India Macro Weekly: Union Budget 2015-16 Special

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Issue No. 45 | February 28, 2015

View Point: Investment revival at its heart

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Manika Premsingh

Bringing out an annual Union Budget in a developing economy of Indias size is necessarily a process
that involves making hard choices in favour of certain pressing requirements at the cost of others. And
the Union Budget of 2015-16 is no different. While there are some definite hits that can have a far
reaching impact on the Indian economy, there are also some initiatives that raise questions as well as
some misses, making it a significant budget but quite far from being a dream budget.
Lets look at both the pluses and minuses.
Ramping up capital formation
Investment revival has clearly been at the heart of the centres concerns, going by the fact that capital
formation in India has been at a virtual standstill. The share of capital formation in 2014-15 so far has
dropped below 30% to 29.1% in the third quarter, from 30.8% during the corresponding period of the
previous year. The centres own capital expenditure as a proportion of budget estimates up to
December 2014 is lagging behind the proportions during the corresponding period of the previous
year. Relatedly, credit growth offtake has also slowed down, suggesting that confidence levels in the
economy far from robust.
Recognising the need to ramp up capital formation, the Finance Minister (FM) has taken a step in the
right direction by providing increased allocation of public sector investments, even if it means some
slippage in the fiscal deficit targets. The centre has set a target of 3.9% for next year compared with
3.6% earlier. However, in the larger context, this is not necessarily worrisome since Indias deficit
situation is fairly contained at present, and particularly since the centre is confident of meeting the
original 4.1% fiscal deficit to GDP ratio target for 2014-15. With Indias growth continuing to be subtrend, some overall push on account of increased fiscal space will not hurt either. Impact on sentiment
might have been less if the government had announced a higher fiscal deficit-GDP ratio in July last
year instead, though sticking to previous targets was exceedingly brave on Jaitleys part at the time.
Nevertheless, the current scenario certainly calls for a definite investment boost. A host of initiatives
aimed at mobilising investments in various forms have also been announced. These include the
establishment of the National Investment and Infrastructure Fund to fund infrastructure finance
companies, efforts at bringing the Indian bond market at the same level as the equities market by
setting up a Public Debt Management Agency, which in turn will bring the countrys external and
domestic borrowings under a single roof, establishment of the Gold Monetisation Scheme to
channelise individual savings in physical gold into the financial system by allowing depositors to earn
interest on metal accounts as well as floating Sovereign Gold Bonds with a fixed interest rate among
others. Credit offtake is being encouraged through the creation of a Micro Units Development
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Refinance Agency (MUDRA) Bank, with Rs. 20,000 crore corpus, which will provide credit to SC/ST/OBC
entrepreneurs.
Even though foreign investment inflows have improved multi-fold during the past year on account of
a stable government at the centre, policy reforms, some improvements in the global economic
environment and better economic prospects for India, the budget has aimed at bringing in more
investments. Towards the same end, the distinction across various kinds of investments has been
done away with. While this will allow easier capital flows, it could prove to be a double edged sword
since India always needs to watch out for higher capital flows volatility. Even though Indias external
account is in a sweet spot with a shrinking in deficit and a significant build up in Indias foreign
exchange reserves, this is in no small measure due to external conditions. On the current account, the
halving in oil prices has kept trade deficit in check while the relative underperformance of the other
BRICS economies has made India comparatively attractive.
Social security gets a boost
Another important budget announcement is towards providing universal social security. In a country
with still cyclically weak economic growth, rising income inequalities, large youth population and the
ever present threat of Naxalism, proactive measures to encourage socio-economic inclusion is a
welcome step. The first big step of the current government in this regard was with the initiation of the
Pradhan Mantri Jan Dhan Yojana (PMJDY) in August 2014, which has made remarkable progress since.
The programme aims at bringing each household in the country under the ambit of financial services.
Encouraged by the performance of the PMJDY, the FM announced the Pradhan Mantri Suraksha Bima
Yojna, which will cover accidental death risk of Rs. 2 lakh at a premium of Rs. 12 per year. Further,
another scheme called the Atal Pension Yojana has been launched, to which the government will
contribute 50% of the beneficiaries premium up to Rs. 1,000 for 5 years in all new account opened
before December 2015 end. A Senior Citizen Welfare Fund was also announced, which will work with
unclaimed deposits of Rs. 3,000 crore in the PPF will subsidise premiums for vulnerable groups like
pensioners, poor, and small and marginal farmers among others.
Juggling revenues
A third positive measure undertaken by the budget is the provision of a roadmap for reduction in
corporate tax rates to other Asian countries levels that will render the Indian economy more
competitive. The budget aims at reducing corporate taxes from the current levels of 30% to 25% over
the next 4 years, which will further encourage growth, investments and employment creation.
The loss in revenue due to a reduction in corporate tax rates, however, can be made up for by two
initiatives. The first is the imposition of surcharge of 2% on incomes of over Rs. 1 crore, which replaces
the wealth tax and the increase in service tax rates. The service tax rate has been increased to 14% at
the composite level as opposed to 12.36% as service tax plus cesses up till now. While the former is
welcome since a higher income calling for a higher tax rate is only fair, particularly at times when tax

