Budget 2015 heralds dawn of fiscal federalism: Tushar Poddar, Goldman Sachs

By Tushar Poddar, Chief India Economist, Goldman Sachs

The FY16 Budget must be seen in the context of the very large decentralisation programme following the Finance Commission's recommendations. As such, the finance minister increased the revenue share of states by 1 percentage point of GDP, to 36% of total revenues. Thus, despite budgeting for tax revenue growth of 16%, and a total spending increase of only 6%, the fiscal deficit shrinks by only 0.2 percentage point of GDP. If the share of states were to be smaller, then the Central fiscal deficit would have been correspondingly lower. So, the 3.9% fiscal deficit target should be seen in that light.

On the composition of spending, there can be little argument with the finance minister. He has increased capital spending, primarily on railways and highways, and cut subsidies. The better targeting of subsidies through the Jan Dhan-Aadhaar-mobile phone trinity is also laudable. So is increasing the share of spending on the social sector, health, education and social security, which need much more funding.

Remarkably, the impact on growth despite some fiscal consolidation is still positive, especially if we take out the large disinvestment proceeds which are financing items. The positive impact on growth could be even higher due to the shift in spending from subsidies to capex, and if the states were to spend some of their increased revenue share on boosting investment demand. With the share of states increasing so rapidly, there is a need to move away from focusing on the Central government's balances to a measure of both the state and Central government balances, that is, the 'general government' deficit. By all measures, however, India's general government deficit is still one of the highest in Asia (around 6% of GDP).

Thus, reaching even a Central deficit of 3% will not be enough. India needs to move to a general government deficit of 3%, which is close to the Asian average, and so the process of fiscal consolidation needs to continue. If one were to take the disinvestment proceeds as a financing item, then the required consolidation path becomes steeper.

The Budget was presented in an extremely benign global environment for India. Going forward, however, less fiscal space could be available if commodity prices rise, and with wage increases for government employees expected due to the Pay Commission recommendations. India is in a sweet spot currently, but what happens when that window closes?

On structural reforms, there was some progress including on a new bankruptcy law, bringing the new financial code to Parliament, agreement on a new monetary policy framework, and the constitution of bank boards to select bank chairmen.