Jaitley should focus on reviving sentiment, creating jobs

Until November 8, the performance of the export sector was perhaps one of the few worries for the economy. A good monsoon in most parts of the country, after two years of sub-par performance, had lifted business and consumer sentiments and demand was looking good.

The rural economy was on the mend and food price volatility was not alarming. Companies were looking forward to improved earnings. Moderate inflation and declining interest rates held hope for cheaper finance. The country’s fiscal position was in a fairly comfortable zone.

On November 8, suddenly everything changed. Demonetisation of ₹500 and ₹1,000 notes overnight left people holding worthless currency and the economy was jolted. The same night also saw the surprise victory of Donald Trump in the US Presidential elections, which brought global uncertainty.

Demonetisation dashed hopes and depressed sentiments, and consequently, demand evaporated as people had little legal tender to use. Remonetisation was far too slow to provide any comfort. Hence, rather than spend freely, people chose to hold on to the few precious notes they managed to get from banks.

While urban India found ways to get around the currency shortage, rural Bharat was in distress once again, almost as much distress as it was in prior to the onset of the monsoon. Farmers were unable to sell or get a fair price for their perishable produce. Manufacturing companies were left watching slow sales of durables. Consumption saw some recovery in December as more cash became available and people turned to electronic and digital payments.

Therefore, reviving sentiments and demand as well as creating employment opportunities for the suddenly unemployed daily wagers need to be the focus of Arun Jaitley’s fourth budget, which he presents on February 1. Equally important is the need to stimulate rural demand by ensuring income for people there. This requires the government to step up spending and investment over the next few months, which would call for some flexibility on fiscal consolidation.

“What is needed is quick turnaround projects that will create employment and transfer incomes,” says economist and former chief statistician of India Pronab Sen. He identifies housing and rural roads as projects that can be implemented without much delay at the State-level as most States have a panel of pre-qualified contractors who can be awarded work.

Such projects together with immediate scaling up of the Mahatama Gandhi National Rural Employment Guarantee Scheme will ensure income flows to rural households and those rendered unemployed due to the note ban.

Rating agency Crisil’s chief economist DK Joshi, too, agrees that the government will need to support private consumption. Interest subvention, low-cost housing and rural roads are some measures that can help revive consumption and additional resources gained from demonetisation could be used for that purpose. “The government needs to support the economy as prudently as possible. A tight fiscal policy at this juncture will not help,” Joshi advises.

That would mean the government will need to abandon the fiscal deficit target of 3 per cent of GDP for 2017-18, set in the medium-term fiscal policy statement. It is expected that the expert committee to review the Fiscal Responsibility and Budget Management, set up under the chairmanship of former Planning Commission member NK Singh, will recommend a relaxation in view of the changed economic scenario. The government, too, will want more flexible targets defined by economic cycles.

Professor NR Bhanumurthy of the National Institute of Public and Financial Policy argues that piecemeal policies without an expenditure plan will not help revive growth. “The government needs to have a medium-term expenditure framework, with clear targets and allocation for each ministry,” notes Prof Bhanumurthy.

Such an exercise was done by the Planning Commission together with individual ministries earlier and since its scrapping this exercise is neither been done by the expenditure department of the Finance Ministry nor by Niti Aayog.

Essentially that means the government needs to go beyond announcing various schemes to relieve the pain, as done by Prime Minister Narendra Modi in his address to the nation on December 31, 2016, besides ensuring each of those schemes is well funded.

There is wide expectations that the government will reap some benefit from the demonetisation exercise — that a significant sum of money not returned to banks will be cancelled by the Reserve Bank of India and paid as dividend to the Union Government. That money could be transferred to a segment of the population as some variant of universal basic income.

“It can be a form of direct benefit transfer to a select group,” says economist Sen, adding that a small sum may be transferred to the Jan Dhan accounts. That money will help stimulate spending.

The Finance Ministry also needs to be mindful of upward pressure on inflation.

There is a risk that a rapid increase in demand when the money situation normalises could also lead to an increase in prices.

The oil price rise is a risk to the economy. So long as it stays below $60-65 a barrel, there is not much of a problem.

Food prices are benign currently both domestically and globally. But there is still uncertainty about food output in the rabi season, the increase in acreage notwithstanding.

The government should be mindful of pushing up food prices through sharp increases in minimum support prices, cautions Joshi.

Another imponderable before the government is the rise of protectionism in global trade. Its impact on the country’s external trade is not known but any adverse impact will mean lower export earnings and hurt export units.

Foreign investors, too, have been very critical of India’s demonetisation exercise and have in recent weeks withdrawn money from Indian stocks to invest in other attractive emerging markets. Policy uncertainty on taxation of foreign portfolio investors is also weighing on investment decisions. Such outflows along with the strengthening dollar have led to depreciation of the rupee. Such a depreciation will have a mixed impact on the economy — imports will get expensive and that could fuel inflation but exports may get competitive.

A delay in rollout of the Goods and Services Tax (GST) is also a cause for concern, but the Finance Ministry seems to be indicating that the integration of central excise duty and services tax at the central level is on the anvil from April. Some relaxations are expected on income taxes, but economists caution against big changes ahead of the GST rollout, when there is a need to protect the Centre’s revenues. All in all, demonetisation has created challenges for Budget 2017-18, and therefore, the focus has to be on normalising growth and consumption, and to ensure income flows for the poor.