India’s Budget Take Three

When India voted in the Narendra Modi government with a stable majority in the last election in 2014 it was widely expected to pave the way for major changes. However, political obstacles and a tendency to follow the path of least resistance have limited progress. The new direction, which emphasises infrastructure, agricultural productivity and marketing as well as health, education and training, governance and making it easier to do business, is the right one — but implementation is critical.

When India voted in the Narendra Modi government with a stable majority in the last election in 2014 it was widely expected to pave the way for major changes. However, political obstacles and a tendency to follow the path of least resistance have limited progress. The new direction, which emphasises infrastructure, agricultural productivity and marketing as well as health, education and training, governance and making it easier to do business, is the right one — but implementation is critical.

The budget offers an opportunity to verify both if the direction has changed on the ground and if implementation has improved. The picture is mixed, but it does show some overall progress.

The actual expenditure in 2015–16, compared to that in 2014–15, shows a sharp rise (above 30 percent) in total capital expenditure, central plan outlay, budgetary and extra budgetary support for shifting government expenditure towards investment. Actual allocations are very close to what was promised in the budget estimates. This is very unusual because fiscal consolidation targets have previously been reached by cutting capital expenditure, which is also inherently difficult to ramp up.

The private sector was not investing due to both low demand and the debt burden on large firms from stalled infrastructure projects— necessitating increasing public sector investment. To fund this, the government retained a large share of the bonanza from the fall in oil prices — rather than pass on lower prices to consumers.

There were shortfalls in planned expenditure in the transport sector, but the 68 percent increase that was achieved (compared to an 82 percent planned rise) was still a large rise. The pace of road building has picked up. Disinvestment fell below targets but then market valuations were down, and revenue receipts exceeded targets because of the fuel tax. Some ministries underspent, but others overspent.

Since 2015–16 was the year when, following the Finance Commission’s recommendations, a larger share of untied revenue was awarded to the states, some central social welfare schemes were rationalised and reduced. Research shows that additional resources available to the states were more than sufficient to compensate for decreases in certain federal social welfare schemes. States now had greater freedom to adjust spending to local needs, which was what they had asked for.

Although the government had reduced spending on agriculture and the social sector in its first budget in 2014–15, both were sharply increased in its 2015–16 budget, as there were clear signs of rural distress after a poor monsoon. Yet rural expenditure was targeted more towards irrigation and building productive infrastructure.

Technological innovations, such as the unique identification number and multiple-use bank accounts for the poor, are being harnessed to better target and reduce leakages in social sector expenditure. Previous governments had pushed for similar spending, but without complementary supply-side reforms, this had only raised inflation.

Budgeted current (2016–17) expenditure maintains the rise in rural and social sector spending. This is necessary after a second poor monsoon. Even so, inflation is on a downward trajectory and has fallen to 5 percent. There is also a large rise in revenue expenditure due to a rise in military pensions and the award of the 7th Pay Commission, which raises salaries of public servants. Excess capacity in areas such as consumer durables and housing implies the demand stimulus may raise output rather than prices.

In order to reduce deficits in line with promised fiscal consolidation, despite these requirements for higher revenue spending, total budgetary capital expenditure is to rise only 3 percent this year compared to 40 percent last year. However, the rise in central plan outlay is still 20 percent, which is to be financed largely by extra budgetary resources drawing on the success in similar fundraising last year. This is in line with the government’s overall strategy of reform and greater market orientation of public sector organisations.

Analysts predict Central and State government market borrowings will remain at about last year’s level of 7 trillion rupees (approximately US$105 billion) since not raising the fiscal deficit has reduced the borrowings requirement announced in the central budget.

These, despite a rise in off-budget market borrowings, can be absorbed on a path of softening interest rates, which will themselves improve government budgets. A move to set up a committee to recalibrate the fiscal consolidation path to allow countercyclical variation in deficits should also be welcomed, as long as pressures to improve the quality of government spending are maintained.

Markets have welcomed the commitment to fiscal discipline demonstrated in the 2015–16 budget, despite pressures to spend more. This, and some signs of better composition and more efficiency of expenditure, has improved the Indian government’s policy credibility.

Assessing Modi’s third budget is republished with permission from East Asia Forum