Fiscal Consolidation Is The Big Story In India

Most analysts are missing the big picture of the India story which is becoming clearer and clearer by the day. Focussing on quarterly results, small upgrades and downgrades, state elections is taking the focus away from the key feature of the Modi Governments development model which was also summarized very well by Raghuram Rajan a couple of days back when he said “PRIME MINISTER MODI RELYING MORE ON STRUCTURAL REFORMS, LESS ON FISCAL, MONETARY MEASURES TO BOOST GROWTH”.

Many people are getting perturbed at the fact that the taxation on services has been increased via the Swachh Bharat Cess or the continued increase in excise duties on petrol and diesel etc. However, if you are an honest taxpayer you should not be perturbed. The fact of the matter is that the Tax to GDP ratio of India is dismal. The reasons for the same are widespread tax evasion, black income generation, corruption in the taxation departments etc. Although it is believed that the government should rely more on direct taxes than indirect taxes however in a nation where paying income tax is considered to be something that is a wastage of one’s hard earned money increasing indirect taxes, especially on services or products where it is difficult to evade paying that tax is the best way to go. Most of you will be shocked to know that only a royal 2.77% of India’s 1.21 billion people pay taxes. And if you are one of the 3 odd Crore taxpayers you should be happy that the burden is being shared by everyone.

One can always argue that there are lot of leakages and corruption in the government and as such why should be pay more to the government? This is factual; however I do believe that the current government is quite serious about curtailing corruption as well as wasteful expenditure. The fact of the matter is that Fiscal Consolidation is a must for long term sustainable growth. Only if the demand of funds from the government reduces and the crowding out of private investments reduces can we have sustainable long term growth with low inflation.

Fiscal Consolidation is one of the bigger successes of the government till date. Increase of duties on fuel, reduction of subsidies, restoration of excise duties to pre crisis levels and the increase in service tax rates have all contributed to it along with reduction in wasteful expenditure. The first level of reduction in Fiscal Deficit has happened without any significant economic recovery. As recovery gains steam next year we will see a rapid decline in Fiscal Deficit even after taking into account the impact of the pay commission recommendations and their implementation. As and when GST is implemented we will see a further improvement in tax collections as leakages come down further. These measures are also being combined with moves to shift some of the non productive investments of Indian’s like gold into production like sovereign gold bonds which look attractive at a 2.75% rate of interest.

More structural reforms, the biggest among them the removal of political influence from PSU Bank lending will make the financial system much more durable. We are already seeing lot of investment in government schemes like Swachh Bharat. The State Electricity Boards revamp announced last week is also huge as it could actually take things towards electricity for all and reduction of electricity tariffs over time. The good parts about the schemes of the current government are that they are implementable. This is contrary to the schemes announced during UPA times which could not be implemented. The other major structural reforms are clearly seen in the areas like Railways where a big investment cycle seems to be starting now with improved financials. The Roads and Ports segments also are seeing big momentum with the investment cycle picking up there. We are seeing a similar momentum in Renewal Energy investments like in Wind, Solar etc. The one area where there is still lot of work to be done is in the Agricultural side and Supply Side Reforms overall. As these issues are addressed going forward we should see sustainable high rates of growth with low inflation.

The other advantage of a healthier banking segment combined with Fiscal Consolidation will be an eventual upgrade in the country’s rating which will further attract long term capital and reduce long term borrowing costs for the government as well as corporates.

On an overall basis improved government finances, reduced subsidies, financial sector reforms as well as restructuring of segments like State Electricity Boards, Railways, Defence procurement etc is likely to provide a strong long term impetus to economic growth. Government not passing the full reduction in petroleum prices, reducing subsidies and increasing some subsidies are long term positives.

We might feel a small pinch today, however reviving a completely destroyed economy as the UPA left it requires some bitter pills to be swallowed.