The Finance Minister, Arun Jaitley, has presented a Budget that looks good from all sides, but one that deserves closer scrutiny to better understand the fiscal maths, and the implications for economic growth. Attention must be paid in particular to the response of the bond market to the government’s borrowing programme. A higher interest rate regime, if it materialises, carries with it the risk of a slower economic recovery than might otherwise have been the case. In terms of changes introduced, the finance minister has continued with his push for greater progression in taxation of individual income, in incremental stages, while the corporate tax structure has been skewed to benefit small- and medium-scale companies. He has also done well to introduce taxation of long-term capital gains for investment in shares and equity mutual funds, and done so in a non-disruptive manner. This focus on progressivity in taxation is welcome in the context of growing inequality when it comes to the benefits of growth. The most important tax changes are not the ones on which the finance minister spent time, but in what was mentioned almost in passing: a substantial and wide-ranging increase in customs tariffs when it comes to a variety of consumption items. Oddly, the effect of this does not show in the assumptions with regard to customs revenue. Regardless, prices of a range of consumer items should go up. This would raise legitimate concerns about industry-specific protectionism, though the fact also is that customs revenue as a whole is barely 4 per cent of total goods imports—not the sign of a protectionist economy. Perhaps the intention is to give a push to the floundering “Make in India” programme. On the expenditure side, Mr Jaitley has boosted investment in the physical infrastructure, mainly transport. From the perspective of next year’s general elections, he has announced what the government clearly intends to market as a signature programme, in the form of a sharply expanded health insurance scheme to cover 40 per cent of the population. As for the fiscal arithmetic, the deviation from the target fiscal deficit is largely explained by the fact that, while other gains and losses mostly cancel each other out, a month’s revenue from the goods and services tax has been lost because of the change in the payment schedule—unlike excise duty and service tax, the goods and service tax (GST) that took their place last July is paid not in the same month but in the following month. Mr Jaitley has rightly underlined the above-normal increase in the number of taxpayers as well as the remarkable tax buoyancy of the last couple of years—raising the tax-to-GDP ratio to possibly its highest ever level of 12.1 per cent (up handsomely from 10.1 per cent in the last Budget of the previous government). If one looks at next year’s Budget projections, with 2016-17 as the base year (the current year, 2017-18, having been a year of disruption), then direct tax revenue is projected to grow 28 per cent, and indirect taxes 29.5 per cent over the two-year period. That is annual growth of nearly 14 per cent over-all, and creditable for a period that saw a marked slow-down in economic growth.
The minister can also look back on a broadly successful introduction of the GST, notwithstanding the initial missteps. The detailed numbers raise some questions. The medical insurance programme could cost about Rs 20,000 crore; yet next year’s health budget remains virtually unchanged from the current year’s number. The fiscal deficit figure this year benefits from an unusually large drawdown of cash balances (which too has to be shared with states); if that were included in the fiscal arithmetic, the deficit would show up in the region of 3.7 per cent. Conversely, next year’s Budget provides for large accumulation of cash balances. Neutralised for that, the deficit for 2018-19 would be only 3.1 per cent, not the announced 3.3 per cent. Taking the two years together, the average deficit of 3.4 per cent is noticeably above the fiscal glide path that has now been formally abandoned, in favour of a new one that projects shallower correction for the future. This is despite a virtual freeze on big and important expenditure items, like health, education, rural development and urban development—all of which, along with defence, get only marginal increases in outlay. Clearly, the Modi government’s preference is for expenditure on hard infrastructure, notably highways and railways. While these do need large investments, the squeeze on other budgetary items is the price being paid for fiscal control. Even with restraints on spending, the borrowing budget for next year has sent shivers down the spine of the bond market. Compared to a year ago, interest rates are now up by well over a percentage point. This is the opposite direction from that which the Reserve Bank has been signaling. The question is whether RBI will feel obliged to reverse direction and start raising policy rates—prodded also by rising inflation pressures and the prospect of higher kharif crop prices, indicated by the finance minister. A full-fledged economic recovery is hard to achieve in an environment of rising interest rates. There are questions about implementation of the health scheme, which might get clarified in time. The basis for selection is to be the existing socio-economic classification, but this has been subject to aberrations. Also, how does the government intend to prevent malpractice, given the problematic track record of private hospitals? One wishes the government had focused its money on setting up more public hospitals, since the existing ones have many times more patients than they can handle.