millions back into irreversible poverty. The government has done well to follow up on Jan Dhan Yojana (programme for financial inclusion) with these two insurance schemes.

As mentioned earlier, the government borrowing remains largely unchanged. Gross market borrowing will rise only by 1.35 percent and that is good news for government bonds. Government bond yields will decline. The one-year delay in meeting the 3 percent fiscal deficit target should not bother the bond market.  It is good to have a delayed fiscal consolidation rather than a sham one. A clumsy effort at reining in the fiscal deficit puts future fiscal consolidation in jeopardy as the quality of fiscal expenditure declines whenever expenditure compression takes place. Only capital expenditure is cut rather than revenue and administrative expenditure. Most of the expenditure under these two categories is almost automatic. The previous UPA government had left that legacy for the new government.[5]

More money in the hands of States
The government deserves to be commended for quickly accepting the recommendations of the 14th Finance Commission and giving effect to it in the budget. States’ share of Central taxes in 2015-16 will be 36.2 percent vs. 25.7 percent about ten years ago.[6] Together with Central grants and loans, States and Union Territories will receive INR8.43trn in 2015-16. In 2013-14, that sum was INR5.18trn. That is a 60 percent jump in two years. It is a profound paradigm shift. Some newspaper reports suggest that the States are not really getting a bonanza as Central grants from States will be reduced.[7][8] That is the intent of the Finance Commission recommendations. The intent is to reduce the Union Government’s discretionary allocations to States and to raise the mandatory share of States from Central taxes. If States have a problem with their accumulated excesses of the past (e.g., West Bengal), neither the Union Government nor the Finance Commission can be blamed for that.

States are yet to grasp the potential and ramifications of that. States can use the windfall to reduce their deficits and boost infrastructure spending. For example, they can reform their State Electricity Boards. Or, they can engage in reckless, unsustainable and politically motivated give-aways. To use the money wisely, they have to up their act and they need competence. State administrations have to gear up in a big way. Competency deficits in states could become big bottlenecks to development.[9]

Infrastructure, Enterprise and Manufacturing
The announcement of the new MUDRA Bank, the promise of a comprehensive bankruptcy code, the choices that will now become available to workers both under ESI and EPF and the labour reforms that have been announced in the past nine months fit nicely into a coherent plan of boosting domestic enterprise and manufacturing. The audacious thought behind the proposed ultra mega power plants in “plug-and-play” mode based on a transparent auction system with all clearances and linkages pre-arranged deserves commendation. This comes on the heels of transparent coalmines auction.

Paragraphs 47 and 48 of the budget speech deal with the setting up of a National Investment and Infrastructure Fund (NIIF). The budget speech mentioned an amount of INR200.0bn as the proposed equity for the Fund. To the best of our understanding, the government has not made any allocation for it in the budget. It is interesting, however, to note the government outlining its thinking on how it sees funds flowing into infrastructure. NIIF will use its equity to borrow in the market and invest in equity in other infrastructure entities such as Railways Financing Corporation (IRFC) and National Housing Bank (NHB), etc. They, in turn, can use that equity to borrow and fund infrastructure initiatives. Multiple layers of refinancing are envisaged, thus. What it would do to liquidity and availability of borrowing for the private corporate sector are anybody’s guesses, for now.

If the private sector sought to meet its funding requirements by borrowing in overseas markets, then it would be running up a big foreign exchange risk. By most accounts, it has already done so. The envisaged or implied market borrowing for infrastructure spending might leave them with no option but to travel further in that direction. That is a potential systemic risk.

Separately, the scheme announced to monetise gold should help unlock household funds, tied up in gold, for infrastructure investment. It is hard to estimate the quantum of funds that would flow from this initiative into the pool of funds that the government can draw from.

In paragraph 56 of his speech, the Finance Minister links the development of a deeper bond market to finance infrastructure development. International experience suggests that a deep bond market is not a necessary condition for infrastructure development. Nor is there any causal or conceptual linkage between the setting up of a Public Debt Management Agency (PDMA) to manage public debt and to issue bonds and debentures of the Central government and the development of a domestic bond market.[10] The growth of private debt market will be greatly facilitated if the Government of India gives up its first claim on banking resources through the Statutory Liquidity Ratio. Until that happens, these measures are symbolic. At one level, the setting up of a PDMA is a welcome step; if it prevents the government from leaning on the central bank to monetise its borrowings as happened under the UPA government between 2010 and 2013.

