BUDGET 2017: ECONOMIC & POLITICAL FALLOUT

May 11, 2017 | Mr. Nishant Shah & Mr. Mehfuz Mollah

Introduction

The 2017 Budget was presented by the Finance Minister Arun Jaitley amidst a lot of expectations from the industry and the common man. Globally, the international market has started to show signs of slow-down because of the uncertainties resulting from the election results in the United States where Donald Trump won a mandate based on a campaign which, arguably focussed on anti-trade rhetoric; and the United Kingdom deciding to leave the European Union. Quite naturally, the industry expected that the Budget would provide for a conducive and sustaining economic space for businesses to flourish in such a geo-political environment.Domestically, India undertook a reformation of sort when on November 8, 2016 the government announced that currency notes of denomination INR 500 and INR 1000 would no longer be valid as legal tender.

 

The stated objectives of this exercise were to curb the menace of black money in the economy and to include a greater section of the society into the formal financial sector. The timing of the Budget was appropriate for the government to roll-out certain measures that would support the objectives of demonetisation. In the present article I have attempted to evaluate the Budget based on the existing economic and political contexts.

 

Providing Support to Businesses

 

India and BRICS[1]

 

As discussed above, there was a legitimate expectation from the industry that the Budget would provide for a supporting environment for the Indian industries to operate and compete with global giants. According to the World Bank Doing Business Report India ranks 130 globally in terms of the overall ease of doing business. For some of the parameters India fared poorly compared to other BRICS nations.Comparing India to other BRICS nation also has a very important geo-political significance. The BRICS represent the emerging economies of the world where each of the economies has a potential to reach superpower status.

 

Quite naturally the competition amongst BRICS nations is quite fierce – each trying to create a leadership role for itself. For example, each of India, China and South Africa contended to have the headquarters of the newly established development bank for BRICS, called New Development Bank, at their country; with finally the Chinese city of Shanghai securing this feat. The chart below compares the gross capital formation (which can be treated as a proxy for investment) amongst BRICS nations. It can be seen that the gross capital formation of most BRICS nations have become stagnant from 2009 onward (i.e. post global recession of 2008) when the same for India has been on a steady drop. It can be argued that without any stimulus to the sector Indian manufacturers would lose its edge in the global market, especially compared to the other BRICS nations.

 

 

The Curious Case of Divergence of Trend of Investment and Foreign Direct Investment

 

Since the liberalisation of Indian economy in 1991 there has been a steady increase in the inflow of foreign direct investment into India till the global financial crisis of 2008. The figure below reveals that the trend in gross fixed capital (which is a proxy to investment) has been in sync with the trend in Foreign Direct Investment (“FDI”). However, from 2012 onwards we see that even though the FDI inflow (% of GDP) into India has increased, the same has not been reflected in India’s gross capital formation (% of GDP), which has in factdecreased in the same time period. This is a sign that there are other significant contributors to the growth of gross fixed capital that is hindering the recovery of the same.

 

Budget 2017

In order to create an environment conducive for businesses, the government had rolled out various schemes like Make in India, Start-up India and further easing of entry of foreign investment:

 

1.Make in India Initiative
 

The ‘Make in India’ has been one of the flagship campaigns of the government from its launch in 2014. It primarily aimed at reviving the growth of the manufacturing sector in India. To provide further impetus to this campaign, the following key policies were announced in the Budget:

  • Reduced corporate income tax rate of 25% for all domestic companies with turnover up to INR 50 crores;

  • Increase in time limit for carry forward of Minimum Alternate Tax (“MAT”) credit from 10 to 15 years;

  • Reduction in applicable Customs duty on various inputs and raw materials (such as LNG, parts for use in manufacture of LED lights, nickel etc.) so as to support domestic value addition

  • Increased allocation of INR 74.5 crores to the Modified Special Incentive Package Scheme (‘M-SIPS’) and Electronics Development Fund (‘EDF’) to make India a global hub for electronics manufacturing

  • Implementation of a special scheme for leather and footwear industries, similar to the already launched scheme for the textile sector, to incentivize these labour intensive industries.

