In India, focus shifts to deploying fiscal stimulus

India's Prime Minister Narendra Modi
Adnan Abidi | Reuters
India's Prime Minister Narendra Modi

India's annual budget was once the country's most important economic event, but times have changed as Central Government reforms no longer need adhere to budget timelines.

There was a time when the Indian government, officially known as the Union Government or the Central Government, had a monopoly on most of the important sectors of the economy, from power generation, oil and metal production to telecoms and airlines, making the presentation of the government's budget an important economic moment.

However, the Central Government's role in the economy has shrunk dramatically, and its spending as a share of gross domestic product is near 40-year lows. In fact, state governments, put together, now spend nearly 60 percent more than the center, versus just 6 percent more at the start of this decade. Yet, media hype around the Union Government's budget persists, while state budgets go mostly unnoticed.

An exceptional budget

This year's Union budget was an exception, however, and deserved some attention for three reasons.

First, the fiscal bonanza for the Central Government from weak crude oil prices (the Union Government kept most of the gains by cutting subsidies and raising taxes: prices at the fuel pumps did not fall as much) created room for a fiscal stimulus that was desperately needed given persistent weak growth in the economy. The government did deliver a 1.5 trillion rupee (around $23.9 billion or 1.1 percent of GDP) increase in plan expenditure, mostly on roads and railways, even if it meant pushing out the fiscal consolidation targets by a year.

Secondly, the government's acceptance of the unprecedented increase in statutory tax transfers to states recommended by the Finance Commission meant that despite a 16 percent increase in gross tax receipts, the Central Government's net receipts increased just 1 percent. While this was offset by reductions in other transfers, the net increase in transfers to state governments was 1.4 trillion rupees. Thus, state budgets will become even more important.

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Lastly, as the government does cash accounting (as against accrual accounting that companies do), writing a check in April versus writing it in March can change the fiscal deficit. We estimate a fiscal deficit of more than 1 percent of GDP was pushed from the previous fiscal year into the current one (the year ending March 2015), necessitating a sharp contraction in discretionary spending. This spending cut, concentrated in the last few months of this fiscal year, is likely the cause of economic momentum worsening in the past 4-5 months.

Stronger economic growth

By the sheer increase in planned spending, and backed by a credible fiscal arithmetic, economic growth should get a boost as the new fiscal year starts in April. The fiscal multiplier, or the quantification of impact on growth—or indeed, how inflationary this growth can be—would depend on the pace at which the additional funds get deployed, and particularly how state governments spend the extra funds they got this year. Investors should shift focus to both these issues.

Many seemed disappointed by the lack of "reforms" in the budget, even though what these "reforms" ought to have been is rarely articulated, or even why they should be announced in the budget speech. In our view, the only four Central Government reforms that matter to the broader economy are in railways (increase productivity, raise capacity), coal (increase output), banking (improve governance and efficiency of government owned banks), and the goods and services tax. These are structural changes that would take several years to push through.

Other required reforms, as in mining, affect smaller parts of the economy or, like the Land Acquisition Bill, are likely to have an impact over a very long time, likely longer than what the market can price in.

Neelkanth Mishra is the India Equity Strategist for Credit Suisse. Prior to joining Credit Suisse, he was a senior technical architect with Infosys Technologies. He has also worked with Hindustan Lever Limited and has been an entrepreneur. Neelkanth is a gold medallist from the Indian Institute of Technology, Kanpur, graduating in Computer Science and Engineering, and was ranked fourth in the prestigious entrance exam to the IITs. He is currently based in Mumbai.