Union Budget 2016-17: A Brave But Disappointing Budget

The government’s decision to stick to fiscal deficit of 3.5% of GDP for 2016-17 and 3.0% for 2017-18 is undoubtedly brave. Moreover, it is important to note that achieving a fiscal deficit of 3.9% of GDP in the current year will be a balancing act because a miss of even Rs 10bn will make it 4.0% of GDP. Nevertheless, we found this Budget disappointing on five counts. Firstly, by not hiking the service tax rate, the government has raised doubts on the expectation of the implementation of the much-awaited Goods & Services tax (GST). Relatedly, it was surprising to see the government assuming deterioration in the indirect tax collection buoyancy from ~1.4x in 2015-16 to ~0.9x in 2016-17. Thirdly, estimating receipts of Rs 990bn from spectrum auctions in 2016-17, along with disinvestment target of Rs 565bn appear extremely aggressive. Finally, the most disappointing part is the budgeted decline in the capital spending from 1.8% of GDP in 2015-16 to 1.6% in 2016-17. Finally, although the Budget is mysteriously silent on the seventh central pay commission (7th CPC), it appears to have been implemented only partially at best, as the total increase in non-plan spending is budgeted at Rs 1,199bn, less than the incremental burden due to the 7th CPC. Overall, in contrast to our expectations, the government appears to have focused on the headline numbers at the cost of the quality of its finances. Consequently, notwithstanding the adherence to the deficit target, the Union Budget 2016-17, we believe, may not appease the Reserve Bank of India (RBI) to cut policy interest rates before the next policy meet in April 2016.

2015-16 an extremely delicate act: As we had discussed, the shortfall in direct taxes in 2015-16 is expected to be more than offset by the higher excise duty collection, helping the gross tax receipts to increase from 9.3% of GDP in FY15 to 10.8% in FY16. However, what concerns us is that the revenue spending for 2015-16 is revised to be Rs 116bn higher than the budget estimates (BE), while capital spending is revised to be Rs 37bn lower than the BE. With these tweaks, the government expects to meet its current year’s deficit target of 3.9% of GDP. However, we call it a delicate act because even a slippage of Rs 10bn would make it 4.0% of GDP:

2016-17 Budget Was Brave But Disappointing: As we have discussed earlier also, the quality of the deficit is more important than the quantity of the deficit. By sticking to its fiscal consolidation roadmap of 3.5% of GDP for 2016-17 and 3.0% for 2017-18, the government, unfortunately, seems to have focused on the quantity at the cost of the quality of the deficit. Given below are the four reasons why we believe the Budget to be disappointing:

1. In contrast to almost unanimous market expectation of a hike of 2 percentage points in the service tax rate, the government chooses not to do it. It disappoints for two reasons – a) hike in service tax rate was an easy, and entirely discounted, manner for the government to garner more receipts to finance one-time spending on the pay commission, b) the hike in the service tax rate has also been considered a recalibration in line with the implementation of the much-awaited GST. With no hike in the service tax rate, doubts have been raised on the implementation of the GST.
2. Relatedly, it was surprising that the government has budget estimated an indirect tax growth of only 10.8% YoY for 2016-17, which implies a tax buoyancy of less than 1.0x, as against the implied buoyancy of 1.4x-1.5x in 2015-16. Although a part of this subdued expectation is on the account of absence of service tax rate hike and re-imposition of custom duty on crude petroleum oil, it also reflects deterioration in tax administration, which is surprising.
3. Although the government budget estimates on tax collection are conservative, their estimates on the non-tax receipts (revenue as well non-debt capital) have been as unrealistic. The four big items are Rs 539bn as dividends from public sector enterprises (PSEs), Rs 699bn as dividends from RBI and other financial institutions, Rs 990bn from spectrum auctions and Rs 565bn from disinvestment proceeds. Overall, the share of net tax receipts is estimated to fall from 80% five years ago to 73% in 2016-17.
4. Fourthly, the most disappointing statistic in the Union Budget 2016-17 was the sharp deceleration in the capital spending growth from ~21% in 2015-16 (revised down from ~25% in 2015-16 BE) to only ~4% in 2016-17. It implies a fall in the capital spending from 1.8% of GDP this year to 1.6% of GDP next year.
5. Finally, although the Union Budget is mysteriously silent on the 7th CPC, we reckon that it has been implemented only partially at best because the total increase in the non-plan expenditure is budgeted at Rs 1,199bn , less than the incremental burden due to the 7th CPC (including one-rank one-pension scheme). Therefore, some hang over could remain in 2017-18 as well.

Besides, the government also imposed a number of cess/surcharges in order to garner more receipts. It is important to note that since the central government does not have to share the receipts earned through cesses, there is an inbuilt bias to impose more cesses/surcharges. Some of the most important cess are: a) krishi kalian cess on any or all taxable services at the rate of 0.5% effective from 1st June 2016, effectively implying a hike in the service tax to 15% (including Swachh Bharat cess). It is expected to raise additional Rs 50bn; b) Infrastructure cess on motor vehicles, which is expected to garner additional Rs 30bn, and c) Clean environment cess (erstwhile clean energy cess), which is expected to get additional Rs 40-60bn. Although these new cess or surcharges will garner more receipts in 2016-17, their existence is debatable as and when the GST is implemented.

Moroever, the customs duty on initation jewellery, gold & silver bars are proposed to increase, along with the duties on several metals such as brass scrap, aluminum and zinc alloys. Finally, the basic excise duty on aviation turbine fuel (ATF) is hiked from 8% to 14%.

Finally, although the government resisted the reduction in the corporate tax rate in this Budget, the government has given guiding principles to phase out the exemptions and deductions for both corporate and non-corporate tax payers.

Overall, although the government has stuck to its fiscal deficit consolidation path, it has compromised the hard-earned quality of the deficit. No hike in the service tax rate, aggressive receipts targets from PSEs dividends, spectrum auctions and disinvestments, sharp deterioration in capital spending and partial implementation of the 7th CPC – all of them deteriorate the quality of the government finances.

Will this lead to monetary easing? Last year, the RBI had cut rates immediately after the Union Budget 2015-16 citing good intentions of the government. The event has set the expectations this time also. Nevertheless, while the headline numbers matter, the RBI has always given equal importance to the details, which are extremely disappointing. Accordingly, we are not so convinced with immediate rate cuts.