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Can the August announcements bring back animal spirits?
By www.moneycontrol.com, 26 Aug. 2019

The government has finally responded to the clarion call to shore up consumer demand and investments. It’s a long way to go through.

 

The set of announcements by Union Finance Minister Nirmala Sitharaman is meant to provide a much-needed stimulus to boost animal spirits in an economy which is going through a soft patch. We analyse the top announcements, and how these are likely to affect growth.

 

Rolling back of surcharge on FPIs and higher tax income groups: The surcharge on the income tax outgo affecting domestic as well as foreign portfolio investment had led to FPIs (foreign portfolio investors) pulling out Rs 23,000 crore from domestic equities as such investments became unattractive. The Budget announcement of surcharge on higher tax income groups reportedly affected 40 per cent of FPIs.

 

The rollback is likely to restore foreign investment as the chief source of capital flows on the financial account of India’s balance of payments. While such FPIs in the past have been a chief source of funding high current account deficit, the government will need to look at boosting foreign direct investment as a means of sustainable financing of the deficit.

 

Relief for startups: The FM has also announced the withdrawal of angel tax on startups. The tax was paid by the startups on the funding received from investors. This will boost confidence in the startup ecosystem. However, much more needs to be done on the startup front, especially with regard to funding. The government needs to bring about greater transparency in funding as part of its Startup India campaign. More importantly, such entities have to be encouraged to grow out of this cocoon, create large corporations and provide employment, besides creating wealth for the entrepreneurs.

 

Boost to the auto sectorThe ban on the purchase of new vehicles by government departments has been revoked so that their old vehicles can be replaced with new ones. Similarly, business establishments can claim additional depreciation of 15 percent on their purchases of vehicles till March 2020.

 

These measures will provide some breathing space for the auto sector, which has witnessed one of its worst runs in the past 20 years. It will also boost the auto ancillary industries. While this would provide a fiscal stimulus by way of lowering tax and higher spending, the government’s fiscal deficit will increase, which will need to be budgeted for.

 

One of the reasons why the auto sector has been facing a decline is the restrictions on credit by both banks and NBFCs to only those with high ratings. This has affected auto sales, especially in tier 2 and 3 cities, with auto dealers and customers not seeing the advantage of the policy rate cuts by the Reserve Bank of India. Another problem faced by the auto sector was the pile-up in the inventory of the BS4-compliant cars in the face of India moving on to the BS-6 emission norms from April 2020. Despite discounts offered on BS-4 inventories by automakers, people have preferred to wait and watch for further discounts.

 

The current announcements seek to make banks offer auto loans based on the falling repo rates, rather than the earlier higher marginal cost of funds based lending rates (MCLR). Such lower auto loans are expected to boost sales. However, lower auto sales are as much about crowded Indian roads, lack of parking space and the increased cost of maintenance of an owned vehicle as higher borrowing costs. As ride-share apps become more prevalent, such structural issues will bite far more than simply the cost of borrowing.

 

Measures to boost MSMEs: The measures announced include a provision to ensure that all pending GST refunds due to micro, small and medium enterprises (MSMEs) are paid within 30 days while that of new applications should be done within 60 days. With a view to streamlining procedures, the Goods and Services Tax Network (GSTN) is to be used for all bill discounting on the TReDS (Trade Receivable Discounting System) platform for MSMEs.

 

While the move is important and will significantly improve the immediate working capital needs of MSMEs, this does not address the chief concern of the policy environment which incentivises firms to remain micro and small. As an academic deeply associated with family businesses -- essentially from the small and medium sector -- I can say what will work is providing positive nudges to these firms to consolidate, as also withdrawing some of the tax exemptions and subsidies which prompt them to open numerous firms and register them under the SME sector.

 

In sum, the announcements will do much to boost the sagging confidence in an economy, which despite the government’s hubristic stance, is in desperate need of a strong stimulus. However, these measures are not enough to kickstart the economy on to higher levels of growth. A set of deep structural reforms, based on an assessment of what really ails the economy, will be called for.