Saturday, February 28, 2015

Major highlights of India’s budget for FY2016

Indian Finance Minister Arun Jaitley presented the budget for 2015-16 (FY2016 starts 1 April 2015 and ends 30 March 2016) today to the parliament. It is the first full budget by PM Modi’s government following the landslide election victory last year. Indian PM Narendra Modi termed it a “pro-growth budget” and a “pro-poor budget”. Essentially, the budget has a medium-term narrative with a strong focus on sustainable fiscal finance and accelerated economic growth.

Here are the major highlights of the budget:

  • GDP growth target of between 8% and 8.5%.
  • Inflation target of below 6% (as per RBI’s strategy)
  • Revenue target (includes net tax revenue to center, non-tax revenue, recoveries of loans, and other receipts) of 8.7% of GDP
  • Expenditure target of 12.6% of GDP
    • Capital expenditure target of 3.4% of GDP
  • As a share of GDP, both revenue and expenditure targets appear lower than the provisional figure for FY2014
    • Capital expenditure allocation is nevertheless increased
  • Fiscal deficit target of 3.9% of GDP
    • Fiscal deficit target of 3.0% of GDP over three years
    • Additional fiscal space will go into funding infrastructure investment
  • Primary fiscal deficit (fiscal deficit minus interest payments) target of 0.7% of GDP

  • Revenue reforms:
    • Reduce corporate tax from 30% to 25% over the next four years
    • Rationalization of various tax exemption and incentives
    • Efforts to implement GST from next year
    • No change in rate of personal income tax
    • Basic custom duty for some imported goods increased
      • Metallurgical coke from 2.5% to 5%
      • Tariff rate on iron and steel and articles of iron and steel increased from 10% to 15%
      • Tariff rate on commercial vehicle increased from 10% to 40%
  • Divestment in loss-making units as well as some strategic divestment
  • Stress on cutting subsidy leakages, not subsidies themselves. Rationalization of subsidies on cards
  • NITI Ayog and States to work for the creation of a Unified National Agriculture Market
  • Micro Units Development Refinance Agency (MUDRA) Bank to be created for refinancing all micro-finance institutions that lend to small businesses through Pradhan Mantri Mudra Yojana
  • A sharp increase in outlays for roads and railways
    • National Investment and Infrastructure Fund (NIIF) to be established
    • Tax free infrastructure bonds for rail, road and irrigation projects
    • PPP mode of infrastructure development to be revisited & revitalized
    • 5 new ultra mega power projects, each of 4,000 MW
    • NITI Ayog to have units for innovation promotion platform and self-employment and talent utilization incubation
  • Public Debt Management Agency to be set up in FY2016 by bringing both external and internal borrowings under one roof
  • Sovereign Gold Bond as an alternative to purchasing metal gold scheme to be developed
    • Gold import duty remains at 10%
  • Main priorities: agriculture, education, health, MGNREGA, rural infrastructure including roads, manufacturing through Make in India program, catalyze private investment
  • To make India the manufacturing hub of the world through Make in India and Skill India programs

Five major challenges identified in the budget:

  • Agricultural income under stress
  • Increasing investment in infrastructure
  • Decline in manufacturing
  • Resource crunch in view of higher devolution in taxes to states
  • Maintaining fiscal discipline

Below is a snapshot of the performance of Indian economy sourced from Economic Survey 2014-15, Vol.2

Tuesday, February 24, 2015

Increasing public investment is critical to support aggregate demand and economic growth

Nobel laureate Michael Spence lays out the case for higher productivity-enhancing public investment when aggregate demand is weak, as negative demand shocks continue to emerge from: (i) excessive debt used into unproductive activities, or that they have not led to much productivity gains, leading to excess debt and falling asset prices; and (ii) demand suppressed by high unemployment in Europe along with the excessive regulation of non-tradable sector in Japan, both constraining economic activities.

Structural reforms are hard to implement in the short-term. Stabilization measures are usually the medicine for short-term demand deficiency.

