As the government prepares to present its first full-year Budget after its re-election, the Indian economy is seemingly in the grip of a structural growth slowdown. The traditional engine of growth (private consumption) seems to run mostly on intermittent support while the other drivers (investment and government spending) have been on a weak footing for some time. The upcoming Union Budget will test the government’s resolve to address the structural demand slowdown and hopefully lay out a plan for generating higher ‘income’ on a sustained basis—more importantly, income which is distributed across the consumer pyramid.

The Backdrop

Consumption growth was supported by lower savings, easy credit, and certain one-offs such as Seventh Pay Commission payouts. However, even as consumption growth remained buoyant, income growth did not reflect a similar trend. Once credit conditions became tighter and the impact of the one-offs faded, consumption came under pressure. The Budget would be set against the backdrop of 4.5% GDP growth for the September quarter with a fair share of slowdown due to domestic factors.

The income situation has been weak for quite a few years. Farm profitability has been largely stagnant (barring dairy and a few crops) while rural wage growth has been muted (averaging 4.5% over the past five years). Rural-urban migration was adversely affected due to the slowdown in real estate and construction sectors. The individuals’ salary income has also grown at a CAGR of only 4%-5% over FY12-FY18. Certainly, alarm bells had been sounded of a jobless growth phase for India but its true impact is possibly being seen now.

The government has done well in articulating that it aims to support growth through the investment cycle such that the economy may reap long-term benefits. Some of the measures are commendable and much awaited such as corporate tax rate cuts (improves India’s competitiveness among peers), essential amendments to the IBC (inclusion of NBFCs), addressing funding concerns in the real estate sector, among various other measures. In addition, the new labour codes (most are yet to be passed in Parliament) look promising in resolving some of the long-standing issues raised by industries time and again. However, the government has focussed mostly on the supply-side till now.

A Measured Demand Push

The government’s revenues have been under significant challenge and compared to a budgeted gross fiscal deficit (GFD)-to-GDP ratio of 3.3% in FY20, the government is likely to end up with 3.8%. The GFD/GDP for FY2021 should be around this level (possibly around 3.7%) keeping in mind the need for some expansionary fiscal policy. The government also needs to present a credible and transparent budget such that fears of fiscal slippage are kept at bay. This is essential in keeping market interest rates under check, especially at the longer end of the yield curve.

Even though the fiscal space is limited, the Budget needs to provide support for the demand side of the economy, especially one which will help in the short-term. The choice of fiscal measures under such constraints should meet two criteria: One, impact a substantially large section of the population, and two: have high multiplier effect.

Given the narrow income tax base in India, any sacrifice of the fiscal room on account of lower income tax rates would be beneficial for only a limited number of people. Based on assessment year 2019 filings, out of around 58 million tax filers, only 15 million tax filers had returned income above ₹5 lakh (tax rate is either zero or 5% below ₹5 lakh). Further, the impact on consumption would vary widely depending on the relative gains across income brackets.

On the other hand, spending on rural infrastructure and employment (through Mahatma Gandhi National Rural Employment Guarantee Act, Pradhan Mantri Kisan Samman Nidhi, and Pradhan Mantri Gram Sadak Yojana) can help alleviate some of the pain in the rural segment. Further, expectedly, a larger proportion of the income gain would be used for consumption. Expenditure on these three schemes was budgeted at around ₹1.5 lakh crore in FY2020. The government should also expeditiously shift towards a direct benefit transfer (DBT) for fertiliser and food subsidies to cap the leakages as well as encourage a more efficient usage of subsidised products. Additionally, the government should also focus on consolidation and rationalisation of various existing transfers into a single transfer through DBT.

The government may also provide some boost to the real estate sector by providing higher-than-existing exemptions on principal and interest components for incremental house purchases. This should help alleviate the pain, particularly in high priced-residential projects in select metros. However, it remains to be seen if the government is keen to address only a select segment (high-end residential) and geography (1-2 metros) of the housing market. The real estate sector also has high linkages with sectors such as cement, steel, building materials and paints, along with high employment opportunities. Investment rate (gross fixed capital formation as a proportion of GDP) in the economy has declined to 28.6% in FY2018 from a peak of 34.3% in FY2012. During the same period, households’ investment in residential real estate has declined to 10.3% from 15.3% clearly highlighting the weak conditions in the real estate sector.

Additionally, in order to support market sentiments while its efforts to bolster the economic situation fructifies over the next few quarters, the government may rationalise the tax structure for capital gains tax on debt and equities. For example, it may do away with long-term capital gains tax (LTCG) on equities for a holding period of more than two years or a somewhat similar variation. Further, the government may want to review the dividend distribution tax (DDT) such that the cascading effect of taxation on corporate income is minimised.

Setting up for Long-term Growth

In the long term, economic growth and income generation are driven by productivity gains through efficient utilisation of land, labour, and capital along with technological gains. Beyond the much discussed land and labour reforms, it is essential to focus on human capital through reforms and expenditure in education, health, and skilling. Agriculture reforms also need to be part of the primary economic agenda. However, along with the improving productivity, logistics, and market access in this sector, India needs to build out an industrial sector over the next decade which can provide opportunity for farm labour to shift to higher value addition. The Budget may not address all the issues but could provide insights into the government’s priorities.

Further, it is imperative that the Budget outlines the financial provisions of the recently outlined National Infrastructure Plan to address the significant infrastructure gap in the country. The government should finalise and outline a credible privatisation programme and take some hard decisions regarding the ownership of even ‘strategic’ companies as well as other assets such as land in the future.

In order to boost long-term growth prospects, the government needs to focus on two fronts: Providing a stable policy regime for better private sector participation, and ensuring that the policies remain outward looking and foster a healthy competitive environment to attract global companies as well as provide opportunities for domestic companies. The upcoming Budget, besides being just an account of receipts and expenditure, also needs to be a template for the government’s economic agenda to push India towards the upper middle-income category of economies.

Suvodeep Rakshit is vice-president and senior economist at Kotak Institutional Equities.

Views expressed are personal.

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