Up in the air

Up in the air

Nirmala Sitharaman’s Budget pitches for large foreign investment. But details have to be fleshed out

Finance minister Nirmala Sitharaman’s first Budget is constructed with an overarching goal in mind: A $5 trillion economy by 2024-25. This requires an annual growth of 8% which will have to come on the back of a surge in investment. The Budget’s salient message is that the Narendra Modi government is going to roll out the red carpet for foreign investment in pursuit of its goal. Consequently, key sections of the speech focussed on plans for the capital market. They include debt market reform to encourage foreign and domestic investment, higher FDI limits and looser restrictions on FII investment. Crucially, Sitharaman announced that government will for the first time look at the option of foreign borrowing to bridge its deficit. Strategic disinvestment is also back on the agenda.

This path will increase RBI’s challenges. Its relationship with government seems to have improved as it has now been entrusted with greater regulatory power over NBFCs. Housing finance companies have again been brought into its supervisory control. Most of these ideas are still on the drawing board and much will depend on the regulatory fine print. A related development is that NBFCs, a crucial channel to fund consumption and investment, will get a fiscal boost to tide over their liquidity problems.

The tax proposals are underwhelming. A small step was taken to lower the headline corporate tax rate to 25%. Companies with a turnover of upto Rs 400 crore, representing 99.3% of base, have been brought into this category. These tentative steps are inconsistent with the goal of attracting large investments in manufacturing. The economy will be better off with a faster transition to lower rates and a phase out of exemptions. This will be a better bet to bring in global companies with the means to establish mega manufacturing plants in high technology – the Budget instead opted for tax concessions under a special scheme. On the customs duty side, there were a series of tariff increases to promote domestic manufacturing. These tax policies lack coherence given the goal of integrating Indian manufacturing into global value chains. In addition Sitharaman went back to raising indirect taxes on petrol and diesel, likely to have an inflationary impact.

The two areas where direct tax policy had clear intent was the use of concessions in personal income tax to promote affordable housing and electric vehicles. Construction has a knock-on effect on many industries and this measure will help mitigate the economic slowdown. Government wants India to capitalise on the inevitable advent of EVs in the mass market. This is where the real challenge comes in. If a fiscal stimulus on the demand side is to also boost local manufacturing, states must work with the Centre to reform factor markets such as land and labour.

The Budget arithmetic rests on a forecast of a 12% growth of nominal GDP in 2019-20 to Rs 211 trillion. It’s expected to translate into a modest 9.5% growth in tax collections. The total expenditure is budgeted to increase by 13% to Rs 27.86 trillion. Given NDA’s willingness to borrow abroad, it’s time to take a closer look at the budgetary support coming through public sector enterprises. It’s an unhealthy trend that’s on the rise. Since overseas borrowing or a possible windfall through transfer of RBI reserves are not accounted, meeting the estimated fiscal deficit target of 3.3% is a foregone conclusion. However, the quality of fiscal consolidation does remain worrisome.

On balance, the Budget does show clearly that the way forward is to attract foreign savings and investment. However, there isn’t much by way of a coherent fiscal policy. Actualisation of these plans will depend on regulatory details and harmonious federalism.