[Editorial Analysis] Distributing the rewards of reform

Mains Paper 3: Economy

Prelims level: Union Budget 2019

Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment


• Since Budget 2019 is the last before the general election this year, it was widely expected to be an assessment of the government’s performance.

• There was a debate on whether the Budget should have announced any substantive measures since they would bind the next government, post-election.

• It turns out the report card is good enough to create space for some substantial measures.

• Painstaking fiscal consolidation, tax reform, more efficient delivery of subsidies, and a rise in the share of capital expenditure, have created the space to reward tax-payers as well as announce a relief measure for farmers in distress without substantially compromising fiscal consolidation.

• It is fair that this government, which imposed the painful reforms and undertook difficult action, should also distribute some rewards of that reform.

Rewards of higher growth

• It may be asked how payment of ₹20,000-₹75,000 crore can be made to farmers and the tax benefits given with only a marginal impact on the fiscal deficit.

• But a larger size economy can afford to spend larger absolute amounts with only a small rise in deficit ratios and borrowing requirements.

• The fact that India is the sixth largest and fastest growing economy in the world has some advantages as well as responsibilities to equitably share the rewards of growth.

Formalisation of the tax base

• Demonetisation, the goods and services tax (GST) and other steps towards formalisation increased the tax base, and it follows that tax rates can themselves be cut.

• Again it is fair that the aam aadmi, who bore some of the costs of reform, should now benefit from the success of these.

• It makes good economic sense to move towards a system of a wider base and lower rates.

• Tax receipts have grown from 10% of GDP a level at which they had stagnated since the tax cuts after the global financial crisis to 12%.

• Although the GST has not yet resulted in a rise in indirect tax ratios above 5.5%, it is likely to do so in the future as it stabilises.

• The transfers to farmers and tax cuts amount to only 0.4% of GDP this year and are partially funded by a 0.3% rise in tax ratios.

• The JAM (or Jan Dhan-Aadhaar-Mobile) complex is the other major set of reforms that enable a smaller expenditure to have a larger impact on social welfare.

• Jan Dhan bank accounts opened through the country and the Aadhaar data base make a cost-effective Direct Benefit Transfer (DBT) possible for farmers.

Rewards of lower inflation

• A slight rise in fiscal deficits to fund transfers to farmers does not threaten macroeconomic stability when inflation is low and food prices are crashing.

• In fact they are likely to help stabilise prices so that farmers do not cut production in the next crop cycle.

• This year, the revenue deficit has been maintained, the primary deficit been reduced, and expenditure on capital account been increased.

• Better quality of government expenditure as well as the GST tax cuts, reductions in obstacles to inter-State trade, and soft commodity prices will keep inflation low.

Government borrowing

• The size of government borrowing is larger than what the market anticipated, and this has raised G-Sec rates.

• The rise in gross borrowing is because of higher redemptions but net borrowing is similar to that last year. There was a sharp rise in G-Sec yields that year.

• As a result, interest payments as a ratio to GDP rose to 3.2 against the budgeted 3.

• But 3.4% of GDP is not a large fiscal deficit, and market conditions are likely to be more supportive of government borrowing this year.

• The international rate rise has peaked, with the U.S. Fed turning dovish and indicating that there will be no more rise;

• It is likely to maintain its balance sheet. Emerging market inflows are set to rise, creating demand for G-Secs up to the current cap of 6% of the domestic market.

• Soft oil prices will encourage foreign investors to return to Indian markets. But since global growth is slowing, inflows are unlikely to be as large as they were in 2017.

• There will be more room for open market operations (OMO) from the Reserve Bank of India that support the debt market.

• Softening interest rates will also make banks more willing to hold G-Secs.

Maintaining capital expenditure

• The budgetary contribution to capital expenditure remains at about 1.6% of GDP there is a rise in internal and extra-budgetary resources, which are now larger than gross budgetary support.

• But public enterprises must be able to raise and use internal resources.

• This is a healthy sign of efficiency, market viability and reduced dependency on the government.

• Even market borrowing by such enterprises used for investment when private investment remains low, is likely to crowd in (rather than crowd out) private investment.

• It will raise demand which will induce more private investment.
• The latter remains still constrained by low demand at present, except for a few sectors where capacity constraints are appearing.

Improving efficiencies

• Well-targeted transfers can be made without destroying fiscal consolidation and creating macroeconomic vulnerabilities.

• As competitive populism creates talk of unfunded universal income schemes, or farm loan waivers that hurt growth of farm credit, it is better to bind the next government to schemes that are less distorting.

Way forward

• The Budget continues the effort to reduce transaction costs and improve compliance incentives.

• Stamp duty amendments that seek to tax just one transaction, which will be shared across State governments, on the basis of the domicile of the buying client, will reduce a major market irritant, increase transactions and take the country further toward becoming one effective market.

• As income tax returns rise, a less than 0.05% will be selected for scrutiny in non-discretionary, machine-based ways without any interface between the tax-payer and the examining officers, thus reducing potential tax-payer harassment.

• India is a very difficult country to change.

• Problems remain, but the rewards are beginning to appear and should be greeted with cheers.


Prelims Questions:

Q.1) In the context of the discretion of Governor under the constitution, consider the following statements:

A. The Constitution provides the Governor with the power to “remit or commute the sentence of any prisoner”.

B. The Governor’s decision will be subject to judicial review by the constitutional courts.

Which of the statements given above is/are correct?

i. A only

ii. B only

iii. Both A and B

iv. Neither of the above

Correct Answer: III

Mains Questions:

Q.1) The expansive Budget reflects the fruits of fiscal consolidation, tax reform and streamlined delivery of subsidies. Critically analyse the statement.

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