Macroeconomics

The 2015-16 Union budget and India's growth

  • Blog Post Date 04 March, 2015
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Nirvikar Singh

University of California, Santa Cruz

boxjenk@ucsc.edu

The 2015-16 Union budget – the first full-year budget of the new government – was presented last week. In this article, Nirvikar Singh, Professor of Economics at the University of California Santa Cruz, contends that the budget is a welcome return to transparency and sanity, and has a host of small changes that add up to a promising reform agenda.



India’s Union budget is a wonderful annual ritual. Perhaps it is just attention bias on my part, but it seems to have a certain dramatic tension, appealing to both the intellect and the emotions - in ways that dysfunctional adversarial processes or bland bureaucratic efforts do not. This year’s budget was special, coming on the heels of a momentous shift in governance – the first full budget of the new government. The budget has two components: the minutiae of tax and expenditure policies and the associated revenue and spending projections, and statements or hints about policy directions. Some policies have to be tied to revenues or expenditures (plans to build things require money to be allocated for those purposes), but others are simply changes in rules or in institutions – they may have significant consequences for monetary flows in and out of the government, but they will be indirect effects; that have to be guessed at, or modeled.

Economic growth

Ultimately, aside from individual and corporate considerations of self-interest (“will my taxes go up or down?”), what is of greatest interest is how the budget might affect economic growth. In the second UPA (United Progressive Alliance) government, there was evidence of sleight of hand with respect to expenditures, and there were nasty surprises like retrospective taxation. Aside from all else that was going wrong with national governance in that period, those budgets were not good for growth. In this respect, the current budget is a welcome return to greater transparency and sanity. Restoring some degree of trust, by foreswearing retrospective taxation, and committing (as much as a sovereign government can) to certain kinds of policies, has to have some positive impact on growth. Thanks partly to the revision of the National Income Accounts, a growth rate of 8% a year suddenly seems like a new normal, and the Economic Survey has once again raised the optimistic goal of sustained double digit growth.

The three major good things that have happened in the past few months, which will support a push toward higher growth, have all occurred outside the budget process. They are: credible progress towards the introduction of a Goods and Services Tax (GST), replacement of the Planning Commission, and the changes in tax sharing recommended by the Fourteenth Finance Commission and accepted by the national government. Clearly all three of these will work together, and all three are works in progress. For example, the Union budget still has Plan and non-Plan spending (and there is still a Minister of State for Planning). But hopefully these remnants of the old order will go within a couple of years. Together, these reforms have the potential to dramatically alter governance in India, for the good. One thing I would have liked to have seen in the budget in this context, but did not, is a commitment to upgrading budget systems within the central and state governments, with corresponding spending allocations for the requisite IT (information technology) infrastructure. There were various references to improving tax administration, but the expenditure side needs attention too.

Financial sector reforms and business environment

Within the budget itself, I could not see anything to obviously dislike. I think I am being accurate in saying that most observers, if they had complaints, were concerned about omissions. There are a host of small changes that together, to me, seem to add up to a reform agenda. Of course, many of these ideas had their genesis in the last government, but who gets political credit is less important at this stage than getting things done. There is a massive reform of financial sector legislation in the works. There is another stab at reform of bankruptcy laws also coming soon. Gujarat will get an international financial centre. There is a new monetary policy framework, and a new debt management institution will be created. Some regulations will be streamlined in various parts of the financial system. There will be a new infrastructure investment fund. Small business finance, both for start-ups and for working capital management, is slated to be improved. The proof of the pudding is always in the eating (which also requires baking it properly) so there is a lot to be done, but it is hard not to see the seeds of genuine improvements in the regulatory environment and overall institutions for doing business in India, scattered throughout the budget speech.

Investment and infrastructure

In terms of the growth process in India, one of my favourite analyses is still that of Kunal Sen, done a few years ago. He found that India’s growth was driven by private equipment investment and public infrastructure investment. That is oversimplifying a bit, but it captures the essence of what we should be focusing on. India’s growth drivers are what basic economic theory would tell us, and all policies should be aimed at promoting public infrastructure investment and private investment in productive capital. For the former, roads, railways, ports, power and telecommunications are all prominent and obvious areas for public attention. The budget could have paid more attention to electric power, which has been one of the biggest failures of over two decades of reform – how can the central government get the states to deal with their dysfunctional electricity boards, for example? Another area that deserved more attention was sanitation and sewage infrastructure. Without those complementary investments, all the new toilets will not help much. Reform needs to reach down into state and municipal finance of these, and related aspects of urban infrastructure.

On the private sector investment front, the prospects of rationalising the corporate tax regime are promising, but have to be delivered on. Fast-track legal resolution of disputes, as promised in the budget speech, would also be a huge benefit. There are several detailed proposals related to taxes and transfer pricing1, that require specialists for assessment, but they seemed to be ‘pro-business’ on the whole. One thing I would have liked to see is tax incentives for greenfield investments2, and for growing the venture capital industry in India. Hopefully those ideas will also come forward in the policy agenda in the next year.

One area that did not get captured in Kunal Sen’s work was the importance of human capital investment. Partly, this is also a reflection of the changing nature of economic development and the global economy. The budget talks about skill development, but education and skill development have been a perennial weak spot of government policy. A radical rethinking of education delivery at all levels is needed for India.

Welfare systems

Finally, there has been a vigorous intellectual and policy debate about the nature of growth: who benefits and what those benefits are. The budget, by leaving in place the expanded welfare system of the previous regime, but focusing on ways to make it more effective and efficient, and indeed, rounding it out with new social and health insurance schemes, suggests that this debate can be put on the back burner for a few years, while the focus is on getting growth up to double digits, and keeping it there.

Notes:

  1. Transfer pricing refers to the setting of prices of goods and services in cross-border, intra-firm transactions.
  2. A Greenfield investment refers to the establishment of a new production facility, as opposed to cross-border Merger & Acquisition (M&A) where a firm purchases shares of an existing foreign firm.
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