The Union Budget for this year comes on the heels of an unprecedented demonetisation drive and the widespread expectation that the fiscal policy will provide some stimulus.
This puts the policy makers in a dilemma where they have to choose between giving stimulus to spur growth in the economy and to remain tough on the fiscal discipline and not letting deficits rise.
In a pre-Budget discussion on CNBC-TV18, Sajjid Chinoy, Asia Economist at JPMorgan, A Prasanna, Economist at ICICI Securities and Rathin Roy, Director and CEO, NIPFP listed their views on how the policy framework should be this year.
The economy needs to grow at a faster rate and the government could use fiscal policy to tackle the temporary fall in demand, says Rathin Roy.
To boost demand the government could tax more and raise consumption, cutting down tax to boost consumption will not work, he says.
He further adds that letting fiscal deficit rise won't be wise as this year it is expected to be a volatile one and the Centre needs to remain tough on fiscal discipline.
On the gross domestic product (GDP), Sajjid Chinoy opines that its growth will be the key for tax revenue and policy makers must assess the lower GDP impact on tax buoyancy.
Below is verbatim transcript of the interview:
Q: Is the government expected to over-deliver on its fiscal deficit simply because we have got the income declaration scheme (IDS) and perhaps high excise on fuel?
Prasanna: As of now the numbers what we are looking at, they are tracking at 3.5 percent fiscal deficit which should be inline with their target. However, potentially it is possible because we don’t know how much is going to come from IDS too. In fact we don’t even know how much is going to come this year and whether there could be some spillovers in to next year. However, the likelihood is that there could over deliver on this year’s target itself, but perhaps we are looking at 0.1-0.2 percent of improvement not more than that.
Q: You mean the fiscal deficit could be 3.4 percent?
Prasanna: That is right.
Q: Will you also assume that next year the government will be able to deliver a higher than trend tax revenue collection, in the sense direct tax revenue collection simply because a little more has come into the formal economy?
Prasanna: That is very difficult to kind of gauge at this point of time. Obviously, we don’t know how much of these trends are sustainable. But a broader sense we have is that it is going to be very difficult for tax revenues – I mean we are talking about overall tax collections for the growth to even cross into double digits into next year. You should remember for the last two years there has been a huge windfall on indirect taxes because of high excise duties on petro products as well as increase in service tax. So, this year abstracting from the goods and services tax (GST) for time being definitely tax growth is going to slowdown.
Direct tax I think we have to remember that at some point of time government has to reward tax payers also, so obviously there is a cut in corporate tax which is already pending and I would not be surprised if they try and give some rebate to income tax payers also whether in terms of whether it is permanent cut or a onetime rebate. So, in that sense our baseline assumption is for next year the tax growth will be in single digits. On top of that now we have to look at how GST kind of affects that, but abstracting from GST we are looking at slowdown in tax revenues.
Q: What will your assumptions be in terms of next year’s direct tax revenue growth? I am assuming that at the moment the government will not touch indirect taxes in this Budget?
Chinoy: I broadly concur with what Prasanna is saying. Essentially there are lot of moving pieces here. One is going to be what is going to happen to nominal gross domestic product (GDP) itself next year. If this year nominal GDP is lower and you get some sort of rebound in consumption or activity then what does that do to tax buoyancy that is the first point. The second is we have see also on direct taxes to the extent that corporate tax rates do come down as the Finance Minister has indicated which exemptions are we closing, so that whether it is revenue neutral or not for the government.
The third is that oil prices continue to go up they has to be the recognition that indirect taxes have over delivered the last few years because tax rates have gone up both service taxes and indirect taxes. My sense is that indirect taxes will grow less than nominal GDP and that ratio may go down and therefore this will all come down to direct taxes and your first point which is how much extra tax revenue does the government expect to collect from all these 15 trillion of deposits that are in the banking systems that becomes the key in terms of what you see for taxes next year.
Going forward keep an eye very closely on nominal GDP. If nominal GDP were to disappoint next year then the tax buoyancy that is typically associated with a dip in growth could be troubling for the government. If in fact you see that as the currency situation normalises and much of the consumption that was delayed from this year re-bounce into next fiscal year then in fact you could have upside surprise to nominal GDP and therefore to tax buoyancy.
Q: What are you assuming in terms of real GDP nominal GDP growth on which your basing your tax revenue and what is your tax revenue growth number?
Prasanna: Next year we are looking at a nominal GDP growth of around 11.5 percent probably based on 7 percent real and 4.5 percent nominal. In terms of tax revenue growth, ours slightly shy of 10 percent it is around 9.5 percent, it is overall tax numbers. I think it is broadly similar numbers for both direct taxes and indirect taxes.
Now of course indirect taxes if you assume GST gets introduced fairly early in the year then we are building in actually a sharper eyes in indirect taxes and therefore the overall tax growth also picks up to around 14.5 percent.
