Good policies at the wrong time

Good policies at the wrong time
x
Highlights

The Budget has been widely acclaimed to be path breaking. It seeks to make a massive increase in public investments in infrastructure while, at the same time, providing relief in Income Tax.

The Budget has been widely acclaimed to be path breaking. It seeks to make a massive increase in public investments in infrastructure while, at the same time, providing relief in Income Tax. The Finance Minister wants to spend more while he collects less. So where is the money going to come from? The secret lies in the implementation of GST. The Finance Minister observed that he is not disturbing the rates of Service Tax at present as they will be readjusted when GST is implemented later in the year. Hidden in this statement is an expectation that tax collections are likely to increase.

The digital economy will also lead to higher collection of taxes. Large numbers of transactions were until now being undertaken in cash and tax was not being paid on them. Now they will come under the tax net. This is the correct policy according to the economic theory. An increase in tax collections along with an increase in public investment will transfer the money from the consumption to investment and lead the economy to a high growth trajectory.

Government investment alone, however, does not pull the economy. The role of government investment is to lay the path for increased private investments. Government investment is the driver of economic growth only in totalitarian countries like the erstwhile Soviet Russia and the present day North Korea. Thus the success of the above mantra depends upon whether the increased investment by the government will lead to increased private investment. There are two sources of private investment—domestic and foreign. Both domestic and foreign investment will be made only when there is demand in the market. This has been subdued in the last two years.

The Finance Minister has made things worse by making an increase in taxes through the GST and the digital economy. The market will remain subdued and domestic investment will not come in this situation. A Chennai-based banker said that demand for loans from large corporations has been virtually non-existent in the last two years. The silver lining for the banks during this time was that retail demand for loans was buoyant. After the recent budget, he felt this too will take a hit. Reason is that the increased levels of taxes will reduce the purchasing power in hands of the consumers.

Foreign investment will additionally not come because of the move of the developed countries towards protectionism. Many multinational corporations invest in foreign countries to avail of cheap labour available here. For example, Ford may make cars in Mexico and export them to the US. President Trump wants American multinationals to stop this practice and manufacture in the US. He has threatened to impose hefty import duties on good coming from Mexico.

He has threatened to walk out of the World Trade Organisation that compels countries to keep import duties low so as to facilitate free trade. A similar rise in protectionism is being proposed by leading candidates for the elections in France, Germany and Netherlands that are to take place soon. This rise in protectionism will hit at our exports. Multinational corporations are not likely to invest in India for supplying goods to their home countries in this situation.

Another reason for less foreign investment is the increase in interest rates by the US Federal Reserve. The ‘Fed’, as it is known, has made a small increase in interest rate towards the end of 2016 and made clear its intention to make more increases in 2017. Bonds issued by the US government are considered safe. In comparison, bonds issued by the Government of India are considered not-so-safe.

Yet they were till recently buying bonds issued by the Government of India because the returns on bonds issued by the US Government were providing low rates of returns. The increase in interest rates by the Fed will make investments in US bonds attractive. Correspondingly, the willingness of foreign investors to invest in India will take a hit. It is even possible that foreign investors may flee India.

Knowledgeable people tell of large scale outflow of domestic capital from India in the last few months. No wonder Prime Minister Modi has lamented that Indian businessmen are more interested in investing abroad than in India. Therefore, domestic investment will not come because of low domestic demand. Foreign investment will not come because of the rise of protectionism in the developed countries and the increase in interest rates in the US.

There will be more damage from an increase in imports. The Finance Minister has continued to follow the policy of increased integration with the global economy by keeping our borders open for imports. This has indeed helped contain the increase in prices by making available cheap goods like mobile phones made in China. However, it has also led to deindustrialisation of India. Large numbers of industries in the country have folded up due to the onslaught of cheap imports from China.

Domestic business investment has remained subdued in the last three years also for this reason. As a result, the budget will fail to jumpstart a fortuitous cycle of private investment and growth. The good policy of transferring money from consumption to investment outlined above will come to a naught because the global economic situation has become adverse. Keeping our borders open and running after exports will only lead to more imports and further hit investment and growth. Running after foreign investment will only lead to more fleeing of our domestic capital.

The alternative is to adopt a policy of fiscal stimulus along with protectionism. The Finance Minister could have increased public investment in infrastructure by borrowing money instead of taxing the people. Normally that would lead to an increase in prices because more money would be chasing the same amount of goods in the market. This could be avoided by importing goods.

For example, the government could borrow $ 1 million from the IMF and use it to import steel for building a bridge. In that case the domestic demand and supply of steel will remain unchanged and there will be no increase in prices. Simultaneously, an increase in customs duty on imported goods would lead to increased demand for goods produced in India and encourage both domestic and foreign investment. The infatuation of the Finance Minister with foreign investment and global trade will undo his abovementioned good policies.

By Dr Bharat Jhunjhunwala

Show Full Article
Print Article
Next Story
More Stories
ADVERTISEMENT
ADVERTISEMENTS