Current General Studies Magazine: "India's Union Budget including MEA's Budget" March + April 2015

Current General Studies Magazine (March + April 2015)

General Studies - III: Economy Based Article (India's Union Budget including MEA's Budget)

A sampling of international and domestic factors which impact our overall objective of higher growth coupled with lower inflation which obviously need to be preceded by fiscal consolidation and other steps outlined briefly below as also management of attendant risks and constraints FACTORS IN FAVOUR

EXTERNAL: Lower International Commodity prices including for oil and gas. Has reduced the trade in goods imbalance and the central government’s subsidy burden on this account. Promotes conditions for lower inflation and has reduced the current account deficit.
INTERNAL: Fourteenth Finance Commission’s recommendations which were accepted provides a larger share of taxes to be spent as per state government decisions. Overall volumes of transfers would not increase but this is positive in terms of decentralised decision making.

VULNERABILITIES AND CONSTRAINTS

1. Overvalued Rupee.

2. Little fiscal room for the central government to invest in infrastructure or other capital intensive long gestation projects. Further, little capacity to provide equity capital to PSU banks.

3. The Public-Private-Partnership model for building infrastructure is fundamentally flawed and hence broken. The specifications on risk-return sharing were just plain wrong. The private sector cannot take the long-term risks which are inevitable in large investment, long-term projects. PSU banks with 10% or more of stressed assets on their balance sheets not in a position to increase lending.

4. Staff cost at about 60% of revenue budget for Railways is way too high. Passenger fares have to be increased. Investments in rail tracks etc. both for safety and increase in length have to be increased, particularly in the North-East.

5. Uncertainty in interpretations of tax laws and application. This is a systemic issue much beyond and more corrosive than the high profile tax disputes with foreign major telecom, oil and other companies.

6. SUBSIDIES: Fertilisers, Food-grains (FCI), Free or subsidised power for farmers (more state governments), No tax on agricultural income. Passenger fares – Railways. Air India. Better targeting through Jan Dhan Yojana and Aadhar is welcome particularly for rice, fertilisers, railways (passenger fares), water and sugar in descending order of magnitude of fiscal expenditure. Inevitably it is the pace of implementation which would be crucial.

7. India has to also watch out for rise in US interest rates and later unwinding of Quantitative Easing in the US. This may prick some asset bubbles particularly in stocks and real estate.

IMPLEMENTATION IS KEY – Time Frame for implementation of BUDGET PRIORITIES

Short-term (up to one year), Medium-term (up to 3 years), Long-term (5 years or more)

SHORTCOMINGS IN ESTIMATES & SHORTFALLS

ILLUSTRATIVE: Total receipts, including borrowings and other liabilities, for 2014-15 at 16.81 lakh crores are now 6.3% lower than budget estimates for 2014-15. Prima facie the total receipts number in the budget estimates for 2015-16 appears to be relatively conservative since this is 1% below the same number for 2014-15

Government does not adequately discuss Primary Deficit i.e. Revenue Deficit minus Interest Payments (this does not account for bunching of principal repayments since our Budget statements are cash flow based and not accrual based). This number will be about 1 lakh crores for 2015-16.

It is obviously not obligatory for the union government to make policy announcements beyond its annual accounts and projections for revenues and expenditures. Reforms and follow-up steps to be taken even within the next 12 months need not be covered in the finance minister’s budget speech. However, expectations are inevitably high because of past practice.

