Over the next 20 days, two major policy events will take place — the Budget and a GST Council meeting — that will reveal the government’s intent and vision for the next five years. While there are a number of issues that it can take up at both these events, there are three main problems that are relatively more noteworthy.
The first is the issue of private investment and how, despite the government’s best efforts so far, it has not recovered enough to shoulder its share of the burden as a prime driver of economic growth. The second issue is the fiscal deficit and whether the government is artificially hamstringing itself by curtailing public expenditure in order to meet an arbitrary target. In other words, can the government afford to shift the target meaningfully to, say, 4% from the current 3.4%?
The third important policy element is whether the government can afford to reduce GST rates even further and whether there are any more steps it can take to widen the tax net. The first two issues are to be addressed in the Union Budget, while the third is the exclusive domain of the GST Council. However, in all three, it has only limited options.
Private performance
The consensus view among economists seems to be that the government has pretty much done all it can in terms of creating the right environment for the private sector to grow. Policy measures such the Insolvency and Bankruptcy Code, the ‘Make in India’ initiative, power sector reforms, easing of FDI norms, and the concerted effort to improve the ease of doing business are all considered welcome steps.
“All of these provide a better environment for the private sector to work in,” Madan Sabnavis, chief economist at Care Ratings said. “One can’t practically expect the government to come up with anything more in most of these areas.”
In the Budget, however, there are a few steps the government can take that can make it more attractive for the private sector to invest.
“On the expenditure side, if it continues spending what it has been on capital expenditure, it will definitely have a positive impact on the private sector,” Mr. Sabnavis added. “For example, if the government spends on roads, it automatically creates demand for cement and steel, which is produced by the private sector. Similarly, if the government spends on power infrastructure.”
However, the caveat here is that this positive impact on the private sector will not be felt in the very short term. That is, capital expenditure undertaken in this financial year will only begin to boost the private sector in the next financial year.
“The other thing the government can do in the Budget is giving certain kinds of tax concessions,” Mr. Sabnavis added. “For example, if you’re talking about the corporate tax rate, which was to be lowered to 25% from 30%, they have done it only for the smaller companies. They have said they would do it for the rest of the companies over a period of time, but there have not been any steps taken.”
Here, too, while there is no guarantee that reducing corporate tax rate will definitely lead to increased investments, it is definitely seen as a good first step.
Fiscally constrained
So, if increased capital expenditure and reduced corporate tax collections are the major way private sector investment can be encouraged, then the natural extension of that argument should be that the government give itself some more flexibility when it comes to the fiscal deficit. While this might seem logical, the government’s own actions have rendered this option nearly impractical.
“The central government is relying quite heavily on the public sector for its own infrastructure expansion programme,” D.K. Srivastava, chief policy advisor at EY India, explained. “Last year, the increment in government debt was considerably higher than the fiscal deficit. The difference is about 1% of GDP, which are all extra budgetary resources. These constitute liabilities of the government, but are not included in the fiscal deficit calculations.”
“On the revenue side, a lot of the expenditure on food subsidies is being picked up by the Food Corporation of India (FCI), which has borrowed from the National Small Savings Fund on behalf of the government,” Mr. Srivastava added. “And so, when FCI has to service that debt, the government will have to come to rescue. So, these are all government liabilities that are just gathering up.”
In other words, since tax revenues either through direct taxes or indirect taxes did not meet their targets last year and don’t look like they will this year, the only way the government can increase its expenditure is by borrowing more. However, by committing to repay debt taken on by the public sector on its behalf, the government has tied its hands in this regard as well.
The only practical option before the government is for a favourable recommendation by the Bimal Jalan committee on the quantum of the Reserve Bank of India’s reserves that can be transferred to the Centre.
“The information is that if you estimate how much of reserves the RBI has got based on its past profits, then that comes to about 28% of its total assets and the global norm is 14%,” Mr. Srivastava said. “It looks like there is room available for it to transfer the excess to the government. That should close some of the shortfall in tax revenues that happened in 2018-19.”
Boosting consumption
There is another engine of economic growth, which, while firing strongly so far, has now begun to show signs of weakness — private consumption expenditure. Individuals, driven by static salaries but increasing costs, have begun to defer purchases and this can be seen in a number of metrics that have slowed down, such as car sales. Boosting personal consumption can also go a long way in reviving the private sector.
One way to encourage individuals to spend more is to increase the amount of money in their pockets. That is, reduce the tax burden. There is some talk in the Finance Ministry about reducing GST rates and addressing the revenue shortfall by widening the tax net. The view among tax experts is that the tax rates currently are already significantly lower than those in the pre-GST era. And, while the impact of a cut in rates affects revenues immediately, the positive impact of trying to increase tax compliance is felt with a delay.
“While the existing GST rates for products are generally lower or at par with the rates prevailing prior to the introduction of GST, there could be some cases where there is scope for further reductions, keeping in mind the revenue implications,” M.S. Mani, Partner at Deloitte India said.
“While rate reductions would lead to an expansion of the tax base in the medium term, it needs to be noted that collections go down immediately while the compliance and expansion of the tax base happens over a period of time,” Mr. Mani added.
“In the next one year or so, the government could look at collapsing the 12% and 18% categories into a 15-16% single category,” Pratik Jain, partner and national leader of Indirect Tax at PwC India, said. “While there is scope for expanding the tax base by plugging the tax leakages, that is a process and cannot happen immediately.”
