India Budget FY17 - Will Be Steady and Staid
Published on 26 Feb, 2016
Budget 2016-17India may meet fiscal deficit target for FY 2016, although marginally.
India’s annual budget is a tightrope walk for any finance minister, considering the underlying challenge of drafting a policy document that’s a steady mix of what is desirable and what is achievable.
The financial year 2015 – 16 was a trying period for a relatively insulated India.
Despite a weak currency due to the slowdown in global growth (that affected exports and capital outflows) there was relief in the form of robust indirect tax collections. These were primarily from opportunistic higher excise duties on petroleum products as well as new levies such as the Swachh Bharat cess (announced in November 2015) in addition to the service tax rate hike announced in the previous budget. The increase in indirect tax earnings helped the government tide over a shortfall in direct tax collections due to slower growth — especially in the export sector — as well as meet its spending requirements for physical infrastructure and social infrastructure programs.
The budget is expected to meet its fiscal deficit target by an improved margin in case of a cut in plan expenditure on capital account.
2016-17 presents challenges such as meeting higher expenses on account of the seventh pay commission’s recommendations, the One Rank One Pension (OROP) scheme, and investment outlays, which could be met through higher tax rates as well as the introduction of new taxes, duties, and cess.
The fiscal deficit target for FY17 could be relaxed from its earlier target of 3.5% of GDP, but not by a large margin. Anything between 3.6% and 3.7% will give the government adequate room to meet its target while keeping its commitment to greater fiscal discipline.
Government Unlikely to Breach the "Red Line" of Fiscal DeficitWe expect the government to meet the fiscal deficit target of 3.9% of gross domestic product (GDP) for 2015-16.
Contrary to media reports, the government may not risk breaching the fiscal deficit target’s "red line", despite temptations to dilute its stance amid a decelerating global economy and declining exports. Once breached, India has (historically) taken several years to restore fiscal discipline. This is particularly evident from the FY2009–14 period, when the country risked being downgraded to "junk" by global credit rating agencies due to its high fiscal deficit. We believe the current finance minister, Arun Jaitley, would strive to maintain this hard-won discipline.
Aranca Estimates 2015-16 Fiscal Deficit at 3.85% of GDP
Based on the actual figures for revenue and expenditure for April–December 2015 (as per the Ministry of Finance’s website) and the actual revenue and expenditure in the comparable period of the previous year (April–December 2014 as percentage of FY2014–15), we estimate the government’s fiscal deficit to be 3.85% of India’s GDP — beating its fiscal deficit target of 3.9%.
A better-than-budgeted fiscal deficit (even by a small amount) has been the norm in recent years, and we expect a pleasant surprise from the government this year as well.
|All Amount (INR crore)||9MFY15 (% of BRE)||9MFY16 (Actual)||9MFY15 (% of BE)||2015–16 (Aranca Estimates)||2015–16 (BE)||9Assumptions|
|Revenue Receipts||61.6%||803,808||70.4%||1,257,179||1,141,575||Revenue receipts to surpass BE due to higher indirect tax collections.|
|Tax Revenue (net)||60.1%||622,247||67.6%||1,057,179||919,842||Indirect tax collections increased 34% in April 2015–January 2016.|
|Non-debt Capital Receipts||24.2%||22,004||27.4%||30,000||80,253|
|Non-plan Expenditure||72.8%||968,019||73.8%||1,312,200||1,312,200||Non-plan expenses to be maintained at BE, as in 2015|
|Plan Expenditure||75.4%||345,978||74.4%||495,662||465,277||State packages, infrastructure programs to push up plan expenses.|
|On Revenue Account||76.9%||230,656||69.9%||330,020||330,020|
|On Capital Account||69.6%||115,322||85.3%||165,642||135,257|
|Fiscal Deficit||103.9%||488,185||92.6%||520,683||526,997||Marginally lower than BE, as in 2015|
|Fiscal Deficit (%GDP)||3.85||3.9|
Cess and Increased Excise Rates on Fuel to Boost Revenue
Direct tax revenue for the year is expected to fall short of budget estimates by INR 40,000 crore, as forecast by Revenue Secretary Hasmukh Adhia. On the other hand, indirect tax revenues went up 33% over April 2015–January 2016. We expect indirect taxes to surpass budget estimates by INR 53,546 crore, buoyed by higher tax rates (service tax increased to 14% from 12.36% in the previous budget), excise taxes (increased on fuel), customs duty (on steel imports), and the Swachh Bharat cess (0.5%).
