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Informist, Friday, Jul 19, 2024

 

--StanChart Sahay: Fiscal consolidation should be gradual post FY26

--StanChart Sahay: Govt may keep FY25 fiscal gap aim at 5.1% of GDP

--StanChart Sahay: FY25 fisc gap may be lower by 300 bln rupees

--StanChart Sahay: Govt need not run to fiscal deficit of 3% of GDP

--CONTEXT:StanChart India research head Sahay's comments in interview

--StanChart Sahay: Govt needs to spend more on education, skilling

--StanChart Sahay: Budget may focus on fiscal consolidation, capex

--StanChart Sahay: Budget may increase spend to boost consumption

 

By Shubham Rana and Priyasmita Dutta

 

NEW DELHI – The government should pursue a gradual fiscal consolidation path once it brings down the fiscal deficit to below 4.5% of GDP by 2025-26 (Apr-Mar) as there still exists a large requirement of public capital spending, according to Anubhuti Sahay, head of India Economic Research at Standard Chartered.

 

"I would support a more gradual fiscal consolidation path rather than just running back to 3% very quickly," Sahay told Informist in an interview. "Unless there is very clear visibility on large increases in taxes on a sustainable basis, I wouldn't recommend a sharp reduction in expenditure just to reach the 3% mark. A gradual path works well for the government, so no need to rush to the 3%."

 

The Fiscal Responsibility and Budget Management Act, 2003, dictates that the central government's fiscal deficit should be limited to 3% of GDP. The government's fiscal deficit had risen to an all-time high of 9.2% of GDP in the pandemic-hit year of 2020-21. In 2021, the government laid out a fiscal consolidation roadmap, under which it set a target to bring down the fiscal deficit to below 4.5% of GDP by 2025-26.

 

In the Interim Budget for 2024-25, the government pegged the fiscal deficit for the year at 5.1% of GDP. Last year, the Centre's fiscal deficit was 5.6% of GDP.

 

According to Sahay, the Centre not only needs to increase public capital expenditure, but also spend a "lot more" on education and the skilling of the workforce. "Given that India is in a good position today, the potential can be improved a lot more by spending on capex, both on social and infrastructure. I think a gradual fiscal consolidation path is a far better route rather than rushing towards the 3% target," she said.

 

Sahay expects the Centre to retain its fiscal deficit target of 5.1% of GDP in the full Budget, which will be presented on Tuesday, even as the absolute deficit may be lower by 300 bln rupees from the 16.855 trln rupees pegged in the Interim Budget.

 

"In this Budget, even if she (Finance Minister Nirmala Sitharaman) gives a tax cut, gives the farmer income scheme yet another instalment, we think food subsidy bill will also be higher, special assistance to states may also go up, and even if we account for some short fall in divestment and telecom receipts, our sense is that 5.14% (fiscal deficit) can come down to 5.06?cause the buffer is large," Sahay said.

 

Below are edited excerpts of the interview:

 

Q. What do you think the focus of the Budget will be this time, considering we have a coalition government after 10 years?

A. I would break down the focus to three parts. Fiscal consolidation, I think that theme remains intact. Second is, the focus on capital expenditure, which is yet another thing which we expect to remain intact in this Budget. However, there is likely to be a little bit more spending to boost consumption and that can take the form of higher spending on rural as well as for the middle-income class.

 

So it is a Budget which will give some support for consumption without losing sight of fiscal consolidation and keep on pushing for higher public capex, especially in an environment where private capex is still shying away from making a large commitment.

 

Q. Where do you think they will peg the fiscal deficit for 2024-25?

A. We are expecting 5.1%. But if you actually take the fiscal deficit number to the second decimal place... in the Interim Budget she presented it at 5.14%. In this Budget, even if she gives a tax cut, gives the farmer income scheme yet another instalment, we think food subsidy bill will also be higher, special assistance to states may also go up, and even if we account for some short fall in divestment and telecom receipts, our sense is that 5.14?n come down to 5.06?cause the buffer is large.

 

On a net basis, if I put a round figure around it, then she has a buffer of 0.6% of GDP in our view and the spending which she needs to make on the items I mentioned, is just 0.49%. So if we don't round it up then it will still remain at 5.1% but if you're looking at the size of the absolute fiscal deficit, it may be lowered by almost 300 bln rupees from the Interim Budget's projections.

 

Q. You are looking at a fiscal deficit lower by 300 bln rupees. Do you also see a borrowing cut along with that?

A. No, because they announced a cut in the Treasury-bill auction size earlier in the year, 600 bln rupees, of which effectively 300 bln rupees will be affected because 300 bln rupees were actually getting redeemed this year. As far as dated securities are concerned, it will remain pretty similar to the Interim Budget.