Q: Now to the key question that the Budget will have to address is there a case for reneging on the fiscal deficit timetable? At the moment we don’t have a timetable because the Kelkar Committee has been replaced by the NK Singh FRBM Committee which will perhaps will not place its recommendations in the public domain at all from what we learnt from the committee. But should 3.5 be allowed to remain at 3.5, should it be allowed to go to 3.6 simply because we are coming on the heels of demonetisation?
Chinoy: I don’t see any case for a stimulus, the debate has changed and last year the debate was to what extent should the government consolidate its finances. This year the debate seems to be is there room for a stimulus. I think absolutely not for multiple reasons. First is let us appreciate the fact that with the bulk of deposits coming back in this is not an enduring wealth shock that we had feared on the morning of November 9th. This is a two to three quarter liquidity shock. With every passing week of the economy getting remonetised our sense is growth will begin to recover so this is a temporary shock. That should be largely done by the time the first quarter of next fiscal year start so the first point is why would you want to fiscal stimulus for four quarters in to 2017-2018 where in by the first quarter of the next fiscal year activity should begin the main revert.
Q: What is your sense is there a case for fiscal stimulus? I mean is there a case for the fiscal deficit going above 3.50 percent?
Prasanna: No, we don’t think there is a case. I think we are still looking at 3 percent for next year as per the earlier road map as one of the guide post and what we are saying is going from 3.5 to 3 percent is going to be very difficult in our base case. So, government should enforce the issue. I think that is the limited point we are making so perhaps if they land up somewhere at 3.3 percent or something like that heavens won’t fall. I think that is the argument we are making.
The second point I want to make is in any case if we assume GST is going to introduced there is going to be lot of uncertainty about the kind of collections we are going to get plus there is a huge issue of compensation to states and this is related to the earlier point Sajjid Chinoy made about nominal growth. Now government has promised states on a normative basis of 14 percent growth that is the compensation calculation. If nominal growth had to slowdown the government will find itself in as sticky wicket. So, our point is don’t force the issue from 3.5 to 3 percent be bit more relaxed next year and then get back to the path the year after that. That is the limited point we are making.
Q: Prasanna’s point is that there is no question of going from 3.5 to 3.6 but also no case for forcing the Kelkar timetable to 3 percent why not 3.3. What would be the number that you will be comfortable with on fiscal deficit?
Chinoy: I broadly agree, as I was saying earlier I think the fact that this shock is temporary the fact that monetary conditions are easy and the fact that state fiscal deficits have widened very sharply have deteriorated suggest that there is no case here for a large stimulus. It is understandable that given where cyclical conditions are I mean appreciate the fact that even before demonetisation GDP growth in the first half had slowed to about 7.2 percent if the pace of fiscal consolidation were to gradually slow and the government were to target 3.2 or 3.3 I am not sure the world would fall down.
In fact if you ask me bond yields already pricing in some degree of a relaxation of the path and people will be okay I think with the 2 or 3.3 and then resuming the path next year. What dangerous is to entertain any thought of stimulus above 3.5 given all these are the factors.
Q: If the widespread demand of demand for a cut in personal income tax and/or corporate income tax is granted then do you think the government will be able to manage everything. Give a little bit of cut as well as manage the fisc at 3.3 or will it renege?
Prasanna: I think it should be possible, I mean our tax number for example already build in some tax rebate on income tax front and of course corporate tax I think it is a bit more difficult to guess because they are simultaneously going to face out exemptions also. So, we don’t know what is the net tax impact is going to be. I think the key is on the expenditure side if the government just sticks to whatever it has already announced on December 31st by the Prime Minister and as well as there is going to be some higher salary component because of allowances and beyond that if you are not looking at too much of expenditure increase then it should be possible.
We have remember I think from this year itself already if you look at the year-to-date spending pattern asset is on a capital spending side. I think the government is going slow so maybe there is a possibility that they are not able to spend what they have Budgeted. So, in that sense I am not sure how much of step up in investments spending and infrastructure spending really the government can come in and deliver into next year.
Q: No Santa Claus Budget for tax payers, no robin hood Budget for the poor would be you desire?
Chinoy: The desire I can understand why the government would – if consumption has taken a big hit in the last two quarters why there would be some pressure on the government to try and offset that. So, some tax reliefs at the low end some expenditure for welfare programs to create safety is understandable. However, my two large principle here is I think not to abandon the path of fiscal consolidation if you slow the pace given where cyclical conditions are that is understandable.
Number two I still continue to believe that the problem in India is not consumption it is investment. If you look at the four quarter before demonetisation consumption was growing at 8 percent. Investment was contracting a 2.5 percent, so I actually think whatever resources the government get from demonetisation from these deposits that the focus needs to be on public investment as it had been last two years. So, I would much rather see more expenditure devoted to those areas.
