A retired police personnel waits outside to deposit and exchange 500 and 1,000 rupee notes in Amritsar, India. Sameer Sehgal / Hindustan Times via Getty Images
A retired police personnel waits outside to deposit and exchange 500 and 1,000 rupee notes in Amritsar, India. Sameer Sehgal / Hindustan Times via Getty Images

Demonetisation move is India’s elephant in the room

India’s union budget, which will be presented on Wednesday, will be watched with particularly intense scrutiny.

It comes amid a cash crunch triggered almost three months ago by the prime minister Narendra Modi’s surprise demonetisation move of scrapping the two highest value banknotes in an effort to address the country’s widespread problem of black money. Also of influence will be upcoming key state elections. And this is all against a backdrop of global uncertainty.

This year, the budget will be presented by India’s finance minister, Arun Jaitley, a month earlier than usual, in a break away from a colonial tradition.

Analysts cut their GDP growth forecasts for India in the wake of demonetisation. The IMF has lowered its forecast for the current financial year to the end of March to 6.6 per cent, compared to an earlier forecast of 7.6 per cent, citing the impact of demonetisation.

“The immediate priority of the government should be to revive consumption demand,” says Dharmakirti Joshi, the chief economist at Crisil, an Indian ratings and research firm which is part of Standard & Poor’s.

Growth of private consumption slowed to 5.9 per cent in the second half of the current financial year from 7.1 per cent in the first half, according to government advance estimates.

“Domestic consumption must be boosted by improving purchasing power, especially among the rural population and workers in the unorganised sector, and smoothing transaction process in cash-driven sectors,” says Mr Joshi. “This will help pave the way for investment recovery.”

Pranjul Bhandari, the chief India economist at HSBC, describes demonetisation and its impact on economic growth as “the elephant in the room”.

She explains that the government should not go overboard in its spending heavily to boost consumption and investment and that the government should stick to its fiscal deficit target of 3 per cent of GDP for the next financial year, which begins in April.

“A fiscal helping hand tends to come at a cost,” she says. “It is possible that higher government borrowing can crowd out vulnerable sectors most, keep debt dynamics fragile and eventually hurt growth more than help.”

She also believes that the government in this budget might start the ball rolling on a move away from subsidies to a basic income to help India’s poor.

“We expect a focus on the quality of spend. It is an established fact that cash transfers can be more efficient than product subsidies, which tend to distort markets. We expect the budget to announce pilots for a universal basic income, which in its Indian form will be an unconditional cash transfer to those identified as the beneficiary group.”

Businesses will also be keenly watching for details on the transition to the new long-awaited goods and services tax (GST), Mr Ganganna says. GST is expected to be rolled out in July, replacing India’s convoluted system of multiple taxes across the different states with a uniform tax.

“The government would try to maintain fiscal prudence while providing for giveaways for stimulating the Indian consumer at large,” says Shashank Khade, the co-founder and director of Entrust Family Office Investment Advisors. “Beyond its own push to build infrastructure assets, the focus shall be on wooing foreign direct investments and enticing the private sector into infrastructure investments in its quest to kick-start economic acceleration and create much- needed jobs.”

There are a number of other steps he will be looking out for, he says.

“The government’s allocation for provision for capitalisation of government-owned banks shall be critical for strengthening the banking system. Government disinvestment plans, level of government borrowings for the next year, shall be also eagerly watched for. With the crude oil price on the rise, it needs to be seen whether the government shall reduce the excise duty on petrol and diesel to give some relief to consumers.”

There are also widespread expectations that the budget will deliver some relief for corporate and personal taxes to ease some of the pain caused by demonetisation and to encourage tax compliance.

“We expect the union budget to lay the foundation of India’s taxation structure in line with the government’s vision of a broad-based, moderate, simple and stable taxation system,” according to Kotak Institutional Equities. “The government will likely reduce income tax rates for companies and individuals.”

But the government is expected to be restricted and influenced by important state elections due this year, which are likely to prevent it from introducing any measures which could potentially upset its voter base.

“With the crucial state election in Uttar Pradesh in February and March and derailment of growth momentum post demonetisation, there are concerns that the government may be tempted to provide some populist measures,” according to Nomura. “However, we believe it will deliver a popular, but not a populist, budget.”

It adds that it expects to see a focus on “disincentives for cash and incentives for digital payments, affordable housing, a push for agricultural and rural development, employment, and infrastructure spending.”

With India increasingly trying to move away from being a heavily cash-based economy, Saurabh Kocchar, the chief executive of foodpanda India, a food delivery online marketplace, says he is “looking forward to a growth-oriented budget that addresses the gaps in digitisation and sets path for a digital economy”.

BVR Mohan Reddy, the founder and executive chairman of Cyient, an Indian engineering firm, also believes that the government needs to focus on promoting a cashless economy in this year’s budget.

“The union budget should announce relief on such transaction charges and should a step forward and incentivise the usage of digital payments through discounts and tax waivers,” he says.

Also noteworthy this year are changes to the structure of the budget. Not only has it been moved to an earlier date, but the railway budget, which is normally a separate event, will be presented as part of the union budget.

Given the high expectations and interest in the budget this year, the pressure is mounting for Mr Jaitley to deliver on Wednesday.

“Post demonetisation, the union budget has gained significant importance,” says Mr Khade. “With expectations running high from the government based on the perceived gains of demonetisation, the union budget has a tough task to please different sections of the society.”


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