Capitalizing on the decline in global crude prices, the government has increased the excise duty on petroleum products multiple times since late 2014, including three times in January 2016.
During April 2015–January 2016, customs duty revenue from electrical machinery and other machineries increased 34.4% and 27.8% respectively, indicating increased investment in the private sector. During this period, the average growth rate in tax collection from the services sector was 27.2%, while that from banking and financial services was 44.6%. The growth rate was 39.9% in work contract services and 41% in goods transportation services. Consequently, we expect tax revenues (net to the central government) to surpass budget estimates by INR 21,310 crore as a result of higher indirect taxes.
Non-tax revenues are estimated to be closer to the actual collection of INR 1.8 trillion recorded for April–December 2015, with dividends paid by PSUs and the RBI accounting for the majority of this revenue. The other major components of non-tax receipts were interest receipts, spectrum charges, royalty, license fee, sale of forms, and RTI application fees.
The government also expects to earn INR 100,651 crore in the form of dividends for FY 2015–16. Of this, INR 36,174 crore is estimated to come from Central Public Sector Enterprises (CPSEs) and INR 64,477 crore from banks, financial institutions, and the RBI. The central bank paid a dividend of INR 65,896 crore in FY 2016 so far, up 25% from the previous year.
Non-plan ExpenditureA major “fixed” expense that leaves little room for expense management.
Non-plan expenditure is a major component of expenditure and comprises salaries, pensions, defense expenditure, and other similar “fixed expense” items with limited scope for any cuts. Almost 45% of the budget is committed, with INR 4.56 lakh crore (25.7% of total expense) allocated for interest payments, INR 0.89 lakh crore (5.0%) for pension payments, and INR 2.46 lakh crore (13%) for defense expenditure. Given their fixed nature, these expenses cannot be lowered.
On the subsidy front, the government has benefited from falling crude and natural gas prices. The ongoing downturn in these internationally traded commodities has eased the government’s burden in terms of lower compensation to oil marketing companies that provide fuels such as kerosene and liquefied petroleum gas (LPG) at subsidized rates.
Furthermore, schemes such as Direct Benefit Transfer (DBT) have helped weed out inefficiencies in subsidy distribution to a certain extent. Consequently, the petroleum subsidy expense is expected to significantly drop on a yearly basis, thereby leading to a drop in overall subsidy expense for the year for the first time in several years.
It would be difficult to trim the subsidy bill substantially however.
Budgeted at INR 2.44 lakh crore (13.7% of the total expenditure), the benefits of declining crude prices would not push fertilizer and food subsidies lower as the government has failed to cut expenditure on the same. As a result, fixed expenditure would constitute about 60% of the budget.
In 2015, the government announced packages for several states, including Jammu and Kashmir (INR 80,000 crore) and Bihar (INR 1.25 trillion), and financial packages doled out by ministers (INR 34,000 crore for roads). Although this expenditure is spread over a longer period, a portion of the proposed disbursements may have been accounted for in this fiscal year. These expenses have not been accounted for in the 2015-16 budget, thereby giving rise to the possibility of non-plan expenditure breaching the estimated threshold.
Cuts in Plan ExpenditureAn ace up the Finance Ministry’s sleeve.
