Finance minister Nirmala Sitharaman has presented the Budget that urges people to focus on giveaways in personal income tax, and take no notice of the government’s failure to offer a remedy for the growth slowdown afflicting the economy. Will the tax breaks spur consumption enough to boost growth? The giveaways cumulate to Rs 100,000 crore, or 0.2 percent of GDP. The total spending by the government is proposed to be cut by nearly 0.4 percent of GDP, to rein in the fiscal deficit at 4.4 percent of GDP. In other words, the budget, by itself, reduces overall spending in the economy, whether by itself or by the private sector.
In the 2024-25 budget, the government had splashed out a big capital outlay, Rs 11,11,111 crore. This represented a 17 percent step-up from the previous year, and was expected to crowd in private investment and boost growth. Growth actually shrank to a forecast of 6.4 percent from the 8.2 percent estimated for 2023-24, and the government failed to spend 9 percent of the budgeted outlay.
Investment burden shifts to private sector and states
This year’s budget does not rely on government capital expenditure to boost growth. Capital expenditure has been maintained at 3.14 percent of GDP, the burden of investment that would revive growth has been shifted to the private sector and state governments.
The budget calls on all infrastructure ministries to come up with public-private-partnership (PPP) projects in their areas. It hopes to finance the public part of the project with new asset monetization proceeds (selling to the private sector up and running bits of infrastructure that generate revenue). It is not easy to locate better examples of what is meant by operating on hope and a prayer.
The budget offers state governments three forms of investment incentives. Interest-free, 50-year loans totalling Rs 1.5 lakh crore, a challenge fund of Rs 1 lakh crore to finance 25 percent of viable urban infrastructure projects proposals, and permission to borrow additional funds, up to 0.5 percent of the state’s gross state domestic product for power sector reforms, including intra-state transmission capacity.
This budget proposal pretends to not see the recent turn in the political economy towards showering voters with assorted freebies. State government resources are slated to increasingly be claimed by a bunch of welfare payments. Power distribution reforms come up against voter expectation of free power. To claim funds from the Urban Challenge Fund, states have to put up 75 percent of the project cost, with 50 percent coming from PPP, bonds or bank loans. After making competitively bid-up monthly welfare cheques to large sections of the citizenry, states would struggle to come up the funds required. The challenge part of the proposed fund would be to find projects that qualify, in terms of the state coming up with bankable projects and financing of 75 percent of the project cost.
PPP projects fell out of favour after the UPA government was voted out, the political narrative around them being that these served to transfer public funds to private tycoons. That narrative will have to change. But that is not all. The corporate bond market will have to dramatically change as well.
A shallow bond market acts as a drag on infrastructure financing
The bond market is what should ideally fund long-gestation infrastructure projects, and not bank loans. This is so for two reasons. Bank loans are financed from deposits, whose maturity profile does not allow making for long-term lending of the kind infrastructure projects require. Then again, the process of making bank loans, typically by a committee, is more amenable to letting in non-commercial considerations that jack up the project cost and loan sizes, compared to bond issuances. Bonds are evaluated by assortments of investment advisors, brokerages, fund houses, and continuously. The funding becomes more realistic and transparent when done by the bond market.
Government needs to persuade RBI to let go
For a bond market capable of financing large infrastructure projects, some vital reforms are required. The schism between regulation of government bonds and corporate bonds must go, the RBI must be persuaded to let go of its control over government bonds, and let Sebi take over the entire bond market. Bonds carry risks with regard to interest, credit and the exchange rate. A full range of derivatives must be available to hedge against credit, interest and currency risks. The transaction tax on derivatives hinders fine pricing, and they must go.
In the absence of such reforms, it is futile to place the burden of reinvigorating growth on PPP projects.
Uncertainty plagues the trade channel
The budget identifies trade as an engine of growth. That engine is likely to stall, under the assault on global trade that the newly elected US president is rolling out. When Trump blocks imports into the US with high tariffs, the exports that would have gone to the US would seek an outlet in other markets. To protect domestic industry from such diverted trade, countries would raise their import duties across the board, and not just against American exports. This would dampen global trade. India would need to make other engines tick.
The budget cuts the import duty on automobiles from 100 percent to 75 percent. Probably this is meant to mollify President Trump, who has railed against India’s high import duties. It is unlikely to work. The Budget also tinkers around with a host of import duties. The sensible policy on import duty is to keep it low and uniform across products and sectors, to offer every kind of value addition the same level of effective protection. Differential rates of duty distort the incentives to produce efficiently in India.
Increasing revealed efficiency in tax collections is a bright spot in the Budget, as well as the readiness to revive PPP projects. But India needs a whole lot more, to revive growth and job creation.
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