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collections are otherwise slow and there is need to support weaker sections of society, the latter raises
some question marks.
Question marks and misses
The increase in the service tax rate is unlikely to garner support, simply because the timing is off. An
increase in the service tax rate at a time of limited growth can potentially create an invisible economy
i.e. where a service is demanded and provided but without it being on the record. In cases where
paying a service tax cannot be circumvented, it can still lead to a re-adjustment of the demand-supply
equilibrium as a lower point of demand. Given that services is the largest sector of the economy and
also the fastest growing one, an increase in the service tax rate could slow the sector down at the
margin, a risk that the government might want to consider. Already, a look at the budget estimates
and collections for 2014-15 for service tax suggests that the actuals for the year could wind up lower
than targeted, and targets for 2015-16 for service tax collections are also lower than those envisaged
for 2014-15. In a post-budget interview, the FM did go on to explain that the increase service tax was
in preparation for the Goods and Service Tax, which is to be implemented from next year onwards.
This gives some theoretical perspective, but is still likely to encourage tax evasion in practically,
something that might be more easily avoidable during high growth phases.
In terms of the clear misses, if we can keep aside our relatively cheerful new national accounts figures
for a minute, it is quite clear that Indias industry is in a deep recession. The monthly industrial
production figures have grown at an average annual rate of an abysmal 2.1% during the AprilDecember 2014-15 period. Credit to industry is lagging behind compared to other sectors and specific
segments like consumer durables have been showing a steady decline in production of as much as
15% over the April-December period over and above a double digit decline last year as well. The FM
does mention Make in India as an important programme for manufacturing and has given
encouragement to the nearly stalled capital expenditure cycle, but has not been explicit about the
steps being undertaken to revive industry and manufacturing in particular.
Further, partly due to policy action and partly due to a stroke of wild luck, Indias inflation is
significantly lower at 5% as per the consumer price index than the Reserve Bank of India had
envisaged in its forecasts. Wholesale price inflation is actually in deflationary zone. This is all good,
until we look at the fine print. Food inflation, which was the major driving force of overall inflation, is
still rearing its head. While food price inflation under the consumer price index is still under check,
food price inflation under the wholesale price index is at 8% as per the January numbers, not
significantly lower than the 8.8% figure during the corresponding period of the previous year. In a
country that has fought a long and hard battle against inflation till very recently, we should be far
from taking our present good luck for granted. And this calls for continued focus on agriculture
related reforms to ensure better storage, irrigation and steps towards less dependence on the weather
gods to determine how our agricultural economy would unfold. A focus on these areas is a miss in this
budget.

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Conclusion
On an overall basis, the budget has placed a heavy focus on some areas, like investment revival and
business revival as such and has also taken strides towards greater soft-development through its
social-security initiatives, it is still wanting in a sectoral perspective on the traditional segments like
agriculture, industry and services.

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