Monetary: Repo rate needs to come down. Useful that the Budget announced the decision to set up a Monetary Policy Committee with inflation targets and attendant transparency.
Overvalued Rupee: Rupee Exchange rate needs to depreciate nominally and gradually against the US$ by 6-8 Rupees maybe around Rupees 70 to a dollar by the end of calendar 2015. Rupee is overvalued by at least 10%. No enough in the public domain about how the Rupee’s managed float is actually MANAGED.
Enabling legal environment for INFRASTRUCTURE development: Short-term objective needs to include getting the legislation on land acquisition through.
Why treat Railways separately from other modes of transport: Roads, Shipping-Ports and Airports? These are all part of the overall Infrastructure sector. Why have a separate Railway budget? Different rules of the game for railways because it is the largest employer? Budgetary allocation of Rupees 40,000 crores to Railways. Since this number is large makes sense to review combined outlays across the transportation sector to look for synergies.
Government intends to corporatize ports – not quite clear what is the road map and time frame? Why not corporatize select railway stations, bus-stops and so on? Is there any overall framework for the infrastructure sector supporting this move?
Power sector - we need more detail on what government intends to do i.e. more than coal auctions e.g. hydro-electricity, prospecting for oil & gas (gas pricing), nuclear power (nuclear liability law needs to be amended as it also inhibits participation of domestic suppliers e.g. L&T.
Funding for Infrastructure Not clear where the additional resources are coming from for Railways. Escrowing future rail revenues to service long-term railway bonds to be purchased by LIC does not add to sources of funds. Railways and for that matter the armed forces own large tracts of prime urban land used principally for independent houses for middle level executives/officers upwards. Some of this land could be leased (not sold) for commercial purposes to raise funds.
New Infrastructure Fund. In what way will it be different from India Infrastructure Finance Company Limited (IIFCL)?
Public investment has to be raised as we wait for private investment to grow. In this context, we have to raise tax/GDP ratio – review and raise excise rates. India has a relatively low tax/GDP ratio compared to developed and developing countries.
If DTC is to be abandoned, this does not augur well. Corporate tax to be lowered over 4 years to 25% is a step in the right direction. However, has to be closely tied to elimination of exemptions.
Projected introduction of Goods and Services Tax (GST) by April 2016, which would help promote one market in the country, appears to be unrealistic given that 2/3 majority is needed in both Houses of Parliament and half the state legislatures.
Another short to medium term objective: FOREX reserves need to be higher. Better way to judge adequacy is by focussing on the FX reserves to short-term debt ratio and factoring in trade credit up to one year.
Medium term objective to fund a larger judiciary at all levels in a phased manner. Too many pending cases including involving tax and infrastructure projects pending in courts.
FINANCIAL SECTOR – Bankruptcy Code: Very important in terms of ease of doing business and also e.g. to promote secondary market liquidity in corporate debt markets
Private savings have to flow more into longer-term financial instruments. That is, further development of financial sector investment alternatives. Capital markets relatively well developed. Pension, Insurance and Banking markets in that order need to grow faster.
PSU banks need to be overhauled, merged as necessary and incentivized.
Composite caps for FPIs and FDI welcome was long overdue. Foreign equity investments now to be regulated by central government rather than RBI under FEMA. Will improve regulatory clarity.
Internal debt management to be entrusted to an independent body was first included in former FM Yaswant Sinha’s Budget of 2000 i.e. 15 years ago. RBI objected on grounds that fiscal consolidation was a pre-requisite. This is a parochial turf issue for RBI and a statutorily independent Debt Management Agency i.e. independent of not just RBI but also Government is overdue.
Inclusion of NBFCs with capital base of Rupees 500 crores in the ambit of Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) is positive since it should help in NPA recovery cases.
Specific issues which are of concern to FPIs (Foreign portfolio investors) and other foreign investors:

Proposed changes in MAT Minimum Alternate Tax benefits for FPIs. Not clear whether this is excessively generous to FPIs. We need a white paper from government on this issue.

MAT is also an issue for SEZs – high time the country became one large SEZ rather than setting up of enclaves which are in some cases thinly disguised plays on real estate.

General Anti-Avoidance Rules (GAAR). Extremely positive that this has been deferred to April 2017. We need to resolve this issue within the next one year.

ECONOMIC DIPLOMACY

What does Economic Diplomacy mean?

In current times can/should diplomatic work be segregated from economic and strategic objectives?
Some countries have set up joint or well-coordinated administrative structures to follow through on economic diplomacy objectives
Should the Ministry of External Affairs, Ministry for Overseas Indian Affairs (MOIA) and Ministry of Commerce be merged with one Cabinet Minister and two Ministers of State?
For instance Brazil and Australia have one Ministry for foreign affairs and foreign trade-investment
FDI and Foreign Portfolio Investments. Stable versus less stable flows
Regional FTAs and regional security
Is India extracting the commensurate economic-diplomatic benefits it could from its larger defence purchases? Finality of decision making at purchase stage and predictability as an end user SPECIALIZATION & PERIODIC TRAINING
Initial and regular training of officers as per their indicated preference for: (a) economic; (b) political; (c) security & strategic; (d) information & cultural work DEVELOPMENT PARTNERSHIP ADMINISTRATION
The extent of goodwill from providing grants, loans or technical assistance and training is eroded if "projects” are not implemented in a timely manner
Decision on projects need to be taken in consultation with or initiated by the territorial divisions in MEA. However, implementation of civil and related projects should be done by an independent agency which is made accountable for delays, if any INTERACTION WITH MULTILATERAL DEVELOPMENT BANKS AND AGENCIES
MoF is the nodal Ministry for MDBs. However, greater coordination is needed on the political aspects of borrowing and interaction with MDBs. For instance, IBRD stopped lending to India, except for humanitarian grounds, for any new projects post Pokhran II in May 1998
The Executive Directors to the World Bank and IMF should be serving officers and report to the Indian Ambassador in Washington DC
BRICS New Development Bank, Contingency Reserve Arrangement and Asian Infrastructure Investment Bank