The first budget of NDA 2.0 was presented in a difficult economic environment. GDP growth rate had slumped to 5.8 percent in Q4 FY19, which is a 20-quarter low, and growth for FY19 had declined to 6.8 percent, which is a 5-year low. All high frequency indicators like the IIP, exports and imports, sales of automobiles and Purchasing Managers Index (PMI) confirmed the slowdown. The Periodic Labour Force Survey report of the National Sample Survey Office revealed high levels of unemployment. The NBFC sector, which has been driving consumption in many consumer durables segments, was facing liquidity issues and many NBFCs were in serious trouble. The economy badly needed stimulus to kick-start growth. The RBI rose to the occasion with three rate cuts this year and the government was expected to provide the much-needed fiscal stimulus. Did the finance minister succeed in delivering what the economy needed?
The Economic Survey presented on July 4th articulated a strategy for growth and proposed a road map for achieving high growth and making it inclusive. All the proposals need not be implemented through the budget. For instance, the much needed labor reforms can be introduced separately. The finance minister has made the right beginning by accepting the strategy of the Economic Survey and articulating it as the strategy of the government.
Desirable fiscal prudence
The FM needs to be appreciated for sticking to fiscal prudence amidst calls for fiscal stimulus all around. The fact is that there is no room for fiscal stimulus now. At a time when the fiscal deficits of the Centre, states and borrowings by public sector entities like the FCI swallow the entire household’s savings in the economy, fiscal stimulus would only crowd-out the productive private sector investment. Recognizing this, the government has correctly explored other options for kick-starting the economy. Fiscal deficit target for FY 2020 has been set at 3.3 percent.
Kick-starting the economy needs credit growth, which, in turn, needs adequate capital for PSU banks and adequate liquidity for the NBFC sector facing a liquidity crisis. The finance minister has addressed both these issues: PSU banks have been given a capital infusion of Rs 70000 crores and sound NBFCs have been extended a onetime six month credit guarantee. These two measures can contribute to revival of credit growth thereby stimulating the economy.
Capital market: Nothing to cheer about
From the perspective of the capital market, the budget is a mixed bag. The suggestion to SEBI (it is not a budget proposal) to explore the prospects of raising the public shareholding in listed companies to 35 percent from 25 percent presently, though desirable and good in the long-term, may face some practical issues in the short run, if implemented in haste. Huge supply of stocks, from large companies that reduce promoter holdings, may create short-run problems for the market. Also, there is the risk of some MNCs opting for delisting their shares. However, in the long-run higher free float will improve India’s weightage in the MSCI index facilitating more FPI flows. The ideal thing to do would be to do this in stages, say over a three year period. The budget proposal to tax share buybacks, to level the field with Dividend Distribution Tax, is negative for companies, which are presently buying back shares. But investors can expect higher dividend from companies in future.
Other measures like transferring the regulation of the housing sector to RBI from NHB and further liberalization of FDI in insurance, media and aviation are positive and desirable.
Squeezing the super-rich: Impact on FPIs
A highlight of the budget is the sharp increase in the tax burden on the super-rich. The higher surcharge on those earning between Rs 2 to Rs 5 crores and above Rs 5 crores annually takes their tax burden to 39 percent and 42.7 percent respectively. The government is unlikely to mobilize huge revenue from this. But from the perspective of inclusive growth, this move is defensible, and it has a clear and clever political message. An unintended consequence of this move to raise the tax on the super-rich has been to raise the tax burden of Foreign Portfolio Investors (FPIs) registered as Association of Persons (AoPs). The stock market reaction to this proposal has been negative.
Sovereign bonds: Should be handled carefully
The proposal to issue sovereign bonds abroad is attractive in the current context of very low global interest rates and India’s low external debt to GDP of 5 percent. The economic logic behind this proposal is sound: By shifting part of government’s borrowing abroad, domestic interest rates can be kept low. The mere mention of this proposal sent the 10-year bond rates crashing to 6.66 percent on July 5th. This reduction in the cost of capital is good from the perspective of investment and growth. However, this option has to be exercised very carefully. During good times this option is good, but during bad times external borrowings may boomerang impacting the economy’s Balance of Payments.
More reforms in the offing
The 2019-20 Budget reflects the philosophy of the Economic Survey that aims at achieving 8 percent GDP growth to make India a $ 5 trillion economy by 2024-25. This is a big challenge; but achievable with the right policy. Learning from the success stories of some of the European nations after the Second World War and the experiences of Asian Tigers, China and India’s own experience in recent times, the Economic Survey makes a strong argument for private investment-led growth supported by government intervention to make growth inclusive. The Survey recommends many policy reforms in this direction. The budget has taken off from the Survey and more policy initiatives are likely to follow soon.
With the budget behind us, the market is likely to be swayed by developments on the monetary front. The latest IMF communiqué warns about a possible 0.5 percent hit to global growth in 2020 from the US-China trade skirmishes. US, China and Euro Zone are slowing down. Consequently all leading central banks have turned dovish and global bond yield have crashed. This is positive for equity markets. In India, the MPC is likely to cut rates twice more by 25 bp each in 2019 on top of the three rate-cuts so far this year. Crashing bond yields and declining interest rates justify higher stock valuations.