I agree with Prasanna that there is a absorptive capacity issue in terms of spending, but that is not something that is insurmountable. So, I would just summarise by saying that let us also not forget the reason is so important that they stay on a consolidation path is there are multiple other stimulus in the system that you don’t talk about. State fiscal deficit have widened by 1 percent of GDP in the last two years and momentary condition at 2.5 years low.
So, the economy is already getting some support that is why it is important from the center’s perspective to keep chipping away even if it is at a slow pace at their fiscal consolidation. However, otherwise my worry is much of the rally you have seen in bond yields may begin to reverse especially given what has happened globally.
Q: In the first place everyone is talking about the stimulus, but does the economy need a stimulus in your estimate?
Roy: The economy definitely needs to grow faster than it is. The question is does the economy need a fiscal stimulus which means more government spending through more government borrowing. Of that I am not very certain that that is required.
Q: The psychic from which this argument is emanating is that demonetisation delivered a part cash and a part psychic shock to the economy it de-railed momentum which needs to be pushed back. It is not an argument you are buying at all or do you think yes that happened but that should be corrected with monetary or non-fiscal stimuli?
Roy: I am not the psychologist, so the psychic shock is not something I can judge. However, if there is a temporary fall in the growth rate then the first thing you need to do actually is decide why that temporary fall in the growth rate has happened. Has that happened because people are producing less and there is demand or it has happening because people have less cash and therefore there is less demand. In the first case if people are producing less because of cash flow problems then the solution obviously is to alleviate those. There is very little you can do in terms of fiscal policy to deal with that.
If the problem is a temporary fall in demand then you could conceivably use fiscal policy to increase demand. The way you would normally do that is to tax people more and then give people money in their pockets to spend. That was indeed the hope that the increases in tax revenues that would occur next year going forward due to demonetisation that is in increase in tax GDP ratio would provide incremental resources to the government to spend on increasing in demand.
Because you must remember demand increases in interms of a short-term shock, increase aggregate demand by increasing consumption expenses. So you give money people to spend and then we are spending more on consumption. You can also give money people to spend more by taxing less but in India given the small number of personal tax payers that is unlikely to stimulate consumption. If you stimulate consumption through increased taxes I have no problem with that to increase the tax GDP ratio. However, if you stimulate consumption by borrowing then I do have a problem with that.
Q: Fiscal math will also be impacted by the fact that there will have to be compensation cess and the fact that in the first year itself the states may not garner much by way of taxes. On both side you may not get much of a stimulus from the states this time around since they will be in a period of transition. Therefore does the Central Bank government need to allow its fiscal deficit to go to probably to 3.6 or something renege for the year that is the argument some people are making?
Roy: I don’t think so.
Q: In that case what should the Budget deliver at all in terms of growth what is the one-three things you will look for to call it a good Budget?
Roy: The three things I would look for to call it a good Budget would be a clear plan to improve the tax GDP ratio, to simplify corporate taxes, to continue with the process of business process reforms to improve India’s doing business indicators, deliver financial sector reforms, deliver tax reforms and also to manage expenditure more efficiently and effectively on part of the central government. With a revenue deficit which is essentially borrowing to consume that is two-thirds of the fiscal deficit we simply cannot afford a situation where the fiscal deficit rises and rises to essentially finance consumption expenditure.
This year is going to be volatile year both in terms of the growth rate and in view of the impending GST reforms coming in. The solution to that volatility is to address it at the moment when it happens and first to thrive your best to switch expenditures. GST is a deliberate policy decision of the government, demonetisation is a deliberate policy decision of the government. These are not exogenous shocks, so what government needs to do is fix its fiscal deficit target consistent with its long-term plan for fiscal sustainability and continuing with fiscal consolidation and then manage its Budget within that overall parameter to deal with such shocks that may arise.
If you already preempt the shock by saying it is going to happen, so let us be laxed right at the beginning then you may end up in a situation far worse than you thought might happen because then laxity will set in. Therefore I think remaining tough on the fiscal deficit is important. What the number is will depend entirely on the FRBM committee which I am a part of and its recommendations and whether they are accepted by government or not which I cannot possibly comment on.
Q: If the choice is between capital investment and consumption investment then if the choice is capital investment are there hurdles in the bandwidth of the government?
A: It is not the question of bandwidth again so example putting more equity in to Air India is also capital investment. Putting money into public sector banks – recapitalising them is also capital investment. If the government believes that these things are important they need to be done then it should make a very clear case on how having made these investments such capital investments will be good for the economy relative to the counterfactual which is remember we are all relying on the same stock of domestic savings, domestic financial savings.
More borrowing the government means less financial savings available to the private sector and at any interest rate that means a higher cost of capital. So then the argument that I have heard is private sector for some psychological reasons is not willing to invest. Here I have a problem because government is not mummy, so if somebody is not willing to invest or somebody is not willing to consume it doesn’t mean that government runs around carrying the can for that.
The government must decide what capital expenditure it wants to undertake in terms of its overall strategy for the country not to compensate for the dilatory behaviour psychological or otherwise of other economic agents, be they firms or households.