One thing is clear. The government has applied its mind to the issue of funding and boosting infrastructure investment. It is planning well. It has to execute well too. Many forces are at work to thwart the government’s intent. The government needs to be aware of them. Of course, that is a different topic for a different occasion.

One only hopes that other organs of governance – the judiciary, in particular – do not position themselves in an automatic adversarial mode. Entertaining frivolous litigation and stalling sound policy initiatives by casting oneself in the role of a policymaker is a national tragedy that the judiciary should be careful not to enact.

Eliminating taxation uncertainties and dealing with black money
The announcement of a roadmap for reducing corporate tax rates and the removal of corporate tax exemptions is a very welcome one. Staying with taxation, the government has done the right thing to clarify on General Anti-Avoidance Rules (GAAR) not only by postponing it for two years but also by making it applicable only prospectively and not retrospectively. Clarifications on the taxation of dividends paid by foreign companies, non-determination of the status of an offshore fund based on the presence of the fund manager in India and the promise of regulations with respect to the operationalisation of GIFT are further proofs of holistic thinking.

Clearly, the government has given a lot of thought to eliminating cash transactions and the reduction of the role of black money in the economy. The detailed measures announced in the budget stand testimony to that. The government is walking the talk on this one. As mentioned earlier in the discussion on the treatment of FIIs, it would be useful to abolish P-Notes if it is superfluous for foreign investors into Indian equities. Continuing to keep that instrument available in the face of diminishing foreigner interest in it would only bolster perception that the government is not serious about tackling black money.

While on the subject, we should note her that many countries have well-established procedures to dispense with high denomination currency notes. As a resident of Singapore, I can safely state that getting even currency notes of SGD100.0 are not that easy. If one wanted Singapore dollar currency notes of 1000 denomination, one has to state the purpose and sign on some forms before the bank hands over the cash to the customer. India should actively consider demonetising the existing 5000 and 10,000-rupee notes and, for the future, institute procedures for customers obtaining cash in denominations of 1000 Rupees or higher, drawing upon best practices from overseas.

Conspicuous omission
The Finance Minister missed an important opportunity to set in motion improvements to the process of budget making and to put in a new fiscal responsibility framework.  This is necessary to ensure that future deficit targets are both quantitatively and qualitatively credible and that deficit compression in the short-term does not come at the expense of long-term economic growth and fiscal sustainability.

For instance, IndiaInfoline research points out that the bulk of the proposed spending on railways and roads – infrastructure sectors is through Internal and Extra Budgetary Resources and not through Budgetary support for Central Plan Outlay. To the extent that these extra expenditure are undertaken by the statutory bodies and corporations set up under these Ministries and not by the Central Government itself, the true fiscal deficit is understated. That is why the focus should be on the General Government Deficit and not just the deficit of the Central Government. A general government deficit figure includes the final deficit of all government entities – Central and State governments and government entities.

Banking and Central banking – huge steps backward
The announcement on the setting up of an autonomous Bank Board Bureau for public sector banks as an interim measure to not only select bank heads but also help them in recapitalisation shows that the government is serious about operationalising the pledge of non-interference made by the Prime Minister to banks recently. Details, especially the timelines, are missing.

The absence of a plan for dealing with the existing stock of non-performing and restructured loans with banks is also a disappointing and serious omission. Reduction of the bad debt stock in banks and their recapitalisation are critical for the flow of credit to the new infrastructure fund and various government corporations as outlined in the budget speech and as envisaged in the expenditure proposals of the Ministries of Roads and Railways, in particular.

Above all, the most regressive measure outlined in the budget speech is the proposed appropriation of the powers of the central bank on the management of capital flows. Capital flows management is a technocratic matter. It is best left to experts and not left to bureaucrats who have no special expertise in capital flow management or to politicians. The Central Government frames policies on foreign direct investment in any case. There was absolutely no need to take on board – partially or fully – the ill-considered and wholly irrational division of responsibility with respect to capital flows on debt and equity and between inflows and outflows, proposed by the Financial Sector Legislative Reforms Commission (FSLRC) which submitted its recommendations to the Government of India in 2013. The Finance Minister should consider retreating from this ill-considered proposal.

