From the behaviour of the Indian stock markets yesterday (4 January), when fears over the health of the Chinese economy damaged share values the world over, it would appear that India cannot escape the gloom. The Bombay Stock Exchange Sensex crashed 537 points, and the sentiment was not better at the time of writing.
Stock market experts keep reminding us that the China’s stumble is not a cause for us to rejoice, for it can take world growth down with it. When the world slows, we too slow down. However, while a global slowdown sinks many boats, India’s floats free. We should, therefore, rejoice that we now have an opportunity to sail faster than China. The going will be good as long as we can act independently and take courage into our own hands. For this time, our fortune depends on our taking risks, not on favourable global winds.
The most important point to underscore is that we need to be in expansionary mode; we should be providing a stimulus for growth, not miring ourselves in fiscal fundamentalism. We should bring forward the corporate tax cuts and accelerate public spending in productive areas when the inflation scenario is benign and the rest of the world is also in stimulus mode. When China is busy cutting rates and stimulating investment through tax cuts, we should not be thinking the fiscal deficit is our lone true faith.
In his 2015-16 budget, Finance Minister Arun Jaitley promised a 5 percent cut in corporate taxes over four years. He said: “I, therefore, propose to reduce the rate of corporate tax from 30 percent to 25 percent over the next four years. This will lead to higher level of investment, higher growth and more jobs. This process of reduction has to be necessarily accompanied by rationalisation and removal of various kinds of tax exemptions and incentives for corporate taxpayers, which incidentally account for a large number of tax disputes.”
The problem with this statement is that Jaitley has only three budgets to go, and he wants to cut taxes in four years. It is best to telescope the 5 percent cuts in the next three budgets, cutting two percent each in 2016-17 and 2017-18, and the final one percent in 2018-19, which will be the last regular budget before Lok Sabha elections in 2019. The 2019 budget to be presented by the NDA will be an interim one. Though this does not bar the government from implementing a tax cut that was promised in 2015, the optics matter more.
The time is propitious for a larger-than-expected tax cut because the global situation is unlikely to be as favourable to us in the coming years.
Let’s first understand the negative implications of the current expected global slowdown: exports will struggle and probably go down; government revenues from customs will dive; remittances from tottering West Asian economies will slow down; maybe, the rupee will weaken, too.
But look at the upside. With China down (its manufacturing shrank for the 10th consecutive month), commodity prices will stay low. This will keep our inflation low and our fiscal and current account deficits within bounds. If oil falls any further, we might even end up with a temporary current account surplus in some months of 2016. Last November, the trade deficit was down to $9.8 billion; in February 2015, it was as low as $6.8 billion.
The second upside is actually the prospect of higher foreign inflows. India, as I have noted earlier, is essentially the only major growth story on the planet right now. If we manage even 7 percent in 2016-17 (which should be possible even with the global slowdown due to domestic factors), we should attract large foreign inflows in equity and debt. So, our markets should be buoyant despite occasional blips.
The third upside is for corporate balance-sheets. Falling commodity prices means margins for manufacturing industries using these raw materials will improve. While natural resource-based industries like steel and minerals and oil will struggle, industries that are downstream will gain – from refineries to plastics to real estate to construction and infrastructure. The net effect for India Inc will be positive, barring those dependent on exports. India Inc has benefited from falling commodity prices for a year-and-a-quarter now; that will show up on P&L accounts anytime now.
The fourth upside is that government investment spending is increasing, and the resources to do so are coming in through higher taxes on oil products. The NDA has been smartly raising taxes on petro-products (it has raised duties seven times in the last 13 months). Net result: despite higher expenditure, the fisc has never been in better shape in recent years.
As at end-November 2015, the fiscal deficit was at 87 percent of the budgetary estimate (the year before, the full-year’s deficit was swallowed up by November, forcing the government to cut back on investment to meet the fiscal deficit target). This means there is no need for any drastic cutbacks in capital spending just to meet fiscal promises.
In short, India’s growth scenario is looking better than before, and if we want to outpace China and the rest of the world, 2016-17 is the year to let ourselves go. It is time to accelerate, using domestic buoyancy as the engine.
The key lies in budgetary action this time.
There is a strong reason to abandon fiscal fundamentalism, and focus on keeping productive public spends up. If needed, we can retain the fiscal deficit target of 3.9 percent for one more year, or slow down the pace of reduction to just 3.8 percent instead of sticking to the promised 3.5 percent for 2016-17.
The rating agencies will gnash their teeth, but what matters is the quality of fiscal spends and its trajectory, not its absolute level. The global slowdown is giving us precisely this opportunity as fiscal targets have gone for a toss in most countries.
Make in India should be accelerated using defence as the focus area. Unlike competitive industries, where investment depends purely on profitability, defence is less vulnerable to external competition and more amenable to executive decision-making. It can be used to give an additional fillip to domestic manufacturing capabilities and defence-related infrastructure.
Taxation policies can be revamped in two areas: the promised reduction in corporate taxation to 25 percent over four years can be fast-forwarded to three years, and a big tax cut of two percent can be front-loaded in this year’s budget, as stated above; some tax loopholes and breaks can be closed to pay for this cut, but a large cut will hasten the repair of corporate balance-sheets and the pace of investment revival.
Private consumption needs no additional stimulus since OROP (one-rank-one-pension) and Seventh Pay Commission payouts will provide a bounce anyway. But there is no reason why tax exemptions cannot be made more liberal. For example, section 80 C currently has two limits – Rs 1.5 lakh for investments/ savings in provident funds, NSCs, PPF, etc. Plus there is an additional deduction available for National Pension Scheme contributions of Rs 50,000 per annum. Then, there is the Rs 2 lakh deduction for housing loan interest payments.
Effectively, most people have a deductible income of up to Rs 4 lakh. Why not combine all the deductibles into one composite limit of Rs 3 lakh or even Rs 4 lakh? This will have two advantages: savers will use the deduction that is most important to them, and investments will not be misdirected to unneeded savings avenues merely to save tax.
A Rs 4 lakh exemption limit will effectively allow anyone earning up to Rs 6.5 lakh to pay no taxes, by combining the basic exemption limit of Rs 2.5 lakh with another Rs 4 lakh of deductions for savings or investment. These tax revenue losses will be regained as the savings made are routed into investment and consumption. It is politically attractive and also economically doable.
Time for Jaitley to step on the gas.