The solution for now: jack up productivity-enhancing public investment.


That brings us to the third factor behind the global economy's anemic performance: underinvestment, particularly by the public sector. In the US, infrastructure investment remains suboptimal, and investment in the economy's knowledge and technology base is declining, partly because the pressure to remain ahead in these areas has waned since the Cold War ended. Europe, for its part, is constrained by excessive public debt and weak fiscal positions.

In the emerging world, India and Brazil are just two examples of economies where inadequate investment has kept growth below potential (though that may be changing in India). The notable exception is China, which has maintained high (and occasionally perhaps excessive) levels of public investment throughout the post-crisis period.

Properly targeted public investment can do much to boost economic performance, generating aggregate demand quickly, fueling productivity growth by improving human capital, encouraging technological innovation, and spurring private-sector investment by increasing returns. Though public investment cannot fix a large demand shortfall overnight, it can accelerate the recovery and establish more sustainable growth patterns.


And, monetary policy alone won’t be sufficient. Fiscal policy together with structural reforms are essential:


Though monetary stimulus is important to facilitate deleveraging, prevent financial-system dysfunction, and bolster investor confidence, it cannot place an economy on a sustainable growth path alone – a point that central bankers themselves have repeatedly emphasized. Structural reforms, together with increased investment, are also needed.

Given the extent to which insufficient demand is constraining growth, investment should come first. Faced with tight fiscal (and political) constraints, policymakers should abandon the flawed notion that investments with broad – and, to some extent, non-appropriable – public benefits must be financed entirely with public funds. Instead, they should establish intermediation channels for long-term financing.

At the same time, this approach means that policymakers must find ways to ensure that public investments provide returns for private investors. Fortunately, there are existing models, such as those applied to ports, roads, and rail systems, as well as the royalties system for intellectual property.


The way to do this would be: (i) G-20 nations increase public investment; and (ii) multilateral and regional development institutions mobilize private capital to fund public investment.


That is why the G-20 should work to encourage public investment within member countries, while international financial institutions, development banks, and national governments should seek to channel private capital toward public investment, with appropriate returns. With such an approach, the global economy's “new normal" could shift from its current mediocre trajectory to one of strong and sustainable growth.


A lesson for Nepal: Increase both the quantum and quality of capital spending first. It is just 3.3% of GDP right now. It need to be increased to at least 8% of GDP in the medium term and also GFCG has to be bumped up to around 30% of GDP. The other associated point is that such investment has to be productivity-enhancing.

Tuesday, February 3, 2015

Higher productivity growth holds the key to sustained economic and per capita income growth

A new study (PDF here) by the McKinsey Global Institute looks at the scenario where population growth slows down (as is happening right now in developed countries and some emerging economies) and working age population declines. The report finds that global growth will depend on how fast productivity rises in the scenario when number of employees peak and starts to decline. Higher growth in productivity will push an economy’s GDP potential in the long run as employment growth slows down.

Productivity has to grow by at least 3.3% annually (80% faster than its average rate over 1964-2014) to compensate for the slower employment growth. The study found that about three-quarters of the potential productivity growth will come from broader adoption of existing best practices (or catch-up improvements). The remaining one-quarter will come from technological, operational or business innovations that go beyond current best practices.

According the MGI, the ten key enablers of growth are as follows:

  1. Remove barriers to competition in service sectors
  2. Focus on public and regulated sector efficiency
  3. Invest in physical and digital infrastructure
  4. Foster R&D demand and investment
  5. Exploit date to identify transformational improvement opportunities
  6. Improve education and skill matching, and labor-market flexibility
  7. Open up economies to cross-border economic flows
  8. Boost labor-force participation among women, young people, and older people
  9. Harness the power of new actors through digital platforms and open data
  10. Craft regulatory environment, incentivizing productivity and innovation

Broadly, countries need to enable catch-up by creating transparency and competition; help to push the frontier by incentivizing innovation; mobilize labor to counter the waning of demographic tailwinds; and open up economies to cross-border economic flows, from trade in goods and services to flows of people.

