While the Budget did not hit any self-goals or give reason for any interest group to be particularly distressed, the Budget was a good holding operation at best.
The Indian economy is currently undergoing an extraordinary amount of flux. GDP growth in FY18 is likely to be a challenge and the banking system is dealing with unprecedented levels of asset quality stress. Besides boosting capex spends and setting aside 0.07% of GDP for recapitalising banks, the Central government did not do much to address these two fundamental issues.
GDP growth in India is decisively slowing as evinced by the dramatic slowdown in bank credit growth as well as auto sales volume growth in 3QFY17. While GDP growth is likely to recover in FY18 from the lows it will hit in 2HFY17, GDP growth in FY18 will be lower than what it would have been if the government was not forcing the economy to formalise at such a rapid pace.
The increased focus on tax compliance is likely to mean that the non-tax paying informal sector in India will shrink at a rapid pace. This, in turn, will entail a degree of demand destruction as the informal sector accounts for more than 40 percent of India’s GDP and provides employment to close to +75% of the labour force.
Separately, the Indian banking system which is the backbone of the economy is reeling under asset quality stress. Banks are already struggling with a corporate asset quality cycle that is yet to bottom out. Furthermore, higher NPAs in the SME/retail segment would worsen the situation. Loss of income due to demonetisation, pressure on cash flows owing to higher tax compliance and a decline in the value of real estate-based collateral will raise asset quality risks.
Though PSU banks have much lower exposure to retail/ real-estate linked lending than private sector banks, their quality of lending is suspect. These segments have grown at a much faster pace for PSU banks in recent years and high reliance on the segment implies a greater in-built risk in PSU banks’ retail/ real-estate-linked lending. Even if the government’s hands were ties with respect to funding recapitalisation, the announcement of a bad bank or banking sector reforms could have helped resolve the situation at hand.
While the above two issues were not given the attention they deserved, the Union Budget ought to be commended for three progressive changes it has announced. Firstly, the finance minister announced the scrapping of the Foreign Investment Promotion Board (FIPB) which is likely to help further liberalise foreign inflows into India. Secondly, the FM decided to exempt Foreign Portfolio Investor (FPI) Category I & II from indirect transfer provisions.
Furthermore he clarified that the indirect transfer provision shall not apply in case of redemption of shares or interests outside India as a result of redemption or sale of investment in India which is chargeable to tax in India.
Finally, the Budget brought down the Capital Gains Tax (CGT) period on immovable property from three to two years and allowed sellers of property to invest the sale proceeds in financial assets whilst maintaining CGT exemption. (Historically, the proceeds from selling property had to be re-invested in property to avail CGT exemption.)
Separately, the Budget furthered the government’s crackdown on black money by announcing two policy measures. Firstly it decided to accept the recommendation made by the Special Investigation Team (SIT) on black money that no transaction above Rs.3lakh should be permitted in cash.
Secondly, it made the point that the Government is considering the introduction of a new law, to confiscate the domestic assets of economic offenders who flee the country until they submit to the jurisdiction of the appropriate legal forum. Both these measures whilst positive in principle, will need to be carefully implemented.
Thus the Union Budget FY18 opted for the path of least resistance. The Budget did not do anything special to boost India’s growth prospects or to improve the state of India’s banking sector. At the same time, it steered clear of announcing retrograde anti-capital market measures and anti-rich measures and it did not drop the ball on fiscal discipline in a big way despite being two years away from a General Election. In these uncertain times these small positives are worth celebrating.
Saurabh Mukherjea is CEO and Ritika Mankar Mukherjee is senior economist at Ambit Capital
Published Date: Feb 01, 2017 18:01 PM | Updated Date: Feb 01, 2017 18:01 PM