The tax exemption on income up to Rs12 lakh, the last of the six transformative domains that made up this year’s Union Budget, hogged all the headlines. But in terms of significance, it might well have been more a desperate step to offset the seething middle-class anger than any visionary policy change to catalyse India’s growth story.
“The question is what people will spend this extra income on. If they are spending it on iPhones and imported products, all that tax-saved money will flow out of the country,” said Padmanand V., partner at the professional services consultancy Grand Thornton Bharat. “Consumption expenditure can fuel economic growth only to a limited extent.”
Real growth may still happen, but not because of any spending spree by the masses, but by the reformist intent written between the lines in the budget. “Accelerate growth, secure inclusive development, invigorate private sector investments, uplift household sentiments and enhance spending power of India’s middle-class,” said Finance Minister Nirmala Sitharaman in her budget speech on February 1, though almost all the attention went just to the last two points.
Perhaps she has got the mix right this time. From pushing for deregulation of many sectors to a strategic rejigging of duties that could help domestic manufacturing and exports, and a conscious push for micro, small and medium enterprises (MSME) through development of industry clusters and easier loans, Sitharaman is hoping to set the stage for a refurbished version of the virtuous cycle she has been dreaming of for long. “This budget would kickstart a virtuous cycle of growth,” said Sanjiv Puri, chairman of ITC and president of the Confederation of Indian Industry.
The difference this time is that the government has actually acknowledged the chink in its armour—the factors holding India back—and taken baby steps to fix it.
That brings us to the most important question: Will it inject steroids into an all-round, all inclusive, growth story, or will that one big hurdle that has tripped up so many good intentions and policies down the years play its wicked hand again?
Modinomics made its first major play with the implementation of GST in 2017 and the corporate tax cut in 2019. GST was meant to formalise the economy and thereby mop up more tax revenue, while the latter was to give a fillip to a slowing economy by making businesses increase capacity or set up new businesses. This went up by another notch with the production-linked incentive schemes to encourage domestic manufacturing.
Since then, successive budgets went on a ‘spend-big-and-ask-questions-later’ format of massive capital spending by the government. This saw money flowing into the system, especially to big companies. The government’s expectation was for a ‘virtuous cycle’—businesses reinvesting the extra money in fresh capacities and new businesses, and by turn, creating jobs that will see the money ‘trickling down’ the value chain.
That simply did not happen, as businesses earning all that extra cash seemed more intent on improving their profits and cash reserves rather then reinvesting it in risky additional capacity or new businesses. They felt it was not prudent to invest in new ventures when rural and middle-class spending remained low.
Betting on future: The thrust on MSMEs through schemes like cluster production could make India a manufacturing powerhouse | Pawan Kumar
So it has been back to the drawing board for Sitharaman and Co in North Block. Their new formula infuses a streak of welfarism, acknowledging the realities of stagnant income and middle-class stress, and, also why businesses are not taking the plunge. “India is going to become the third biggest economy in a matter of a few years,” said Padmanand. “But the question now is whether it will be inclusive. From $2,000 to $3,000 per capita, how do we go to $30,000?”
The solution has been staring at our face all this while. In economy-speak, one calls it ICOR, or incremental capital output ratio, a metric which figures out how much you get out of every rupee that is invested.
In plain-speak, you call it ‘improving productivity’.
Under the current ICOR, India would need to increase its present growth rate of around 6 per cent to 8 per cent. That can only come when all these big capital spending of recent years start showing results that lead to growth.
For instance, the capex of the past few years were directed at big infrastructure projects. “Now if you are building ports and roads, but you are not giving businesses the freedom and competitiveness to use those ports and roads to go out there, win global markets and expand aggressively, then the infrastructure has diminishing returns,” said Rahul Ahluwalia, founding director of the Delhi-based think-tank Foundation for Economic Development.
And this is important because India’s ‘viksit’ dreams cannot be achieved by making its masses splurge in malls or on e-commerce sites. That will come only through taking on the world through exports.
“Global competitiveness is the name of the game. Domestic economy will only grow at relatively limited rates. Export economy is where we can take large amounts of share if we are aggressive about it,” said Ahluwalia.
Sitharaman’s budget, and the Economic Survey which preceded it, have this as their guiding light. The usual lip service on easier loans apart, the thrust on MSMEs through schemes like cluster production could well make India a manufacturing powerhouse. Cluster manufacturing refers to certain areas being demarcated for certain businesses so that an entire ecosystem of competing companies mushroom there, ensuring that a particular sector or value chain becomes competitive.
With grants for technology upgrade, the emphasis on deregulation and the rationalisation of export/import duty (Sitharaman has made a start with seven out of 15 duty slabs struck down) could just catalyse thousands of small businesses and manufacturing units aimed at export.
“There is going to be a trade war throughout the world. Bilateral and multilateral trade agreements are now very critical to penetrate the global market,” said Padmanand, referring to US President Donald Trump’s recent moves against Mexico, Canada and China. “It is a great potential opportunity to tap the American market now,” he said.
With budget provisions like an Export Promotion Mission, Bharat Trade net and a digital public infra in place to reduce costs and compliances, India is well on the right track. But will its Achilles’ heel hold it back from achieving this grandiose vision?
While capital investment in this budget went up by more than Rs1 lakh crore, once you take the revised budget estimates of last year, the fact is that industry is not too chuffed with the budget. Stock markets tanked both on the day of the budget as well as the following Monday. Why?
“In the past five or six years, the economy has been growing on the back of public investment. And private investment has been slowing down. There is nothing in this budget that has definitely arrested that story,” said Ahluwalia. “The government has not created conditions under which the private sector feels excited to invest.”
It is a story as old as the nation—great visionary measures announced from the top, but faltering on implementation. Simplified taxation, stable rules and policy, ease of doing business, better infra and connectivity, all remain a chimera for businesses that hope to be part of the India story. “These are the legacy issues India has always had. It’s easy to make announcements, but difficult to deliver,” said Ahluwalia.
There might just be hope on the horizon. “At least the budget acknowledges that there is a problem in ‘ease of doing business’ and major steps on deregulation are supposed to be taken. The budget proposes to set up a high-level committee on ease of doing business, because they themselves understand it is not where they want it to be,” said Ahluwalia. “The announcements are positive. But businesses will be in wait-and-watch mode. Implementation will be key.”