In follow-up commentaries, Ricardo Hausmann argues that there has to an adequate supply of productivity-enhancing public goods (when markets don’t supply such goods), and its effectiveness may be rated by an independent ration agency. Justin Lin argues that China should be able to benefit from “latecomer advantage” by achieving technological advances through innovation, importation, integration and licensing (a lower-cost and lower-risk path to productivity improvement).

Saturday, January 31, 2015

Base year revision: Indian economy grew by 6.9% in FY2014 (2011-12 constant prices)

India recently revised its base year to better reflect structural changes in the economy since 2004-05, which was the earlier base year. Now, the new base year is 2011-12. Accordingly, FY2014 GDP growth has been revised upward to 6.9% against 4.7% estimate based on 2004-05 base year.

Here is an infographic sourced from Hindustan Times that illustrates the major changes:

Full details about the new series estimates of national income, consumption expenditure, savings and capital formation here.

While doing base year revision, three important changes are made: (i) shift in reference year to measure GDP growth, (ii) conceptual changes, and (iii) statistical changes (revision of methodology, adoption of latest classification systems and inclusion of new and recent data sources). Systems of National Accounts, 2008 has been followed. In current prices, there hasn’t been much change in GDP estimate, meaning that the standard GDP ratios (fiscal deficit, public debt, investment, etc.) are unlikely to change drastically.

The table summarizes the latest estimates based on the base year revision.

Monday, January 26, 2015

Why is global poverty so intractable?

World Bank Chief Economist Kaushik Basu explains:


[…] it remains largely out of sight for those who are not living it, safely somebody else’s problem. The fact that most participants in discussions about global poverty – the readers of this commentary included – know few, if any, people who live below the poverty line is an indication of the extent of the world’s economic segregation. If poverty were communicable, its incidence would be far lower by now.

[…]Another reason poverty endures is persistent – and, in many places, widening – inequality. The current level of global inequality is unconscionable. […]To be sure, there will always be a certain amount of inequality in the world; in fact, as with unemployment, a limited amount is desirable as a driver of competition and growth. But the deep and pervasive inequality that exists today can only be condemned. […] Extreme inequality is, ultimately, an assault on democracy.


On employment for all agenda for post-MDG framework (SDGs):


This is an impossible target. All economies of any reasonable size will have some unemployment. In fact, a limited amount of unemployment can help to promote development. To declare “employment” a right is to divest the word “right” of its meaning.


On macroeconomic impact of micro-interventions:


[…]a government policy in which subsidies, funded with newly printed money, are handed out to residents of 1,000 villages. This will not necessarily be a boon for the economy as a whole. Injecting money might improve the living standards in the villages receiving the funds, but doing so may well drive up the cost of food throughout the country, causing residents of non-subsidized villages to fall into poverty. The macroeconomic impact of micro-interventions is an important reason why poverty has persisted, despite well-meaning interventions to combat it.


Thursday, January 15, 2015

Very large electricity losses in Nepal (34% of total output)

Electricity losses in Nepal (transmission and distribution) are really large in Nepal (over 34% of total output in 2011). The chart below is extracted from the latest World Bank update on economic prospects.

Nepal faces a double whammy (low generation leading to large and growing gap between demand and supply, and large transmission and distribution losses further exacerbating the shortages) due to (i) low investment as well as low capacity to fully execute/utilize available budget productively, and (ii) shoddy construction and substandard appliances increasing inefficiency of the system, and low operations & maintenance budget and capacity. Fortunately, a large number of hydropower projects are ongoing and are expected to generate enough electricity to bring load-shedding to almost zero during wet season. The economy will likely continue to face electricity rationing during dry season in the absence of storage-type hydropower projects.

More on hydropower condition in Nepal here and on the potential demand for electricity in India here.

Below is a chart showing the top ten countries with the largest electricity losses. Nepal comes at number 4 in the world. Electricity losses are increasing (signals massive inefficiency)— 28% in 2005 and 34% in 2011.