Budget must help enhance capital formation

The Union Budget 2019-20 will be presented against the backdrop of a slowdown in economic growth, rising unemployment, benign inflation outlook and a resilient external sector. The main drivers of growth — investment and consumption — remain weak. The current account deficit (CAD) has widened and adverse geopolitical developments coupled with the trade tensions are a potential threat to trade and thus the CAD. The financial system is “stable” for now though non-banking financial companies’ (NBFCs’) exposures remain a threat. The fiscal management has been weak as evident from the accounts figures of 2018-19. Slippages not only question the integrity of the Budget but also jeopardise the fiscal consolidation process.

Against this backdrop, the latest Economic Survey has offered “blue sky thinking” that rejects the conventional wisdom of virtuous and vicious cycle of growth. It offers the promise of India as a $5 trillion economy with four per cent inflation and eight per cent GDP growth. The Survey gives three contributory factors to achieve this: domestic savings, private investment and exports. But the Finance Minister has the more Herculean task of managing the hard Budget constraints. There are five priority areas before the Finance Minister: revival of growth; effective and sound coordination with other regulators, particularly the RBI; infrastructure development; micro, small and medium enterprises (MSMEs); and prudent fiscal management.

Weak growth

Economic growth has weakened during 2018-19 to 6.8 per cent and is expected to be around 7 per cent in 2019-20. To address this, the Budget must have a medium-term perspective, to take growth to 7.5 per cent for the initial three years, and subsequently move it to 8 per cent. In order to achieve and sustain this, the Budget should focus on enhancing capital formation in terms of raising the rate of investment to GDP ratio.

This means the budgetary policy will have to be geared to increasing both domestic and foreign investments. The former requires policy initiatives to increase the financial savings to GDP ratio. This could be facilitated by a cultural change that discourages investments in physical assets like gold and real estate, supported with an appropriate real rate of return for the savers. The regulations on foreign direct investment (FDI) in terms of sectoral caps should be also be relaxed.

The deposit growth remains sluggish at 5.5 per cent for public sector banks (PSBs) whereas private sector banks’ deposit growth continued in double digits at 17.5 per cent. Gross non-performing assets as a ratio of gross advances of PSBs was 14.33 per cent as on March 19, 2019, as against 6.34 per cent of private banks.

This clearly demonstrates the structural rigidities in PSBs. In the Budget, the FM should therefore reassure the people that the government has a strong commitment to functional autonomy of the financial sector, particularly PSBs and of the RBI in its role as the regulator. It is also important to streamline the appointment procedure of heads and directors of regulatory bodies and keep PSBs free from any political interference while holding them accountable for performance.

To boost infrastructure, a bond with tax benefits will be helpful in the current context. Enhanced budgetary allocation for modernisation of infrastructure in terms of mechanisation of farming, high quality seeds, agricultural marketing, better storage facilities and diversification of agricultural products should be the policy priority. With regard to jobs creation, the focus should be on encouraging vocational education. Since agriculture, health and education are mostly on the State list, the FM should focus on consultations with State governments under the auspices of NITI Aayog.

The UK Sinha Committee on MSMEs, which submitted its report to the RBI Governor last month, has, among other thing, recommended: the creation of a distressed asset fund with a corpus of ₹5,000 crore; and the creation of digital public infrastructure. The FM would do well to accept these recommendations.

The government has a track record of fiscal slippage with a shortfall of revenue vis-a-vis expenditure. This has led it to breach the commitments in the FRBM Act. Budget integrity is critical. Even though fiscal deficit is the sole target currently under the FRBM Act, 2018, the focus should be to eliminate the revenue deficit, which is the root cause of creating a perpetual vicious cycle of deficit and debt.

Herein lies the art of Budget making, where the challenge lies in “doing” rather than the blue-sky “thinking” offered in the Survey.

The writer, a former central banker, is faculty member at SPJIMR. Views are personal. (Through The Billion Press)