[dropcap]T[/dropcap]he Budget of 2016-17 was yet another incremental Budget of the NDA government. This Budget was primarily focused on agriculture.
The fiscal deficit figure was one of the key numbers that was awaited by the markets and financial analysts. In his Budget speech last year, Finance Minister Arun Jaitley had committed the government to a path of fiscal prudence and had set a target of 3.9% for 2015-16 and 3.5% for 2016-17. But looking at the added burden of the 7th Pay Commission and One Rank, One Pension (OROP) for the defence forces personnel, several commentators had asked him to reconsider this stiff target. The Pay Commission alone is expected to have an impact of 0.65%.
One month ago on 30 January, RBI Governor Raghuram Rajan had warned “against generating economic growth through additional debt” saying that “any deviation from the fiscal consolidation path will hurt stability of the economy”. Rajan had implicitly hinted that further rate cuts would be dependent on the Finance Ministry keeping its promise.
In this years Budget, Jaitley has set the target at 3.5%. This looks extremely ambitious, considering the fact that the mid-year Economic Survey of last year pointed out that “The Indian economy is doing well for a car with only two wheels running. Compared to the boom years of 2004-11, neither exports nor private investments are contributing much to economic growth. As such, the economy is essentially being run on the other two wheels — private consumption and government expenditure”.
Considering the global situation, exports are unlikely to pick up anytime soon. Similarly, without any rise in the domestic demand and also credit expansion by banks (plagued by non-performing assets), corporate investments are unlikely to happen. What this means is that, in case anything goes wrong — like a sudden spike in oil prices, monsoon failure, global recession, etc — all these fiscal projections are likely to go for a toss.
It would be worthwhile to remember what happened with the Vote of Accounts of Jaitley in 2014. Even in 2014, experts had warned that 4.1% target would be too aggressive. In the end, FM was forced to cut allocations. While Jaitley may have met the 2015-16 target, it was largely due to the low oil prices. While I am a deficit hawk, I prefer conservative projections. I would have preferred to see Jaitley promising 3.7% and delivering 3.5% rather than vice versa.
Nitin Gadkari’s Ministry for Road Transport, Highways and Shipping has been the top performing ministry of the NDA government. The FM has promised massive allocations to the infrastructure — particularly roads. Road construction has a huge multiplier effect on jobs and growth. The finance minister has promised Rs 97,000 crore to the sector, which includes Rs 27,000 crore on PMGSY, Rs 55,000 crore on road transport and highways, Rs 15,000 crore on NHAI bonds. The corresponding numbers for the previous year were Rs 19,000 and Rs 42,000 crores for PMGSY and Highways. The FM further brought ahead the PMGSY target to 2019 from 2021. This scheme aims at providing good all-weather road connectivity to unconnected villages.
The scheme was started by Atal Bihari Vajpayee; it has brought significant change in the lives of the rural people. Physical connectivity is the basic requirement without which the government cannot deliver any other services to the villages.
Agriculture and rural development
After two successive droughts, this Budget focused primarily on agriculture and the rural economy. It is unfortunate that only 46% of cultivated land is under irrigation while the remaining is exposed to the vagaries of nature. The government has set out a goal to double the income of farmers by 2022. The FM allocated a total of Rs 87,765 crores on rural development as a whole. This includes spending on Pradhan Mantri Krishi Sinchai Yojana, Long-Term Irrigation Fund, Programme for Sustainable Management of Ground Water Resources, MGNREGA, Pradhan Mantri Fasal Bima Yojana and PMGSY (already covered above).
The government also plans to incentivize the cultivation of pulses. The Pradhan Mantri Fasal Bima Yojana, which was launched recently, deserves a special mention. This scheme has reduced the insurance premiums substantially. The farmers will now have to pay a uniform premium of 2% for all kharif crops and 1.5% for all rabi crops. This number was as high as 15%. Not surprisingly, only 23% of the crops are currently insured.
Another interesting feature of this scheme is that, earlier, in case there was no rain in July-August, the farmers would not sow their crops. As a result, they were not eligible for insurance, since no crop was damaged. This scheme has a provision to provide a fixed income at predetermined rates in case of such extremes.
Dividend Distribution Tax
DDT is a tax on already taxed income (corporate tax has already been paid on the amount) and this is thus double taxation. In the current Budget, Jaitley has applied an additional 10% DDT on individuals, HUFs and firms receiving dividend in excess of Rs 10 lakh per annum. In other words, this is a form of triple taxation.
While people may try and justify this tax on individuals and HUFs, the FM certainly needs to reconsider this tax on mutual funds for those who hold shares of various companies and thus would be levied this tax. Mutual funds are held by small investors and, thus, this tax is essentially on small holdings. Further, DDT is hardly expected to bring substantial revenue to the government.
Further, we need to understand how stock markets work. Dividends are decided by the big guys, i.e. the promoters of companies. In case of such heavy taxation, they may decide to stop dividends and to do a buyback and thus boost stock prices. This is yet another unintended consequence when government tries to interfere too much.
As a regular stock investor, one of the most important lessons I learnt while picking stocks is to look at dividends and taxes paid by the company. This is because of both dividends and taxes are to be paid out of profits. If a firm which regularly pays dividends and taxes, one can be reasonable sure that its financial numbers are real and there are real profits and not accounting profits. Dividend yield is one of the most important indicators used by investors and high tax on dividends would lead to an unintended consequence of firms reducing the dividends to its investors.
Disinvestment and privatization are a favourite of free market waalas. The government aims to collect Rs 56,500 crore through disinvestment in PSUs in the next fiscal, as per the Budget for 2016-17. Of the total budgeted proceeds, Rs 36,000 crore is estimated to come from the minority stake sales in PSUs, and the remaining Rs 20,500 crore is projected to come from strategic sales in both profit and loss-making companies. In 2015-16, the government has only been able to achieve Rs 25,000 crores out of Rs 69,000 crores. Even this could not have been achieved without LIC being forced to subscribe to these issues.