 

If at the end of the year, she has sensed that amount has not been spent as planned, which is possible because now she will have just eight to nine months to spend the amount very quickly, which might not happen for a whole list of reasons. Then there is a possibility of a cut in market borrowing. But our sense is that the decision will be deferred to the last quarter rather than announcing it on Budget day itself. 

 

Q. Do you think an income tax cut is a way to boost consumption demand sustainably?

A. A tax multiplier or a fund transfer like the farmer's income scheme has a multiplier close to 1. So, in totality, it won't be more than 0.15% of GDP in terms of a tax cut and rural income spending. I'm not including higher food subsidies here. The support to consumption will only be that much because the multiplier is 1. These kinds of boosts are very incremental in nature.

 

The big support to consumption this year will come from better monsoons because almost 42% of the labour force is still dependent on agriculture. Last year, crop production was down by 6% and if you look at a typical agricultural household, they dropped close to 40% of their income by sale of agricultural produce.

 

And if output was bad, it clearly impacted their earning capacity, and we have had three bad crops in succession. That in turn has impacted rural demand, which is almost 50% of our aggregate household demand in the country. So, our sense is that consumption this year will improve, but that will be more a story of second half, rather than immediately in the second quarter of fiscal year 2024-25. The support which will come from the Budget will be incremental. At times, you need that positive sentiment also to start the virtuous cycle.

 

But the big push has to come from a revival in the monsoon and that will drive rural demand, which in turn will also be important for private investment. Private investment has been on a cautious footing because they still don't see, or they still don't have a very clear visibility on aggregate demand within the country. If 50% of the demand driver, which is rural India, comes back in full force, say by 2025, then that will crowd in private investment.

 

Q. For providing relief on the personal income tax front, what do you think is the best way of going about it? Is it raising the standard deduction limit or is it just raising the lower end of the limit?

A. It is tough to say what is the best way, but I think the finance minister will try to work with the best permutation combination which gives maximum relief to the middle income class or say income to someone who has a net effective taxable income of 15 lakhs (1.5 mln rupees) or below. I think that is where the maximum multiplier impact can come through, because if you give a lot of tax reduction on the higher end, only so much extra will be consumed. But if you give it at the lower income, the consumption multiplier is much higher.

 

At the end of the day, the intent of the finance minister is to want more and more taxpayers under the new tax regime. Whatever tax boosts are announced, it will be directed to benefit the middle income segment plus ensure that we see more people shifting towards the new tax regime than the old tax regime. Right now, mathematically, the old tax regime still looks attractive. So whatever permutation combination she does, she has to make the new tax regime more attractive.

 

Q. The government has been putting a lot of thrust on capex to crowd in private investments, and it had also cut the corporate tax to give corporates a little bit of comfort to come forward and invest, but their animal spirits are still at bay, and they have not come forward. Why exactly is that and what more can be done?

A. First is obviously on the demand side. Right now, if you look at it, everything is in place. Leverages are low for the corporate sector, and the banking sector is in good health. And the outlook on the Indian economy is extremely positive. Having said that, we have not seen a revival in demand. It's a big commitment in terms of investment and unless they get clarity on what is plaguing demand--at this point in time, whether that factor is temporary in nature or permanent in nature--it becomes very difficult for the private sector to come and start investing in a big way. So that brings us back to the point of whether rural demand be revived to an extent that the corporate sector gets a better visibility on demand sustainability. It is not just about demand revival but also the sustainability of that demand. The monsoons are a factor to keep an eye on.

 

Second, I think we will get to see in this Budget the 15% tax rate which she announced in September 2019 for a new manufacturing unit. She announced it, and then we immediately got into COVID period, so probably not many corporates were able to take that advantage. Maybe she can reintroduce it because it expired in March 2024.

 

Third, on the production-linked incentive scheme, the government has been talking about including more sectors, but there is also equal emphasis on streamlining the process, like reimbursement of incentives. I think all these factors, policy clarity, policy vision map, demand clarity and probably a better tax rate for profits will help them. I think these, in turn, will bring back private investment. Let us remember when we speak about the animal spirits in India, we always compare them to the period of 2010 or 2011. I don't think we will go back to those highs, because it's a very different world globally as well as domestically. There are issues around geopolitics and climate change. You have these broader narratives at play that can have an impact on policy strategy.

