Arun Jaitley's toughest test yet; will he be able to pull off a smart trick?

Finance Minister Arun Jaitley will walk a tight rope on 1 February. Jaitley’s fourth budget is also likely to be his toughest so far since this comes at a time when the economy is fighting a self-imposed cash crunch after Prime Minister Narendra Modi pulled out 86 percent of the currency in circulation on 8 November, the impact of which is still unravelling.

Secondly, Jaitley is presenting the budget without a good sense of where the economy is at this stage. The recently released advanced GDP estimates, which forms the basis of budget estimates and growth projections, has been arrived at with just nine month data and without reflecting on the impact of demonetisation.

Finance Minister Arun Jaitley. PTI

Finance Minister Arun Jaitley. PTI

By far, it is now clear that for the Narendra Modi government, which stormed into power in May 2014, wriggling out of the demonetisation mess unhurt isn’t an easy task no matter what it promises to gain in the future (an economy, free of black money, corruption and fake notes) and no matter how good the later-stated objectives are (including a shift to a cashless economy).

The demonetisation move has thrown the economy into a near-crisis situation. Corporate profitability and business confidence have taken a hit, lakhs of jobs are reportedly lost in the informal sector, consumers have cut down spending, bank credit growth is at multi-year lows, farmers are affected as prices have crashed, services and manufacturing sectors are impacted and there is skepticism globally on the rationale behind Modi’s currency ban.

It isn’t hard to understand why official and private forecasters are competing to show lower growth projections. The estimates range from 7.1 percent (Reserve Bank of India) to an extremely pessimistic 3.5 percent by Ambit Capital, a private brokerage firm. The available data on tax payments by corporates, PMI numbers, two-wheeler sales and slowdown in service-oriented sectors confirm the fear of a deeper, prolonged impact on the economy.

Most economists have ruled the third quarter as a miss, but the bigger danger comes if the cash crunch woes spillover to the fourth quarter since then there will be a cascading impact on the economy. According to a study by All India Manufacturers’ Organisation (AIMO), In the first 34 days since demonetisation, micro-small scale industries suffered 35 percent jobs losses and a 50 percent dip in revenue. The study showed nearly all industrial activities came to a standstill post note ban, with the Small and Medium-sized Enterprises (SMEs).

In this backdrop, Jaitley’s budget will be evaluated on how well he can answer the following questions:

a) Can he offer a budget that will reboot the banking sector? It is critical that the government urgently focuses on boosting the capital base of banks so that bank credit flow to productive sectors doesn’t suffer, and sell off the loss-making banks or consolidate a few if there is synergy amongst them. Jaitley has a good opportunity to announce some bold measures to take the reform process ahead in the public banking sector.

Presently, state-run banks are severely undercapitalized. At least 7 of the PSU banks have their Tier-I capital adequacy less than 8.5 percent and one bank less than 8 percent. The problem is worsened with their non-performing assets (NPAs) hitting the roof (nearly Rs 6 lakh crore as on September, 2016 or nearly 8 percent of the total bank credit), and total chunk of stressed assets (bad loans and restructured loans together) jumping to 12-13 percent of the total bank credit. Under the government’s Indradhanush plan, of the Rs 1.8 lakh crore capital needed by banks under Basel-III, the government has offered to infuse Rs 70,000 crore over four years till 2018-19 and wants the government banks to fend for themselves for the remaining Rs 1.1 lakh crore from the market. This is not enough. Also, it is almost impossible that weak state-run banks will find takers. This compounds the problem. So far, there is not much progress on the banking reform front.

b) Can Jaitley’s budget offer a fiscal boost to the economy by ramping up spending? A section of economists agree that the economy is in need of a strong stimulus to get back on track from the demonetisation-resulted slowdown. This is warranted because several layers of economy have taken a hit post-demonetisation. One of the expectations from the demonetisation exercise was to get a ‘windfall’ of Rs 4-5 lakh crore provided that kind of money doesn’t return to the system as black money hoarders run for cover. The government was expecting to garner around Rs 10 lakh crore of the Rs 15.44 lakh crore demonetized on 8 November. But, that didn't happen. On the other hand, the exercise has resulted in considerable damage to the economy. Can Jaitley offer a fiscal boost to reduce the pain?

c) Can Jaitley win back the confidence of the common man and industry, feeling the pain of cash-crunch, announcing reliefs to both individuals and corporations to tide over the difficult phase? This will work to reverse the negative mood on account of the artificially imposed cash-crunch and put more money into household kitty to keep the consumption story going. Corporate tax incentives should be over and above the ongoing plan to bring down corporate tax rates to 25 percent over a period and gradually remove exemptions. But this hasn’t found much appeal in the industry since the effective rate is only about 23 percent after exemptions. This is the reason the marginal tax cut in the last budget hasn't received much response. The government will have to act to regain losing momentum by offering industry a temporary stimulus.

d) Can the FM still find the space to continue on the fiscal consolidation path? This is a tricky task for Jaitley. He needs to meet a 3.5 percent fiscal deficit target for the fiscal year 2017.

e) Lastly, how well does Jaitley intend to handle a bigger budget, including that of the Railways, will be watched. “There is a big monster called the Railway budget coming as part of the general budget this year. This can sharply spike numbers on the expenditure. How will the government handle the new situation is worth watching,” said Devendra Pant, chief economist at India Ratings and Research. The expected boost to tax kitty from more number of digital transactions will come, but only at the beginning of the next year.

Will Jaitley impress the nation with a solid blueprint to get the economy back on track or will he start from where Modi stopped on New Year's eve--dole out more populist schemes? Over to you, Mr Jaitley.

(Kishor Kadam contributed data to this story)

Published Date: Jan 11, 2017 12:17 PM | Updated Date: Jan 11, 2017 17:03 PM

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