29 Jan 2018 19:52 IST

Budget: The Finance Minister must walk the tightrope

Raising revenues, keeping fiscal deficit in check and factoring in poll expenses will be a tall order

The International Monetary Fund (IMF) expects the Indian economy to grow at around 7.5 per cent during the following two fiscal years. At this rate, India will be the fastest growing economy in the world. China — which saw double-digit growth over the last two decades — is cooling down and its growth rate is now closer to mid-single digits.

However, we need to understand that the country is limping out of the effects of one of its biggest tax reforms — the goods and services tax (GST), which came into effect on July 1, 2017. The economy then was recovering from the onslaught of the ‘note ban’, implemented in November 2016. This is why disruptions caused by GST, including the short-term consequences, had a major impact on the country’s economy. Although the negative effects are slowly waning, it could take till the coming fiscal year for a completely recovery.

Structural constraints in many industries, such as banking and telecom, are likely to put more pressure on government finances. For example, Reliance Jio’s entry into the telecom market has slashed the revenue of existing players to a large extent, making them financially weak; they are unable to pay the government for the spectrum sale and the banks for initial loans taken for spectrum payments.

In effect, such financial weakness adversely impacts the government’s fiscal deficit (because of the revenue shortfall) and strains the financials of banks (they will require more funding from the government to strengthen their capitalisation).

Rural and populist schemes

Stories on farmer distress are ubiquitous across the country. With the General Election slated for 2019, the current government will arm itself with populist initiatives to ensure a seamless return to power. This year will be the last ‘full’ budget before the elections.

Although the BJP has secured some support from the educated, urban voters, who trust it is aggressively on the ‘reform’ path to improve employment and income levels, it cannot ignore the farmers and the rural communities if it wants to come back to power. This will trigger many social and rural initiatives; such populist measures, many of which could be announced in the 2018-19 Union budget, will see a component of the expenditure allocated for the coming fiscal year, thereby exerting further pressure on the economy.

The budget will be challenging as the government has to increase revenues and reduce expenditure to preserve the fiscal deficit at the same time.

Fiscal discipline

The actual fiscal deficit for the current year, which closes in March 2018, is expected to widen from the target of 3.2 per cent of the country’s gross domestic product to around 3.5 per cent. Some analysts even peg the possible deficit at more than 3.5 per cent. The main reasons for the widening of the deficit is the shortfall in budget revenues, primarily due to disruptions in the economy caused by the implementation of the GST and the resulting lower tax collections.

Lower economic activity and slower growth post-demonetisation, following which many sectors including construction, infrastructure and real estate were severely hit and the overall corporate performance stalled, resulting in lower corporate tax collections, was a major disruption.

The Finance Minister could move the fiscal deficit target for the proposed 2018-19 budget to 3.5 per cent and attempt to achieve the same in the forthcoming year.

Aggressive disinvestment targets

In order to bridge the shortfall in tax revenue the government is likely to become aggressive in disinvestment targets relating to sale of shares in public sector units. A number of initiatives already seem to be attempting to maximise such revenues — Oil and Natural Gas Commission’s acquisition of Hindustan Petroleum Corporation’s shares from the government alone is expected to bring in around ₹35,000 crore to the government kitty.

Crude oil prices play spoilsport

While the IMF and the World Bank are optimistic about India’s economic growth rate, the increasing crude price, which has already moved from around $50 a barrel to around $60-65, is a concern that could widen the deficit further. Over the last four fiscal years, international crude prices have fortunately been lying low in the range of $35 to $50, without exerting much pressure on the fiscal deficit targets. This, however, may not hold good for 2018-19.

Enhancing tax burden to improve revenue

Though economic activity is expected to improve, the biggest concern for this year’s budget is the continued shortfall in income, clubbed with increased budget expenditures. In light of the general elections increased costs cannot be avoided, which means the spotlight will be on tax revenues.

The government may not increase the corporate tax rate, which is anyway considered high compared to peer group countries, but it could introduce an additional surcharge on the income-tax to bridge at least some part of the income shortfall. This could be levied on high-income individuals.

The Finance Minister is expected to look at tax revenues from long-term capital gains of assets, which are currently taxed at a lower rate when compared to short-term gains. In some cases, such as shares and mutual funds, long-term capital gains attract zero tax. The government may tinker with such provisions and reconsider the the holding period of these assets, to enhance tax revenue.

With all these challenges, the Finance Minister is expected to walk the tightrope in managing the additional revenue and controlling expenditure. The stock market has already soared over the last month to levels unseen in the history of the Sensex and Nifty. Any provisions adversely perceived by foreign and Indian investors could affect market sentiment.

Recommended for you
/* article author desc short */