A big budget in times of small mercies

This Budget offers no dramatic tax cuts, no change in tax slabs nor even any tweak of the tax-exempt saving limit, and builds up government borrowings to the tune of 6.8% of GDP. Yet it has been a big hit: the stock market has gone through the roof. Why? Because it gives growth a big push, the one thing the Indian economy desperately needs, after a rampaging virus had eaten up nearly a tenth of the national output that had been shrinking even before the virus started to gnaw at it some 10 months ago.

It is natural for people to assess a budget by looking at what is in it. But the budget’s overall size and how it is financed matter more, from the point of view of economic growth, than its precise composition.

The 2021 Budget is huge: total expenditure is Rs 34.8 lakh crore, or 15.6% of the GDP forecast for 2021-22. India’s Budget in the recent past has not exceeded 13.5% of GDP. The extra spending in the coming fiscal is the kind of crisis response India needs.

Within this big rise in overall spending, the allocation for capital expenditure has gone up by 34%. Sure, a chunk of it is repayment of past loans and some fresh lending that need not end up in fixed capital formation.

But for the Indian economy, which has seen its investment rate stuck below 27%, about six percentage points below what used to be taken for granted in the high-growth years of the first decade of the 21st century, the Budget offers the hope of a revival of fortunes. And not just because of additional investment funded by the exchequer.

The Budget seeks to channel domestic and global savings to finance an infrastructure boom in India. India’s banks have grown reluctant to do their basic duty of mediating savings to those who would use those savings to generate fresh incomes, that is, to capital. This is because the sins of past reckless lending weigh down the banks’ books in the form of non-performing assets.

The Budget proposes to take this burden off the banks, through a new Asset Reconstruction Company and an Asset Management Company. Such bad loans would be sold at a steep discount to their original size, and banks have to set aside capital against the write-downs.

The government also proposes to recapitalise them, with Rs 20,000 crore from the Budget and letting them raise capital from private investors, entailing privatisation of the bank in some cases. With these two steps, credit would once again start flowing from the banks to fuel the recovery the economy needs.

Big bet on infrastructure

But that is not the only source of funds for funding infrastructure. Global capital, desperately seeking returns higher than the one per cent yield on 10-year US government bonds and much lower rates in Europe and Japan, is being lured to Indian infrastructure through multiple routes.

A development financial institution is being created once again, after the existing crop all turned into commercial banks, from ICICI to IDFC, one after another, to provide and facilitate long-term capital for infrastructure. The government would give an initial capital of Rs 20,000 crore. The rest would presumably come from local and foreign savings.

Insurance will make room for yet more foreign direct investment: the cap is being raised from 49% to 74%. Insurance is a large provider of long-term capital: it returns funds to insurers after longish periods, during which prudent investment is supposed to grow those premium payments into significant returns.

But the biggest play to attract foreign savings into Indian infrastructure is through monetisation of existing assets and a variety of Infrastructure Investment Trusts (InvITs), and Real Estate Investment Trusts (REITs).

A new infrastructure project is a source of risk, especially during its take-off — assorted clearances might get stuck, land acquisition could stall or a change of the government could bring along a change of policy, as has been manifest in Andhra Pradesh, regrettably.

It is better to buy into a built-up and operational chunk of infrastructure, tolled highway, airport, power plant, transmission grid, seaport, warehouse, whatever. This would release the capital locked up in the infrastructure in question and make it available for fresh investment.

The government has identified a pipeline of infrastructure projects, and now proposes to make a monetisation pipeline. It would recycle the investments made in the past into fresh projects. This is most welcome.

STT needs scrapping

What is missing in this investment drive is lifting the securities transaction tax (STT). How is that relevant? Infrastructure has risk during the take-off phase but is inherently low-risk, compared to, say, fast fashion or moonshots.

So these projects are funded with low levels of risk capital, that is, equity, and mostly with long-term debt. When an investor puts her money into a bond that will mature after a decade or two, she would like to hedge against the risks it carries: that the bond might not be redeemed (credit risk), that the general interest rates in the economy might rise, making the anticipated return on the bond look low (interest rate risk) and that the exchange rate might depreciate, shrinking the return in dollars (currency risk). This mitigation of risk takes place through a variety of derivative products sold on the capital market. The STT hinders trade in finely priced derivatives.

A corporate bond market is hobbled by STT, so a budget that seeks to invigorate the debt market should have scrapped STT, too, and not just old cars and trucks, as in the scrappage policy.

Borrowing risks

But can we celebrate a fiscal deficit as large as 6.8% of GDP? The fiscal deficit, or the borrowing the government would undertake to finance its expenditure, is a claim on the non-government sector’s savings. If that claim is in excess of what the non-government sector can spare after meeting its own investment requirements, the result could be inflation and a wider current account deficit.

However, in a year when the private sector is not minded to invest, if the government takes the non-government sector’s savings and invests it, the result would be to create growth and fresh demand for the private sector’s output, it would induce, ‘crowd in’, new investment by the private sector.

Governments around the world are borrowing big to support their economies in the year of the pandemic. There are no fiscally virtuous governments anywhere, comparing India with which a rating agency can shout ‘sinner!’.

But there is a problem with the kind of borrowing the Narendra Modi government has been undertaking. It borrows heavily from the small saving schemes. To fund the current year’s fiscal deficit of 9.5% of GDP, it borrowed Rs 4.8 lakh crore from small savings. In 2021-22, it proposes to borrow Rs 3.9 lakh crore from small savings.

What is wrong, you might ask. The money people put into postal saving schemes, public provident fund, etc is meant to be borrowed by the central and state governments, after all. The trouble is, it short-changes senior citizens and the relatively less well-off in rural areas who put their savings into small saving schemes.

Market borrowing for the coming fiscal is estimated to be Rs 9.7 lakh crore. The borrowing from small savings is 40% as large. If the government had raised that money, too, from the market, its interest rates would have gone up, so would the general rate of interest in the economy.

So, isn’t it a good thing that a part of the borrowing is being done away from the market? Well, the government administratively fixes the return on small savings, linking it to the cost of raising debt in the market. So, by artificially depressing the cost of debt in the market, it lowers the return offered on small savings, too. In other words, our senior citizens who put their savings into small savings are being asked to bear the burden of what economists call financial repression, the artificial lowering of interest rates, along with the ingratitude of their grown-up children.

Raising funds

The government can take credit that it has delivered this big budget without raising any fresh taxes. A cess on petrol and diesel to finance farm infrastructure will replace a portion of the existing excise duty and cess on these fuels, and place no additional burden on the consumer. Well, not entirely. The government has increased import duties on a number of goods.

The total collections under the head, Customs, is budgeted to go up from Rs 1.09 lakh crore in 2019-20 and Rs 1.12 lakh crore in 2020-21 to Rs 1.36 lakh crore in 2021-22. This protection is meant to help Indian producers.

But that is not quite how it works out. Protection helps the industries it protects, but harms the industries that use the output of the protected industries as their input. Lowering the import duty on steel scrap would dent the domestic scrap industry, for example.

The most sensible policy on import duties is to keep them low and uniform, say 5% on all lines of production. This would allow equal rates of effective protection to all industries, instead of the government deciding which industries should thrive in India at whose expense.

The budget has announced road projects in all poll-bound states, makes tall claims on its achievements on the farm front, promises a big boost to investment in healthcare, drinking water supply and nutrition and other soft infrastructure. But its biggest contribution is that it is big, in itself.

(TK Arun is a senior journalist based in Delhi)