The top PGDM College in Delhi NCR has been vocal on the Union Budget 2017. As India approaches the D-Day of 1st February 2017, the FM Shri Arun Jaitley shall once again arise to deliver the Annual Financial Statement, the Macroeconomic Framework, the Indian Economic Survey and the Budget Speech on the floor of the Parliament amidst a clamour to get over the colonial hangover. The Union Budget 2017 shall be special and in focus for a wide variety of reasons. First, this shall Union Budget shall witness the formal integration of the Railway Budget with the Union Budget. Second, this year’s Union Budget comes ahead of the formal induction of the GST, the biggest tax reform in India as a policy initiative to initiate economic federalism. Third, the Union Budget 2017 comes post the demonetization exercise that has been touted as an economic reform in pursuit of a cashless economy along with stated objectives of elimination of black money, counterfeit currency and income inequality in the country. While the house is still divided on the pains and gains of demonetization, without an iota of doubt it shall leave its imprint on the FM and the Union Budget 2017.
Separating the Grain from the Chaff in Policy Mix for India
There is wide spread acceptance of the ingraining of seeds of political ideology in the formulation, execution and analysis of macroeconomic policy mix. Despite brave attempts to confer economics the status of a social science, the fact remains that the laboratory of economists is the economy itself and men and women are but mere tools in this laboratory. Hence subjective reflections like constitutional economics and political economy find their way into policy mix. This is no exception for demonetization and the Union Budget 2017. As such it makes enormous good sense to prune and streamline opinions of warring economist on both side and filter out the substantive technical points from the political ideology questions.
Yet there is a consensus on the effect of demonetization on the Union Budget 2017 and the economy of India in the short run. The effect on the economy in the short run operates through two ways: digitization and the informal economy. What could have earlier taken years to complete a transition towards digital payments shall now happen in months. This is an opportunity for Indian IT companies to find big ticket projects on web and mobile apps for digital payments and also for cloud computing based projects like the much hyped GSTN that has been bagged by the prestigious IT bell weather Infosys. Yet the larger issue for the FM to resolve is the Union Budget 2017 is the effect of demonetization felt by the informal economy.
The Informal Economy in India and the Chase for Black Income
The informal economy in India, to quote Paul Samuelson has the “importance of being unimportant.” The informal economy contributes 45% of the GDP and 80% of the employment of the workforce in India. The old exposition of Okun’s Law associates GDP growth rate to employment growth rate. Based on this hypothesis one is tempted into presuming that 1% of GDP produced by the informal economy of India leads to 1.77% of jobs created for the workforce in India. The importance of the informal sector of the economy can hardly be overstated. This is also the sector that relies heavily on cash transactions and thus has been the hardest hit due to demonetization and hence requires some serious repair and maintenance work by the FM in the Union Budget 2017. The opportunity cost of cash in the informal economy is very high amounting to informal lending of credit at rates of 14-17% as estimated by the National Institute of Public Finance and Policy. Yet again agriculture the backbone of the Indian economy since ages is also an extension of the informal economy with gross reliance on cash and being largely free from the noose of the tax man for decades now. Perhaps the time has come to change this.
It is also true that the informal economy in India has always shied away from enrolling into the formal economy for motives of tax evasion, tax avoidance, failure to comply with the Factories Act, the Industrial Disputes Act and other labour legislation that has allowed the MSMEs in the informal economy to gain access to cheap labour-both skilled and unskilled. Tax evasion is rampant in the informal economy and has cost the ex chequer 19% of the tax revenue and 3% of the GDP. The “White Paper on Black Money” presented by the Ministry of Finance, Government of India in the year 2012 under the then FM Shri Pranab Mukherjee had pointed out to such data while conceding that the financial statement approach is the best one to assess black income. It had further stated the need to ensure better tax compliance in the informal economy to streamline tax incidence and tax payment to the ex chequer. Given that the informal economy and its induction into the mainstream of the economy can squeeze out precious increment of 3% to the real GDP, the FM is right in emphasising on cashless economy and demonetization.
What does this mean for Union Budget 2017? It means that the FM has to increase capital expenditure on infrastructure development, fixed asset creation and schemes like MGNREGA as a loss offset for demonetization. The total outlay on PMGSY in the last budget was INR97,000 crore. While this should have ideally been reduced, there are chances of the FM going benevolent on it and in the process finding it difficult to sneak into the fiscal deficit to GDP ratio of 3% by the year 2019. This shall also lead to a crowding out effect as a result of heightened government outlay and fiscal deficit along with the monetary tightening that is likely to be announced very soon by POTUS Donald Trump.