India is one of the few countries where the government’s annual Budget is the equivalent of a national event, and this is not without reason! It is a large democracy with an absolutely free-political system, unlike many developing country peers; this makes its Budget one of the easiest policy tools to get passed through. On Feb 1, the Budget declared by the Modi government for the fiscal year 2018-2019 was its last before the 2019 general assembly elections. The year will also see elections across some of its largest states. With India now featuring amongst the eight economies worldwide that have a $2 trillion plus nominal GDP, its budget has implications for the global economy as well.
This budget’s tone was reasonably populist and for good reason too! India’s finance minister recommended better minimum support-prices (MSP) for certain agri-produce, apart from strengthening crop insurance. Non-agriculture rural occupations like fisheries and animal husbandry also received incentives. A mass-scale health insurance scheme was announced for the poor, covering up to Rs 0.5 million. Gas connections were to be given to poor women. Socially-backward communities were allocated outlays in education, etc. Roads and highways would see a continued push, as would irrigation. It also hiked the custom-duty on gold and silver and certain manufactured products, lowered the corporate tax-rate on smaller companies, amongst other steps. Most of these initiatives have the populism motive to woo two key electorate constituencies – the poor and the rural. This move was sorely needed, both economically and politically.
These two segments have been largely left out of India’s two-decade-old economic story, which has been relatively skewed towards certain educated demographics in urban clusters. In a country where income inequality has grown with GDP since the 1990s economic reforms, swathes of population have been left behind. A Credit Suisse report said the Top-1% in India control nearly 60% of its wealth, up from 36% in 2000. Demonetisation highlighted further how income inequality and the imperative to make the growth-story more inclusive have become political economy challenges. Indians have votes, but not all have incomes, jobs and opportunities; and the two cannot be long left apart! As impatience increasingly overpowers aspiration amongst these segments of the populace, there was a need to incentivize them before election-year. But will these initiatives be as effective as one imagines them to be?
Better MSPs and crop insurance would help protect rural incomes, while incentivizing non-agriculture occupations would help diversify rural incomes. Better rural incomes would benefit all those businesses who sell to rural consumers. But the issue is whether this would push excessive consumerism at the cost of saving and investment? That would only fan retail inflation. While benign oil-prices globally helped keep India’s inflation under control during this government’s tenure, north-bound oil prices (~$50 to ~$70 over the last six-months) has put pressure on inflation. Resultantly, India’s consumer inflation roughly moved from 2% to 5% over this period. Rising inflation made its central bank hawkish, which has not lowered the policy lending rate in its recent meetings; much to the angst of the industry. Moreover, a shift in India’s agriculture output mix from food-grains to horticulture can hit the demand-supply equation for key grains, which is typically consumed more in rural lifestyles. All in all, while an improvement in rural incomes was needed, there was a need to ensure it does not entirely flow for consumption, but some of it also flows into saving and investment. That would protect their future purchasing-power as well, and not just current consumption. India needs more incentives to expand retail financial services and microfinance networks across all rural districts that can mobilize this investment. While financial inclusion has been a policy of the Modi government, it should have received more emphasis in the budget to complement its push towards rural incomes.
Health insurance and gas connections should help improve the overall health and well-being of people, and help improve productivity. Access to education to socially deprived sections should help add to the workforce. But the issue is whether there is adequate job-creation to absorb so many people? While job-growth data published after demonetisation was debated for accuracy, the crux remains that job-growth does lag economic growth. Add to this two trends. Profitability growth in Indian companies has lagged many developing market peers, as Bloomberg data shows the average profit-per-company of India’s largest, listed companies de-grew from 2011 to 2016. This implies cost-pressures and concerns over hiring budgets, especially when corporate earnings in India are yet to mirror its economic growth story. Also, the universal trend towards automation would impact hiring, even in mass-scale process jobs. For instance, most Delhi Metro stations now have automated ticket-vending machines, and only 1-2 human-counters are operational at any given time despite 3-5 human-counters being built originally in most stations. So while this budget’s focus to drive the overall health, well-being and productivity are steps in the right direction, it should have emphasised more on job-creation as well.
