Navigating in Choppy Waters

The world is in a turmoil. The Russia-Ukraine conflict is well into its third year with no end in sight. Israel’s pounding of Gaza is eight months old, with nearly 40,000 dead due the bombing. The U.S. Presidential favourite just survived an assassination attempt. The United Kingdom just had a massive electoral reversal, with the Conservative Party swept out of power after fifteen years, and the Labour Party gaining nearly two third majority with just one third of the votes cast. And while these geopolitical upheavals are going on, we also had the world’s biggest IT failure, of the ever-reliable Microsoft system. This was presumably a bug in the cyber security module and not a cyber attack. The global outage caused hundreds of flights to be cancelled and disrupted government functioning. The country not affected by the Microsoft outage was China, and to a large extent India. There is perhaps some subtle geopolitical message in this quirky fact!

The global macroeconomic context is that big economies are still fighting inflation which refuses to come down to the target level of 2 percent. That is why monetary tightening continues even though industry keeps asking for an increase in money supply, and lower interest rates. Because of the still high interest rates industrial and housing investment is not rising as fast as it should to support employment. Unemployment worries are bringing out strong anti-immigrant sentiment, which has been tapped by the campaign of Donald Trump, and the far-right parties in France and elsewhere in Europe. It has also led to a protectionist sentiment. Trump has already promised further penal import duties on Chinese goods. China too has its own economic woes. There is a glut of production of electric vehicles which are being dumped on the world.

The stock markets index however continues to zoom higher. We have to be careful about bubbles, because the index rise is fueled by only a few tech stocks like Nvidia, Apple, Tesla, Microsoft and of course everything connected with Artificial Intelligence. Out of the five hundred stock prices in the benchmark S & P 500 index, if you take out the seven biggest gainers, the rest of the index performance is very modest. This stark intra-index variation in stock price rally is true of stock markets elsewhere too, including in India.

In this global scenario of turmoil India’s macroeconomy is showing remarkable strength, resilience and stability. For the past four post-Covid years the average growth rate has been about 7.5 percent, inflation has hovered around 4 to 5 percent, exports are doing well, especially of services including software, foreign exchange stock of dollars is at healthy levels, and the fiscal deficit ratio has been steadily coming down. The latter is a pointer to fiscal responsibility. Thus, these are indications of macro stability. Furthermore, the banking sector is doing exceptionally well with very low non-performing loan ratios and record profitability.

The upcoming Union Budget is important because it is the first one of Prime Minister Modi’s third outing as PM. Hence this is being called the Modi 3.0 government. It will be Finance Minister Nirmala Sitharaman’s seventh budget presentation to parliament. Note that not even a single rupee of taxpayer money can be spent without the consent of Parliament. Extensive consultations have preceded the Tuesday presentation of the Budget proposal by the FM. The budget proposals need to be only passed in the lower house, i.e. the Lok Sabha, where the NDA has a majority, but not the single party BJP by itself. This implies that the budget may see some shades of influence of push and pull of coalition politics, although it is not the same as complete tug of war between parties of opposite ideologies within a coalition. Besides the budget now consists of a large portion of non-discretionary items such as interest payment (the largest component), subsidies, salaries and pensions and other revenue expenditure items. The element of surprise has been largely taken out of budget announcements over the years. Nevertheless, given the political atmosphere, there is bound to be some nod to freebies and extra welfare spending.

Even though this budget will be for the next seven months, it will be an occasion to articulate economic strategy for the coming years and an economic vision too. It will be the first time that total spending of the Union government will cross 50 trillion rupees. As a percentage of GDP, it will be about fifteen percent. The fiscal deficit this year has benefited from a windfall bonanza of a large dividend of 2 trillion rupees from Reserve Bank of India to the Union government. This large “profit” resulted from deft forex management and handling the debt management of the government. This cannot be counted upon next year. The RBI dividend more than offset other areas of shortfall which are non-tax revenues from privatisation and disinvestment. Income tax collection has risen faster than the GDP growth rate showing good buoyancy. Will the FM give some relief and at least bring personal income tax rates in line with the (lower) corporate tax rates? India’s income tax has a peculiar anomaly. On one hand it grants complete exemption till 7 lakh rupees income, but on the other it taxes income above 15 lakhs at the full rate, which with additional cess comes to a rate of 39 percent. A radical reform is needed wherein a small tax rate should become applicable at say 4 lakhs, and the top rate applies only about 50 or 75 lakhs.

The FM is aware that below the rosy macro scenario is a worrying micro picture. Consumer spending is sluggish, and so is private investment spending into new factories and expansions. The rural economy is struggling. The latest National Sample Survey shows household consumption data, which if we apply a slightly higher poverty line of 3 dollars per day, makes India’s rural poverty shoot up to 25 percent. This means a lot of households are hovering just above the official poverty line. Their prosperity requires not just welfare spending, but creation of job opportunities. The single most important determinant of long-term prosperity is investment in human capital, i.e. health and education. India’s education spending needs to more than double, to reach 6 percent of GDP. Hence look for these cues to support long term and inclusive growth in the FM’s budget speech.

(Dr. Ajit Ranade is a noted Pune-based economist) (Syndicate: The Billion Press)