This is a key area where there are high chances that government may miss its target and hence might miss the fiscal deficit target as well.
The text below is quoted from the book Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism by Ha Joon Chang:
When it comes to selling off enterprises for which public ownership is not necessary, there is a dilemma. The government usually wants to sell the worst performing enterprises — precisely those that least interest potential buyers. Therefore, in order to generate private sector interest in a poorly performing SOE, the government often has to invest heavily in it and/or restructure it. But if its performance can be improved under state ownership, why then privatize it at all? Therefore, unless it is politically impossible to restructure a public enterprise without a strong government commitment to privatization, a lot of problems in public enterprises may be solved without privatization.
The privatized firm should be sold at the right price. Selling at the right price is the duty of the government, as the trustee of the citizens’ assets. If it sells them too cheaply, it is transferring public wealth to the buyer. This raises an important distributional question. Given fluctuations in the stock market, it is important to privatize only when the stock market conditions are good. In this sense, it is a bad idea to set a rigid deadline for privatization, which the IMF often insists on and which some governments have also voluntarily adopted. Such a deadline will force the government to privatize regardless of market conditions.
The above text aptly describes the dilemma Jaitley is facing. He has tried to go for disinvestment, but stock markets are down and aren’t supportive to his plans. It makes more sense for Jaitley to not set any disinvestment targets. He must look for elsewhere to meet his deficit targets and wait for stock markets to turn around. Further, he must immediately stop using LIC to meet the fiscal deficit targets.
Personal income tax
This is a topic that has been hotly debated since 29 February when the FM delivered his Budget speech. BJP has thus ignored its most ardent middle class supporters who have stood by the party and Modi in the worst of times. As the Indian economy is struggling to recover in 2016, I am reminded of the 2009 BJP manifesto, which was also written during a time when Indian economy was struggling. Its 2009 manifesto said:
The BJP plans to do so through robust policies aimed at revitalizing the economy and placing India on the path of employment-generating growth coupled with rapid development. Towards this end, the BJP will put in place a low tax, low interest regime so that people have more money and their purchasing power increases, which in turn will serve as an impetus for the economy. Exempt income up to Rs 3 lakh from Income Tax. Women and senior citizens will receive an additional exemption benefit of Rs 50,000.
If exemption limit was to be raised to 3 lakh in 2009 to fight a recession, considering the high inflation it ought to be raised to at least 5 lakh in 2016. Ignoring the middle class has been the most disappointing aspect of Modi government; they are perhaps betting on the fact they face no risk as Congress and Kejriwal are likely to target the poor and not middle-class voters.
Taxation on EPF
This is another issue that has been actively discussed on Twitter and Facebook in the last 2 days. In this Budget, the FM has proposed to make PF taxable at the time of withdrawal. As per the proposals, 40% of the corpus would be tax-free and can be withdrawn at retirement while the remaining 60% would be taxable. However, in case the individual buys an annuity out of this 60%, no tax shall be applied. As per the subsequent clarification issued by the government, only interest earned on the corpus would be taxed.
The EPF is a retirement product; there is a point of view that the government’s effort to incentivize people to buy an annuity and thus have a steady income until their death is laudable. However, in India, the EPF has been used by people for all sorts of purposes like building a house after retirement, marriage or higher studies of children. But we also need to understand how our societies are rapidly changing and in many cases children are not looking after their old parents. The EPF should remain a retirement product and such loopholes need to be plugged so that individuals have adequate savings.
There are a few things that I would like the government to do. First, the government must regulate this sector, which is rampant of malpractices and bad selling. If people cannot buy proper financial products, can they really buy the right annuity plans for themselves? This requires a major drive towards financial literacy and needs to be targeted particularly to those who are nearing their retirement.
Second, the government must also have an opt-out option, which enables individuals to opt out of the mandatory PF it they want. Behavioral research suggests that most people are too lazy to opt out. Thus, keeping such an option wouldn’t hurt at all and it would also keep the market libertarians happy as well.
Lastly, the EPF is hardly an efficient scheme. It does not enable people to save adequately for their retirements. Government needs to nudge the citizens to make more of their saving into equities and not in fixed income, real estate or gold.
Other notable features of the Budget
- Sunset clause for every government scheme: To improve the quality of government expenditure, every new scheme being sanctioned by government will have a sunset date and outcome review.
- Abolition of the license permit-raj in the transport sector: Government will enact necessary amendments in the Motor Vehicles Act and open up the road transport sector in the passenger segment. An enabling ecosystem will be provided for the States, which will have the choice of adopting the new legal framework.
- Amendments in the SARFAESI Act 2002: It is to enable the sponsor of an ARC to hold up to 100% stake in the ARC and permit non-institutional investors to invest in securitization receipts.
- Comprehensive Central legislation in 2016-17 to deal with the menace of Ponzi schemes
- Amendments to Companies Act 2013
- Pilot project on giving Direct Benefit Transfer in Fertilizer and Food subsidies. This could be a major game changer, as these subsidies form a major portion of the subsidy Budget.
- Health card for all farm animals
Update on monsoons
The Economic Survey 2016 says,
Making a payroll-based savings plan available to everyone is essential because it is the most effective way for the middle class to save. But having a plan offered at the workplace is not sufficient. Even for those with access to an employer-sponsored plan, almost a quarter fail to join, and among those who do join, many save too little.
This is precisely what Jaitley would be hoping for, a help from the rain god to meet his numbers. History seems to be on his side.