In fact, subsequent to the budget presentation, it has come to light [11] that the Government intends to transfer powers on the regulation of derivatives that derive their value from underlying ‘securities’ with ‘securities’ as defined [12] in Section 45U (e) of the Reserve Bank of India Act 1934 as amended in 2009. In addition, the power to regulate Repurchase (repo) and Reverse Repurchase (Reverse Repo) transactions on government securities are being removed from RBI.

Simply put, the power to regulate derivatives on all government (Central, State and local) debt and repo and reverse repo transactions on government debt shall, henceforth, vest with SEBI and not with RBI. The transfer of regulatory powers with respect to derivatives whose values are derived from underlying government debt securities may be understandable because the government has plans to set up a separate PDMA to issue and manage public debt, which task is currently performed by RBI.

However, to vest regulation of transactions in Repo and Reverse Repo securities with SEBI is baffling, to say the least. Repo and Reverse Repo transactions are usually undertaken in government securities and are used by banks to manage their liquidity. The counterparty in such transactions undertaken by commercial banks is the central bank of the country. To entrust the regulation of these transactions to the regulator of Securities Markets makes no sense, to put it mildly. That it was not mentioned in the Budget speech raises more disturbing questions about the motives and goals of the exercise.

This leaves us with one disturbing conclusion: the government has not applied its mind to the FSLRC recommendations. In many respects, the recommendations of the FSLRC appear to have been framed with the sole purpose of undermining RBI. It is hard to present evidence on intentions but such an inference is reasonably drawn through an examination of the various recommendations of FSLRC. If all recommendations of FSLRC are implemented, RBI will only be responsible for monetary policy, which will be decided by a Monetary Policy Committee (MPC) dominated by government nominees. Responsibility for regulation of banking and payments will be given to a separate regulator. Financial Stability will be in the hands of the Financial Stability and Development Council, which will be overseen by the Finance Minister. In other words, the Reserve Bank of India will be reduced to the role of a relatively unimportant department of the Ministry of Finance while the Governor’s job will be that of a rubber stamp of the MPC overwhelmingly staffed with government nominees.

It is important to understand the context in which this is happening. The United States is keen to open up services sectors in developing countries for its corporations. Its bilateral investment treaties are means to that end. The transfer of regulatory powers over the financial system and the financial sector from RBI, with its stellar reputation for integrity and distance from the financial sector, to the government raises the risk of regulatory and other forms of capture of the government by the financial industry.

The United States may be either unwilling or unable to reverse financialisation. However, world over, it is being recognised that financialisation has wrought havoc with economic system stability and has contributed, at least partially, to rising wealth and income inequality. It has spawned excessive executive compensation policies that have harmed long-term interests of shareholder, workers and the economy. Such policies have incentivised corporate managements to accord primacy to the goal of boosting share prices in the short-term over investing surpluses for long-term growth. Serious rethinking is going on in several capitals on reining in and even reversing financialisation of economies.

In India, RBI has won praise from well-meaning and disinterested observers and academics for its calibrated and cautious approach to financial liberalisation. If the government and the Finance Minister, in particular, were open-minded about educating themselves on the complexities of regulating the modern and globalised financial sector, it could do no worse than starting by reading three pieces links to which are given in the footnote below.[13]

The government should consult widely with past RBI Governors and study international practices and experience in this matter. The government’s treatment of national institutions should transcend both short-term and personality based considerations.

In fact, just as the Food Security and the Land Acquisition (Rehabilitation and Resettlement) Bills are the worst legacies of the previous government that have caused semi-permanent damage to India’s future growth potential, this government’s legacy might become the evisceration of one of India’s reputed institutions, trusted for competence and integrity. That it reflects no learning from recent experiences in the world with financial liberalisation is madness. That the process could be unfolding, unintended and unconsciously, is sadness.

The Union Government budget for 2015-16 has several things going for it. It has taken calculated risks with the purpose of boosting the country’s productive potential. Hence, one did not want to end this piece on a note of disappointment. But, it is a fact that one cockroach is enough to spoil a bowl of cherries.

[1] Existing fiscal rules required the government to eliminate effective revenue deficit by March 2015 and limit revenue deficit to 2.0 percent of GDP. Now, the government projects that these will be achieved by March 2018.
(Source: Medium Term Fiscal Policy Statement of the Government India, presented as part of Budget 2015-16 documents).

