Posted by: John Elliott | February 1, 2017

India Budget tries to bounce back from misery of bank note ban

Government admits demonetisation caused widespread disruption

Arun Jaitley, India’s finance minister, today presented his annual Budget which was aimed at bouncing the country’s political and economic focus away from the miseries of prime minister Narendra Modi’s three-month old bank note ban and at projecting an economy with increased growth and less corruption.

Known as demonetisation, the cancellation of Rs1,000 ($14.8) and Rs500 notes was suddenly introduced by Modi in a nation-wide broadcast on November 8. It removed 86% of currency in circulation and led to widespread economic and social disruption and hardship that Jaitley and Modi have always underplayed in public statements.

img_1507Although Jaitley did not spell this out in his speech (left), the government has now admitted that demonetisation has had “significant implications for GDP”, reducing 2016-17 growth by 0.25% to 0.5% from an expected 7%. That statement came with the finance ministry’s annual Economic Survey, that was published yesterday and included an analysis of the problems and potential benefits.

“Like all reforms, this measure is obviously disruptive, as it seeks to change the retrograde status quo,” was all that Jaitley would acknowledge. “Drop in economic activity, if any, on account of the currency squeeze during the remonetisation period is expected to have only a transient impact on the economy”.

Modi initially said that the aim was to curb the role of black money but, when it became clear that massive amounts of cancelled notes were being corruptly banked and converted into new currency, the government switched to say that the aim was to drastically reduce the role of cash in the economy by encouraging digital transactions. Amitabh Kant, chief executive of Niti Aayog, the government’s revamped planning commission, has even claimed that “by 2020 India would make all debit cards, credit cards, ATMs and POS machines totally irrelevant”

arvind-subramanian

Arvind Subramanian, chief economic adviser, launching his annual Economic Survey

The Economic Survey however was more realistic and said that “digitalisation is not a panacea, nor is cash all bad”. Public policy should balance benefits and costs of both forms of payments and “the transition to digitalisation must be gradual; take full account of the digitally-deprived; respect rather than dictate choice; and be inclusive rather than controlled”.

In his speech today, Jaitley put more focus on reducing corruption, which has been a major government policy since the general election nearly three years ago.

He talked about how “tax evasion for many has become a way of life”, which “compromises the larger public interest and creates unjust enrichment in favour of the tax evader, to the detriment of the poor and deprived”. That had bred a parallel economy that was “unacceptable for an inclusive society”. Demonetisation sought to create “a new ‘normal’ wherein the economy would be “bigger, cleaner and real”.

To illustrate that India was “largely a tax non-compliant society”, Jaitley said that only 172,000 people declared annual income of more than Rs50 lakhs ($73,500), yet in the last five years more than 12.5m cars had been sold and, in 2015, 20m Indian citizen flew abroad for business or tourism. “The predominance of cash in the economy makes it possible for the people to evade their taxes,” he declared.

Political funding

The government now needs to show that it will follow up the possible demonetisation gains by taking more steps to tackle corruption than it has done so far. One major area is funding of political parties, which depends on massive use of black money. It was widely assumed that Modi’s November 8 note ban was timed to hit hordes of Rs500 and Rs1,000 notes collected by regional parties in five states, including Uttar Pradesh and Punjab, for campaigning in assembly elections that start on February 4.

Jaitley announced that the maximum cash donation that any party could receive from one source would in future be Rs2,000. Other donations could only be by cheque or a digital transaction. The Reserve Bank of India will be issuing electoral bonds that donors could buy for redeeming by a political party. These measures however fall far short of full declaration of party funding, which Modi said recently was desirable. Sceptics say that the Rs2,000 limit will not be effective.

arun-jaitley-with-budget-2017

Arun Jaitley with his ministers of state and senior bureaucrats

Jaitley also said the government is considering introducing legislation that would provide for the confiscation of assets owned by people who leave the country to evade court action. Although he did not name him, the most recent such example is Vijay Mallya, former head of the leading liquor and (bankrupt) airline business with the brand name Kingfisher, who has failed to return from the UK for court hearings.

One significant reform is the abolition during the coming financial year of the government’s Foreign Investment Promotion Board (FIPB), whose main job since it was founded in 1991 has been to examine foreign investment proposals (sometime attracting bribes).  With FDI inflows totalling $75bn in the past year, more than 90% of FDI inflows are now automatically cleared without vetting  Plans for further easing FDI restrictions and phasing out the FIPB will be announced in the next few months.

Fiscal deficit

The budget’s aim, Jaitley said, was to “transform, energise and clean India”. In an attempt to boost employment and consumer spending, there were measures for agricultural and allied sectors including rural jobs schemes, plus $58.8bn more spending on infrastructure, notably highways and the railways. Taxes were reduced for the poor and raised for the higher paid.

The fiscal deficit for the coming year has been set at 3.2% of gdp instead of the planned 3%, presumably because Jaitley does not want to over-restrict the economy when recovery from the shock of demonetisation is the main priority.

For the first time since 1925, there is no longer a separate Railway Budget. This is one of three significant changes this year. The speech has been brought forward from its traditional February 28 date to February 1 to enable the government ministries and states to plan for the start of the next financial year. Complex distinctions between what have been called plan and non-plan expenditure have been abolished to simplify financial allocations.

Overall the budget has been welcomed, as it always is, by business federations that rarely dare to criticise the finance minister publicly. Opposition political parties have inevitably attacked it for failing to tackle basic problems of joblessness and sluggish investment.

More independent observers however have seen it as a politically competent budget that has tried to move on from demonetisation by boosting growth and taking some anti-corruption measures. There is little to show how its plans will work in practice, but its pro-poor rural announcements might well help garner votes for Modi and Jaitley’s Bharatiya Janata Party in the coming assembly elections.

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