     

2. Start-up India
 

‘Start-up India’ has been an important initiative of the Government of India to support and nurture budding entrepreneurs in the country. In pursuance of this campaign, the Budget provided for the following support to start-ups:  

  • Unlike other business entities, start-ups would be entitled to carry forward business losses even if there is no continuous holding of 51% of voting rights, provided that the holding of the original promoters continues

  • The profit-linked deduction granted under Section 80-IAC of the IT Act can be claimed in a block of three consecutive years out of the first seven years (instead of the earlier requirement of claiming such deduction within three consecutive years of the first five years).

3. Foreign Direct Investment

In order to address further ease the movement of capital, the Budget proposed the following:

  • The Foreign Investment Promotion Board (“FIPB”), which offers a single window clearance for applications on FDI in India that are under the approval route, is proposed to be abolished in 2017-18

  • Further liberalisation of the consolidated FDI policy is under consideration and announcements will be made in due course. 

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  • Supporting the Objectives of Demonetisation

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  • Economic Situation Pre-Demonetisation
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    The 2017 Budget has assumed significant importance as it has been presented after the historic movement of demonetisation of high-value notes. The Government’s move came in the wake of multiple issues within India’s cash-dependent economy, ranging from accumulation of black money, corruption, counterfeiting, etc. Additionally very few Indians had access to the formal banking sector. The chart below shows that of all the BRICS nations India has the second lowest domestic credit provided by financial sector (as percent of GDP).

 Another issue that the demonetisation exercise aimed at addressing was to expand India’s low tax base. The chart below reveals that India and China have almost a similar (and the lowest) trend in the tax revenue as a percent of GDP. However, this has to be contextualised to the economic realities of China, which does not follow the same market based philosophy of India. Evidently, there is quite a scope to improve the tax base and it was the purpose of demonetisation to address this deficiency.

 

Macroeconomic Impact of Demonetisation

 

Even though the macroeconomic impact of such a move is yet to be properly determined, there are quite divergent views about the expected impact. In light of the move the Asian Development Bank revised its estimate of growth projections for India from 7.4 to 7 % and the IMF from 7.6 to 6.6%. Others believe that such adverse impact on the economy is only temporary and the economy will not only recover very soon but will also reap the benefit of a larger tax base.

 

Budget 2017
 
The Finance Minister in his Budget Speech addressed this topic head on and reiterated that the objectives of demonetisation are as below:
  • Curbing tax evasion and the parallel economy;
  • Elimination of corruption, black money and counterfeit currency;
  • Greater formalisation of the economy;
  • Surplus liquidity in the banking sector.

The Finance Minister, reiterating the assurances given by the Prime Minister Mr. Narendra Modi in the Rajya Sabha, clarified that the benefits of demonetisation would be reaped by India in the medium to long-term and any drop in economic activity will only be transitory in nature – the ‘normal’ GDP in the long run will be “bigger, cleaner and real”. The Finance Minister was confident to state that the effects of demonetisation will not spill over into the next year.

 

According to the Finance Minister, the availability of surplus liquidity in the banking sector due to demonetisation has already resulted in reduced lending rates offered by the banks. Additionally, the Finance Minister has laid down the following tax proposals to address the objectives of demonetisation:

  • Restricting cash donations and measures to discourage cash transactions;

  • Disallowance of depreciation under Section 32 and capital expenditure under Section 35AD on cash payment;

  • Measures to promote digital payments in case of small unorganized businesses

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    Conclusion

The 2017 Budget was presented at a very important juncture of global geo-political situation which called for the government to provide a very conducive and sustaining economic environment for Indian firms. Through the various measures, the Budget did address this so that Indian firms, especially the start-up, are in a position to compete globally. However, one of the most anticipated events in India - the roll out of the Goods and Services Tax (“GST”) was curiously missing from the Budget. The Budget failed to give a clear path and datelinefor the introduction of GST. If it had been introduced in this Budget, it had the potential of bringing about great economic and political benefits.On the other hand, the Budget was significant because it was presented just after the bold exercise of demonetisation which had a stated objective to curb out black money and introduce major sections of the Indian population to the formal financial institutions. The various provisions in the Budget supported this objective of the government. The question of final impact on the macroeconomic variable is still open; however, it is expected that the long term economic benefits would far overshadow the short term losses.

 

[1] BRICS is an acronym for the following group of emerging economies, viz. Brazil, Russia, India, China and South Africa.

 

 

Authors:

Nishant Shah – Partner

Mehfuz Mollah – Associate Manager

Economic Law Practice

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