[2] We will note here an observation by JP Morgan Research: “… actual tax buoyancy in FY15 was 0.7 and is budgeted at 1 percent. While this is not egregious like in previous years, it is not a slam dank either. For tax buoyancy to increase from 0.7 to 1 would need a meaningful acceleration in real growth.”

[3] In his comments on the budget, Subramanian Swamy reckons that this legitimises the Indian financial market instrument called “Participatory Notes” (P-Notes) which are used by foreigners to buy into Indian stocks without having a license themselves but through a licensed FII. Mr Swamy reckons that P-Notes have been a vehicle for black-money based portfolio investment. The white paper on black money released by the Government of India in May 2012 identified P-Notes as a potential conduit for black money generated in India to be taken out of the country through the Hawala route and return to the country via investment in Indian stocks through P-Notes. The White Paper did not estimate the sums involved. Soon after the release of the White Paper, in June 2012, India’s Capital Markets Regulator, Securities and Exchange Board of India (SEBI) tightened reporting requirements for FIIs on P-Notes from six months to ten days. Further, according to a Wikipedia entry, P-Notes are used by investors to invest in other countries such as China and South Korea. The size of P-Notes in the overall FII investment into India.

An article published in First Post in November 2014 points out that a first attempt to ban P-Notes was made in 2007 but it was not enforced. Some restrictions were placed on the issuance of P-Notes but they were eased in 2008 when the global crisis struck. The article suggests that the share of P-Notes in the overall FII investment into Indian stocks has fallen due to the ease of registration of FIIs with SEBI and due to the tightening of rules with respect to the issue of P-Notes. Hence, it might be a good time to phase them out.

 [4] In a recent research note Sajjid Chinoy of JP Morgan (India) makes the same point. He considers this “asset swap” desirable (“In effect, that’s what the government seems to have done: asset sales revenues have been increased by 0.2 percent of GDP, which is exactly the same quantum by which capex allocation has been increased. In effect, therefore, the government is attempting an asset swap on its balance sheet.”)

[5] While announcing its interest rate cut that followed the budget presentation of the Finance Minister, the Reserve Bank of India noted that “the government has emphasised its desire to clean up legacy issues which gave a misleading picture of the true extent of fiscal rectitude, and has also moderated the optimism in its projections. To this extent, the true quantum of fiscal consolidation may be higher than in the headline numbers.”

[6] These figures are based on trends in Gross Central Tax Revenue and States’ shares given in Annexure 2 to the Receipts Budget in the Budget documents.

[7] For example, the article in The Business Standard has a misleading title whereas its contents deal with self-inflicted problems of budget management that States have.

[8] Neelkanth Mishra of Credit Suisse has a good exposition of the implications for States of the Centre’s large tax allocation to States.

[9] IndiaInfoline Research has pointed out that the surcharge on income-tax levied on those earning above Rupees one crore of taxable income per year in lieu of the wealth tax and its conversion of excise duty on petrol and diesel into a road cess will not be shared with States. Nonetheless, the share of gross tax revenues going to the States has indeed gone up substantially.

[10] We have to record here our disappointment with the sloppy phraseology deployed in the budget speech. In paragraph 56, for example, the Finance Minister said: “I intend to begin this process this year by setting up a Public Debt Management Agency (PDMA) which will bring both India’s external borrowings and domestic debt under one roof. “ What he referred to here is external borrowings and domestic borrowing by the Union government and not by the private sector.

Similarly, in paragraph 47, the first line refers to the National Investment and Infrastructure Fund and the second line refers to the ‘Trust’, which is the legal structure of the Fund. Instead of the word, ‘Trust’, the word, ‘Fund’ should have been used in the second line to stay consistent with the first line of the paragraph.

[12] The definition or description of ‘Securities’ under Section 45U(e) of the Reserve Bank of India Act: ‘securities’ means securities of the Central Government or a State Government or such securities of a local authority as may be specified in this behalf by the Central Government and, for the purposes of “repo” or “reverse repo”, include corporate bonds and debentures.

[13]The Monetary Policy Lab’, MINT, September 2007.
The Reddy years at RBI’, MINT, September 2008.
How India avoided a crisis’, New York Times, December 2008
What the US Fed needs to learn from RBI’, MINT, September 2014

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