Budget 2017 amid demonetisation: Jaitley has tough task of rejuvenating slowing economy

Union Budget 2017-18 will be unique, given that it is coming at a very difficult time for the Indian economy. The crisis confronting the economy has been triggered by the government’s rather ill advised action in ordering demonetisation of high denomination currency notes.

Demonetisation has led to the emergence of recessionary conditions in the Indian economy. This is resulting in uncertainty for the economy because it is not clear how far the decline would continue. The formulation of the budget requires some idea of what the GDP is likely to be so that one can make projections of the revenue that could be collected. Without this, one cannot determine how much can the government spend without raising the deficit further. In fact, the government is committed to lowering the fiscal deficit and that would further reduce resources for expenditures and especially for the social sectors and the poor.

The government has been denying any negative impact of demonetisation and this may get reflected in the budget also. Thus, the formulation may be on incorrect assumptions which will mean that the budgetary arithmetic may turn out to be wrong and lead to problems over time. Either the deficit would be much higher which could lead to a downgrade by the credit rating agencies resulting in higher costs to the economy or social sector and capital expenditures may be cut leading to a deepening of the recessionary conditions. The budget faces a pincer. The problems resulting from demonetisation would be compounded.

A budget is formulated for the year ahead. The basis of the formulation is the current performance of the economy. But what is the performance in 2016-17 is not yet clear. What happened till 8 November is known but what is happening since then is not yet revealed by official data. The Chief Statistician of Government of India has said he does not know. So, should the projection be on the basis of the average for the financial year which would not be representative of the recent trend or on the basis of the post 8 November trends in the economy? Clearly the latter, since that is the trend that is likely to continue into the new financial year 2017-18. What happened before 8 November, cannot suddenly start happening after an interregnum of so many months and in which irreversibility has set in with decline in investment.

Further, the budget has been advanced by a month so that the data for the year we are in is even more incomplete than earlier. This adds to the uncertainty of budgetary calculations for the current and the coming year. The two months data post demonetisation, up to December, will not be adequate to make the revenue projections. Thus, large errors are likely to creep in to the budgetary exercise.

The budget has to take care of the problems confronting the economy and try to give the economy a direction. For the latter it has to base itself on new policies requiring additional expenditures. The PM has already announced new sops to the poor who have been hurt by demonetisation, like policies for housing and farmers. But new expenditures will require budgetary allocations but it is unclear where will they come from. So, the budget has to try to raise revenues.

The government had hoped that it would get additional funds from unearthing of black incomes but that is not happening. Most people with black cash holdings seem to have converted it into new cash. Money deposited in accounts cannot be assumed to be black. The Income tax department does not have the wherewithal to investigate so many accounts and usually is unable to prosecute due to provisions for appeal, etc.

With the output and profits hit, regular tax collection will decline in spite of the initial news from the government that in the first 7 months of the year, taxes have risen rather sharply.The rise is in direct and indirect taxes. Will this buoyancy continue in the future?It will be a big mistake to assume that since the tax collection was rising it would continue to do so. It could have been due to fortuitous reasons in the first six months and those reasons are unlikely to continue given demonetisation.

Data on IIP which rose sharply in November 2016 cannot be used to assume that the same would happen in December and January - the lead up to the budget. It does not take into account the unorganised sector which is 40 percent of the economy and which suffered an immediate decline. Recent surveys by different agencies are showing a sharp decline in business prospects.

Due to demonetisation induced difficulties, there would be need to increase expenditures – capital and on social sectors to boost the economy, compensate for the decline of investment by the private sector and mitigate hardships of the people. Demand under MGNREGS has already increased substantially. How are these expenditures to be met?

In the past, governments have shown higher expenditures in the budget and later cut them to meet the fiscal deficit target. During the UPA II regime, over 5 years about Rs 6.5 lakh crores of expenditures were cut from the Plan.

This budget is coming in the shadow of not only demonetisation but also the coming crucial elections in 5 states and the crucial one in UP. The part A of the Finance Minster’s speech is always full of promises to all sections of society and this year it is likely to be even more so. The moot question is where will the resources come from in the post demonetisation scenario? Or, these will be mere promises without delivery.

There is likely to be huge external uncertainty confronting the budget makers. The external sector is uncertain given the outflow of the foreign capital and the fear of the increase in interest rates by the US Fed which could aggravate this trend. So, the external sector would have to be tackled along with the impact of demonetisation. This is going to be a tough exercise.

Reform of direct taxes is badly needed. GST implementation is complex and needs to be postponed till the conditions settle down in the economy. There is no point in compounding the problems. The states will be worried at the loss of revenue due to demonetisation and GST will add to their worries. These uncertainties will create more problems for tax collection.

In conclusion, this year’s budget faces a lot of internal and external uncertainty. Its calculus could easily go wrong because its problems are not due to the natural working of a capitalist economy. If that happens, the economy could find itself in a worse situation.