Haseeb Drabu on Budget 2018: Prudent, productive and political

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A social budget that uses market instrumentalities in a federal democratic framework.

Italo Calvino, the Italian master story teller wrote novels like “Invisible Cities”, which are basically short stories—but they’re bound together by an overarching theme, thus making them a novel. While that is the hallmark of his novel-writing, the real fun of reading Calvino also lies in discovering this.

Finance minister Arun Jaitley’s Budget 2018 is also a short story, the nuances—budgetary, economic and political—of which can be fully appreciated if seen as part of the last four budgets that he has presented.

Jaitley will be remembered in the budgetary history of India for three things: democratization of public expenditure policy (Budget 2015), federalizing India (Budget 2016), and formalizing the Indian economy (Budget 2017).

In this year’s offering, he has combined as well as consolidated all these disparate elements to present a seemingly eclectic but, on deeper analysis, sectorally and socially articulated budget.

While the expenditure allocations in this budget have a ‘socialist’ flavour, the framework is decisively market-oriented. The soul of the budget continues to be federalist, and the design of interventions has democratic moorings, which is what gives it a political tone. This is a socialist budget with market instrumentalities in a federal democratic framework.

The best example of using market instrumentalities for achieving distributional benefits in this budget is, of course, the flagship National Health Protection Scheme, aimed to cover over 100 million poor and vulnerable families (approximately 500 million beneficiaries) providing coverage of upto Rs5 lakh per family per year for secondary and tertiary care hospitalization. This will be the world’s largest government funded health care programme. Quite apart from the low budget funding to achieve the objective, it also will give a huge impetus to the BFSI (banking, financial services and insurance) sector.

The overarching theme that gets due attention in the budget is that over these five budgets of Jaitley, the system has moved away from subsidies and mere entitlement-based fiscal transfers. As a result, it has given a lot of fiscal flexibility for rural India across the states.

This is bound to pave the way for the core guiding principle that spending and tax decisions must reflect local preferences as far as possible. This is a far-reaching change from the centrist mindset of all the earlier Union budgets. There is no denying the fact that Jaitley has made the Budget irreversibly a ‘Union of states budget’.

It needs to be noticed that the bulk of the expenditure allocation in this budget is in areas that are constitutionally and operationally the responsibility of the state governments and not the central government.

This is in addition to the massive hike in the devolution of tax revenues that was recommended by the 14th Finance Commission and accepted by this government.

Continuation of the relentless focus on the democratization of public expenditure—in this budget as well—is based on the premise that it is the only way to lead to a democratization of the public service delivery system, which has been a crucial missing aspect in the Indian decentralization experiment.

Now, the next steps have to be taken by the states and the third tier, if fiscal decentralization has to be meaningful. The Economic Survey has some telling statistics in this regard, showing that India has a long way to go when it comes to last-mile fiscal federalism.

For example, as per the Survey, rural local governments in India generate only 6% of revenues from their own resources, compared to 40% in Brazil and Germany.

Even in the face of obvious electoral compulsions, the budget resists the temptation to be populist. Indeed, in articulation and intent, the FM has shown continued reformist intentions.

In fact, more than elections, the budgets seems to have been more driven by the macroeconomic risks that are on the horizon—be it the level of asset prices, bonds yields or commodity prices. No wonder, the attempt at pragmatic and practical initiatives is most evident on the market side.

Notwithstanding the logic of parity in the tax structure across various investment avenues, bringing back a 10% tax on long term capital gains is a super smart move by the FM. Any worries that the money will flow out of equity markets because of this tax burden seems pointless given the investment scene in the country today.

If the flows into equities have been good in the past year, it is because finally local individual investors are seeing equities as a viable alternative. The buoyancy in capital markets and inflows in mutual funds are mainly a result of lack of viable alternatives to stash savings.

Real estate, which used to be the preferred investment for rich Indians, and also where much of the black money was deployed, is no longer the hiding ground that it used to be, thanks to the clamour for transparency with RERA or the Real Estate (Regulation and Development) Act, 2016, coming in.

Not that the returns are looking fancy either. Prices have been stagnant or correcting for the past couple of years now, yet they seem out of whack. Whether you benchmark against other parts of the world, or against the affordability criteria within India—no one can convincingly make an argument for steady capital appreciation from these levels.

That makes fixed income look a lot better, but by themselves they don’t look good, given the trend in inflation. Tax-free bonds yielding 6% covers inflation at the moment, but there is no such guarantee that’ll be the case consistently. There have been long periods of negative real rates in India, but the fear psychosis associated with stock markets has kept investors from staying with this safer alternative. So, the only way to ensure a return consistently above inflation is to stomach the risk and invest in equities.

Given the reality that money will come into equities because of the lack of alternatives, there is no reason for the government to forgo a potentially large kitty.

The markets are of course glad that the tax will be applicable only on gains hereafter, and not on gains accrued so far; the question is the potential for substantial gains from here on. Equity markets, helped by global liquidity and momentum, are at elevated levels with bleak chances of super normal gains. But that hardly determines flows into markets in the short term.

In reality, the irony with equities is that there is greater demand at higher prices. When the sentiment is good, they don’t really care about valuations—or for that matter the tax. The FM’s decision to cash in on this huge potential tax collection must be complimented for impeccable timing.

In keeping with the style and trend of the earlier budgets by this government, most reforms and issues are now being addressed outside the budgetary exercise in any case.

For example, much of the banking system-related issues are being addressed through measures such as the recapitalization plan and the bankruptcy code.

Simplification of the goods and services tax (GST) architecture has been under the purview of the GST Council as an ongoing process. Additionally, the GST has restored some dignity to the budget process by doing away with the usual industry clamouring for reductions in indirect taxes.

The headline fiscal numbers are in line with market expectations, though the assumed growth numbers for GST and personal income tax revenues seem a tad aggressive.

While the budget meets the mark in terms of being socially responsible and fiscally prudent, this being the last full budget for the government, a statesman-like articulation of vision for addressing some of the longer-term structural issues facing the country would have been welcome.

One key issue that hasn’t received the attention it deserves is the natural resource deficit. With oil prices having been subdued over the last few years, India’s natural resource deficit is something that has not been talked about for a long time. The last couple of years were perhaps the best time to have locked up energy assets. The government was proactive on downstream market de-regulation, but more could have been done on raw material sourcing.

With global growth surging, it may be only a matter of time before oil prices spike enough to start causing discomfort. And this can, in the long run, be the biggest threat to India’s growth story.livemint