If non-plan expenditure surpasses budget estimates, the finance ministry could exercise the option of controlling plan expenditure in order to control its overall expenditure, thereby meeting its fiscal deficit target. India’s finance minister Arun Jaitley could emulate his predecessor P. Chidambaram, who deployed this method to control the fiscal deficit during FY 2013–14. Measures such as freezing fund disbursement to ministries after December have been repeated over the past few years. These have resulted in gaps between initial budget estimates for plan expenditure and actual spending under the category.
Expense Expectations for Budget 2016-17High increase in expenditure on account of the seventh pay commission and OROP.
The government has outlined objectives such as reviving investment growth and decreasing farmers’ poverty, among others, for Budget 2016-17.
Before we can even consider what expenditure the government allocates towards these, certain additional expenses have already been identified in the form of payouts under the Seventh Pay Commission (SPC) and the One Rank One Pension (OROP) scheme. For instance, budget 2016–17 would have to allocate more than INR 1 lakh crore for the implementation of the seventh pay commission’s recommendations — which makes up for nearly 1% of GDP — thus putting strain on fiscal consolidation targets.
To ease the pressure, the government could adopt measures such as staggering the recommended hike in pension or deferring the hike in house rent allowance (HRA) on account of a stagnant real estate market.
While the pay commission and OROP would constitute substantial components of next year’s increase in expenditure, the need for increased outlays on the investment side is nonetheless important to push up domestic demand. We expect increased expenditure for physical infrastructure projects such as railways, roads, and ports due to their immediate effect on capital investments and long-term multiplier effect on the economic growth.
The weak rupee has not been kind to the export sector, which has been declining for several months. The government may announce direct intervention (such as interest rate subvention and special packages) or impose import barriers (custom duty on steel imports) in response.
The much-anticipated food security scheme — if implemented — would exert pressure on the delicate balance between declining revenues and rising expenses as well.
Tax Expectations for Budget 2016-17Increase in rates imminent, some old taxes may be revived.
To shore up revenues and meet the increased expenses, the finance minister would need to increase tax rates or introduce new taxes. Service tax, increased to 14% in the previous year, may be increased by another 1% to 2%.
Considering the sharp fall in crude prices and low likelihood of an increase over the next year, the government has the option of reintroducing customs duty on imported crude, petrol, and diesel, which was removed in 2011, when crude prices had increased to over US$ 100 per barrel.
New cess to fund initiatives such as Start-up India or Digital India and other programs could be introduced, similar to the Swachh Bharat cess levied last year. The percentage of Swachh Bharat cess could be increased as well.
The government could increase import duty on gold, since gold imports have increased over the past year, partly contributing to the trade deficit and weak rupee on account of forex outflows.
While the finance minister had announced reduction of corporate tax rates from 30% to 25% over next few years, he may keep the rates unchanged for 2016-17. In case the headline corporate tax rate is reduced, we expect the quantum of reduction to be small (~1%) and accompanied with withdrawal of concessions in taxes, which will effectively ensure net increase in tax collections, even after a reduction in rates.
Fiscal Deficit Target for 2016-17More than 3.5% of GDP, but not by a large margin.
The fiscal consolidation roadmap outlined previously by the finance minister targeted fiscal deficit to reach 3.5% of GDP in FY17 and 3% in FY18. These targets were predicated on an improving domestic economy, without provisions for large expense increases on account of the pay commission, OROP, or even the need for a higher investment outlay to compensate for weak private sector growth.
While part of the expenses will be met by higher tax rates, they would not completely help meet the fiscal deficit target of 3.5% for FY17.
We expect the fiscal deficit target for FY17 to be relaxed, with the timeline to attain a 3% fiscal deficit target (by FY18) extended by one more year. The target for FY17 is likely to be between 3.6% - 3.7%, which gives the government some leeway on the path toward fiscal consolidation. Even if the timeline or target were relaxed, it would still be commendable for India to commit itself to a fiscal consolidation program despite waning global growth.
The finance minister’s key objective this year will be to improve his budget at the margins, not overhaul it.