 

The fourth part which I would add is the ease of doing business. It requires limited costs, but it is an area where, hopefully, we can see more measures by the government. You can give all kinds of incentives, but if the approval process takes very long or the time period taken to set up a shop takes very long, then it becomes difficult. India definitely has a reason to get a larger chunk of investment. It has been getting investments, but it can get a larger chunk of investment if doing business becomes far easier. These are the four pillars that may push private investments.

 

Q. Is there a case to revisit states' borrowing limits?

A. I don't think so. When we are talking about fiscal autonomy or the need to spend, considerations will have to be made of the broader framework of what it means for the overall debt to GDP. India's debt-to-GDP is already very high, at 83%. If there is another COVID-like scenario, it can very quickly jump towards 90% and higher. And it takes a lot of time before debt-to-GDP actually comes to a more desirable level. There is a camp that says the government, both central and state governments, should spend a lot more and not bother about debt to GDP. But if you look at it, barring the US, no country has been able to live with very high debt-to-GDP from a medium-term perspective.

 

And if you look at the states, even though they have a limit of 3.5%, they have been very conservative and have not even utilised their current fiscal deficit limit fully. Last year's fiscal deficit for all states combined was 2.6%. This year they are factoring in 2.8%, removing the capex loan because that is coming on Centre in terms of borrowing.

 

Our sense is, every year they budget higher, but they end up at least 0.1%, 0.2% less in terms of actual fiscal deficit. So they are not even utilising the full amount. Simply raising the limit is not the best way to go about it. I think maybe more consultative efforts are required to improve the efficiency of expenditure. States are, anyway, very efficient in terms of their expenditure because they are closer to the ground.

 

Q. How feasible do you think it is for the government to bring the fiscal deficit close to 3%?

A. I would support a much more gradual fiscal consolidation path for a simple reason: there is a large requirement for public capex. India has done exceedingly well in many sectors, like roads, railways, airports, but there is still a lot more ground to cover.

 

So, I would support a more gradual fiscal consolidation path rather than just running back to 3% very quickly. Unless there is very clear visibility on large increases in taxes on a sustainable basis, I wouldn't recommend a sharp reduction in expenditure just to reach the 3% mark. A gradual path works well for the government, so no need to rush to the 3%.

 

They need to spend more on public capex, they need to spend a lot more on education and skilling. Because when we talk about employment opportunities we usually just focus on the aspect of job creation, but it's equally important to have the right quality of labour force. India has been creating quite a lot of jobs over the last five years based on the RBI's latest KLEMS data--26 mln on an annual basis and half of it is in the non-agricultural sector. But the quality of jobs that have been created are in usually very low-productive areas like domestic trade or construction. So there is a need to spend a lot more on physical infrastructure. There is an urgent need to spend a lot more on skilling.

 

Given that India is in a good position today, the potential can be improved a lot more by spending on capex, both on social and infrastructure. I think a gradual fiscal consolidation path is a far better route rather than rushing towards the 3% target, because even if you rush towards 3% target, your debt to GDP takes time to come off and debt to GDP always has two components. One is the pace at which fiscal consolidation happens, and the second is how sustainable the nominal GDP growth rate is. India is able to see 7-8% growth because we invested a lot in capex and that has to continue. So one has to look at it from all aspects.

 

Q. Do you think the current high tax buoyancy is sustainable?

A. The record-high GST in April was because of the March effect. March is the last month of the year. So, usually, that number has a seasonality. I think the most sustainable number is 1.7 trln rupees. If you look at the GST collection, it has been growing a little faster than the nominal GDP. Nominal GDP has been less than 10%, GST has been growing at 11-12%, and I think that can continue going forward because GST has got very well integrated with the system.

 

The bulk of the gains in revenue is likely to come from the income tax side, where we are already seeing a shift happening, not because of an income component to it, but because there is also a large role played by increased compliance. I think this is an area where we can see a lot more benefits coming in. It used to be less than 3% of GDP and just talking about income tax, in 2023-24, it has jumped to 3.5%. So almost a 0.5% gain in a matter of one year. That much gain in a matter of one year is not easy. Every year the compliance gains can't be a safety net. Last year, we saw income tax going up by 22%. We can't see that much growth every year. We need to see a few more years, because right now the government has more data, it has a better sense because of the whole rise of the digital economy, how much income is generated, so they will be able to do it for a few more years, but it will plateau out at some point. But I think there's still time to plateau. We will continue to see good tax points going forward because data is still getting mined. Especially when they start integrating GST data with the digital transaction data, they will have far more clarity on how much taxes they should ideally be collecting.  End

 

Edited by Ashish Shirke

 

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