The budget’s continued focus to invest in infrastructure like roads and highways, as well as irrigation, should help in job-creation to some extent. However, India’s gross investment rate continues to lag its peers from the East and Southeast Asia. As per IMF’s WEO data, Korea, Malaysia, China and Thailand notched investment rates between 35-40% during the early years of their economic development, even crossing 40% at times. But India’s investment rate has only hovered around 30% over this time, sometimes falling to the late-20s%. IMF’s economic projections expect this to drop to below 30% in the coming years. That is not good news for a country which wants to attain a higher economic growth, since it means even more pressure on consumption as the sole growth driver.
Moreover, within investment, infrastructure is only one side of the story. The other side is manufacturing. India severely lags here. As per CIA Factbook, India is one of the few large developing countries where manufacturing still comprises a below-30% share of the economy. Most peers score above 30%. This is all the more critical as manufacturing employs a huge chunk of the educated and skilled workforce, an area the Modi government has pushed with its national skills mission. But the sluggish growth in manufacturing bears worries for job-creation.
The budget gave a corporate tax incentive for smaller companies, which expands their retained earnings and their ability to invest more into future hiring. But unless private-sector investment cycle picks up, job-creation will be constrained. If investment can pick up in manufacturing, it would then push investment into services around that region and into infrastructure to reach that region. Perhaps the budget should have focused more to incentivize the private-sector investment cycle? Considering that GST and demonetisation saw smaller companies suffer due to the added costs of compliance and non-cash operations, perhaps they needed more incentives to push investments to grow? Unless they grow and earn more profits, a lower corporate tax rate would anyway not lead to meaningful retained earnings growth!
Exports, the third driver of economic growth along with consumption and investment, faces a tricky situation. Foreign portfolio investors have been significant net buyers of Indian securities in recent times. This flow of global liquidity might have pushed its forex reserves over $400 billion, but it also strengthened its currency. This was just when a weakening currency could have helped improve its export competitiveness.
As per IMF’s WEO, Asian peers have seen a far higher growth rate than India in goods-export during their early development years. Even in services export, changes in global technologies has impacted the services demanded from India’s software exporters. Bloomberg data shows that the average profit-per-company of the largest, listed companies in India’s technology sector has grown from 2011 to 2016, but this turns south if one removes HCL and TCS from the tally. The budget may not be the best platform for the devising an exports policy that can balance exchange rates and foreign reserves, but it could have given more emphasis on related areas. One positive step in the budget was the custom-duty hike on gold and silver. While some import of capital equipment and machinery are always needed to push investment into productive asset-creating activities, jewellery from imported bullion has no productive asset-creating purpose. It is only a blatant consumption that spikes India’s current account deficit.
Continuing on custom-duty, a higher duty on imported mobile phones may render them expensive for consumers, but any improved competitiveness for Indian-made mobile phones might just help push investments, job-creation and income of that domestic industry, something it needs much more than cheaper imported mobile phones at this point!
Economists may argue about the impact of this budget’s populist initiatives on the fiscal deficit (and it is expected to slip to 3.3%), but this focus on poor and rural segments was long overdue. The urban, educated middle-class may complain about the budget, but the budget’s real target audience of those two electoral constituencies was purely a political decision. But one will wait and watch if these initiatives are implemented properly to benefit the real target audience, or whether it only benefits a few cosy groups. The challenge will be the last-mile connect for reaching the real beneficiaries. Just like LPG’s direct cash benefit transfer, even these incentives have to ensure a transparent last-mile connect to benefit the real target across the hinterland.
If these initiatives do improve the lives of these two electoral constituencies, it may yield the BJP political dividends in the upcoming elections, both state and central. Assuming it wins both, that might help tilt the majority in the Parliament’s Upper House to it, unlike the situation now. That would give it the bench-numbers it sorely needs to pass more critical reforms. If that can happen, then the political populism of today can lead to economic reformism tomorrow!