India's Budget Presented under Shadow of Banknote Ban

Arun Jaitley, India’s finance minister, this week presented his annual Budget aimed at bouncing the country’s political and economic focus away from the miseries of prime minister Narendra Modi’s three-month-old bank note ban and at projecting an economy with increased growth and less corruption.

The demonetization – or cancellation – of 1,000 rupee and 500 rupee notes was suddenly introduced by Modi in a nation-wide broadcast on November 8. It removed 86% of the currency in circulation and led to widespread economic and social disruption and hardship that Jaitley and Modi have always underplayed in public statements.

Although Jaitley did not spell this out in his speech, the government has now admitted that demonetization has had “significant implications” for gross domestic product, reducing 2016-17 growth by 0.25% to 0.5% from an expected 7%. That statement came with the finance ministry’s annual Economic Survey, that was published yesterday and included an analysis of the problems and potential benefits.

“Like all reforms, this measure is obviously disruptive, as it seeks to change the retrograde status quo,” was all that Jaitley would acknowledge. “Drop in economic activity, if any, on account of the currency squeeze during the remonetization period is expected to have only a transient impact on the economy.”

Modi initially said that the aim was to curb the role of “black money” but, when it became clear that massive amounts of cancelled notes were being corruptly banked and converted into new currency, the government switched to say that the aim was to drastically reduce the role of cash in the economy by encouraging digital transactions. Demonetisation sought to create “a new ‘normal’ wherein the economy would be “bigger, cleaner and real”.

The Economic Survey however was more realistic and said that “digitalization is not a panacea, nor is cash all bad”. Public policy should balance benefits and costs of both forms of payments and “the transition to digitalization must be gradual; take full account of the digitally-deprived; respect rather than dictate choice; and be inclusive rather than controlled”.

In his speech today, Jaitley put more focus on reducing corruption, which has been a major government policy since the general election nearly three years ago.

He talked about how “tax evasion for many has become a way of life”, which “compromises the larger public interest and creates unjust enrichment in favor of the tax evader, to the detriment of the poor and deprived”. That had bred a parallel economy that was “unacceptable for an inclusive society”.

To illustrate that India was “largely a tax non-compliant society”, Jaitley said that only 172,000 people declared annual income of more than 5 million rupees ($73,500), yet in the last five years more than 12.5 milllion cars had been sold and, in 2015, 20 million Indian citizen flew abroad for business or tourism. “The predominance of cash in the economy makes it possible for the people to evade their taxes,” he declared.

Political funding

The government now needs to show that it will take more steps to tackle corruption than it has done so far. One major area is funding of political parties, which depends on massive use of black money. It was widely assumed that Modi’s ban was timed to hit the 500 and 1,000-rupee notes collected by regional parties in five states, including populous Uttar Pradesh and Punjab, for campaigning in assembly elections that start on February 4.

Jaitley announced that the maximum cash donation that any party could receive from one source would in future be 2,000 rupees. Other donations could only be by check or a digital transaction. The Reserve Bank of India will be issuing electoral bonds that donors could buy for redeeming by a political party. These measures however fall far short of full declaration of party funding, which Modi said recently was desirable. Sceptics say that the limit will not be effective.

Jaitley also said the government is considering introducing legislation that would provide for the confiscation of assets owned by people who leave the country to evade court action. Although he did not name him, the most recent such example is Vijay Mallya, former chairman of United Spirits (which makes Kingfisher beer) and who ran a failed airline of the same name, who did not return from the United Kingdom for court hearings.

One significant reform is the abolition during the coming financial year of the government’s Foreign Investment Promotion Board (FIPB), whose main job since it was founded in 1991 has been to examine foreign investment proposals (sometime attracting bribes). With FDI inflows totalling US$75 billion in the past year, more than 90% are now automatically cleared without vetting Plans for further easing FDI restrictions and phasing out the FIPB will be announced in the next few months.

Fiscal deficit

The budget’s aim, Jaitley said, was to “transform, energize and clean India”. In an attempt to boost employment and consumer spending, there were measures for agricultural and allied sectors including rural jobs schemes, plus US$58.8 billion more spending on infrastructure, notably highways and the railways. Taxes were reduced for the poor and raised for the higher paid.

The fiscal deficit for the coming year has been set at 3.2% of GDP instead of the planned 3%, presumably because Jaitley does not want to over-restrict the economy when recovery from the shock of demonetization is the main priority.

Overall the budget has been welcomed, as it always is, by business federations that rarely dare to criticize the finance minister publicly. Opposition political parties have inevitably attacked it for failing to tackle basic problems of joblessness and sluggish investment.

More independent observers however have seen it as a politically competent budget that has tried to move on from demonetization by boosting growth and taking some anti-corruption measures. There is little to show how its plans will work in practice, but its pro-poor rural announcements might well help garner votes for Modi and Jaitley’s Bharatiya Janata Party in the coming assembly elections.