ExplainSpeaking | From (interim) Budget to IMF’s World Economic Outlook to US Fed and RBI meetings: A preview

What lies ahead?

On January 30th, the International Monetary Fund will release the latest update of its World Economic Outlook. The IMF releases two WEOs each year — one in April and another in October — and two updates to these WEOs — one in January and one in July. Readers might recall that by the end of 2022, there was a near consensus that the world economy would suffer a global recession in 2023, thanks to the Russia-Ukraine war and the ensuing inflationary spike. But the January 2023 update of IMF’s WEO provided the first glimmer of hope that most economies might just dodge that bullet. This year’s update has no less riding on it. Many still believe that several of the biggest economies could yet suffer a recession — indeed Germany has just narrowly escaped a technical recession.

On January 31st, India’s Chief Economic Advisor will present the Economic Survey for the current financial year. Considering that the financial year is not yet over and that the CEA works under the Finance Ministry’s Department of Economic Affairs — the same department that formulates the Union Budget — the Economic Survey is often read to understand the government’s detailed reading of the state of the Indian economy.

Over January 30th and 31st, the Federal Open Market Committee (FOMC) of the United States Federal Reserve (popularly called the Fed) will also sit down to deliberate its policy stance. The Fed is the US central bank, responsible for monetary policy issues such as inflation and interest rates in the US.

However, the Fed’s decisions have global ramifications because the US dollar is as close to a global currency as any. Central banks of other countries hold US dollars just as they hold gold — as an asset. As a result, the interest rate decisions of the Fed affect all economies. Even a slight strengthening of the US dollar can create significant ripples for everyone — from other central banks (such as the RBI) to exporters to students (taking out foreign education loans) to investors.

January 31st will also see the latest update of the Union government’s financial accounts. This is hard data provided by the Controller General of Accounts (CGA), within the Ministry of Finance, and comes with a lag of a month. It tells us, for instance, the actual level of fiscal deficit (the proxy for the amount of money the Union government borrowed to meet the gap between what it earns and what it spends).

Then on February 1st is the big one — the presentation of the (interim) Union Budget for the coming financial year (2024-25). The full-fledged Budget for FY25, however, will most likely be presented in July when a new cabinet takes charge after the general elections in April-May.

A week later, on February 8th, India’s RBI, too, will share its latest monetary policy stance. The RBI monetary stance determines the home and car loan EMIs. But the RBI will have to calibrate its view based on both the Union Budget as well as global factors such as the US Fed’s commentary.

Together all these releases will provide a good understanding of not only where the economy is but also where the economy is headed in the coming months.

What does a Budget do?

Stripped to the bare essentials, a Union Budget is nothing but a statement of the government’s finances both in the current year and the forthcoming.

In particular, a Budget tells about two variables:

👉🏽 How much did the government earn (and from where) in the current year and,

👉🏽 How much did it spend (and on what)?

These are called the Revised Estimates (of FY24 in this case) and they are read in comparison to the Budget Estimates that were provided in February last year.

The Budget also projects what the government expects on both these counts in the forthcoming year. These become the Budget Estimates (of FY25 in this case).

The gap between these two variables — and typically in India, much like almost all developing economies, this gap is negative i.e. government’s spending is more than its income — provides what is possibly the most sought after detail of a Union Budget: The Fiscal Deficit. This deficit is typically expressed as a percentage of the GDP and it matters because too high a fiscal deficit results in two problems:

There is little investible money left for the private sector (everyone barring the government) to borrow. Less money relative to the borrowers, in turn, implies borrowing costs (read interest rates) will inch up. In other words, higher EMIs. If the government attempts to get around this problem by printing fresh currency notes, it would lead to inflation (a rise in the general price level). Either way, the common man, indeed the poorest among them, gets hit the hardest.

Each year’s fiscal deficit adds to the stock of overall government debt. If a government continues to spend on borrowed money, repaying the debt and associated annual interest payments will become a massive worry over time. Retiring old debt typically takes the shape of higher taxes, which, in turn, drag down economic activities be it consumption or production.

What to look for in this Budget?

Often, and almost always incorrectly, the Budget Estimates for the forthcoming year get more attention than the Revised Estimates of the current year. However, given the fact that this is an interim Budget, Revised Estimates of the current year will be even more important than the Budget Estimates for the next year.

There are two key reasons for this:

The data on the current year bookends the 10 years of governance under the leadership of Prime Minister Narendra Modi. The time frame also allows for as close a comparison as there can be between the BJP-led governments (2014 to 2024) and Congress-led ones (2004 to 2014) in terms of fiscal health and budgetary priorities.

The data for the coming year will likely see a revision by the time the full Budget is presented in July. For instance, in 2019, the last time a full Budget was presented mid-year, almost everyone outside the government knew that the Indian economy was unlikely to grow at more than 5% in 2019-20. That’s because the April to June quarter of 2019 saw India’s growth plummet to 5%. Even though the July Budget (the first one by Nirmala Sitharaman) did not reflect this sentiment — it projected a real GDP growth rate of 8% — the actual data (a GDP growth rate of less than 4%) underscored the need for revisions.

So, what about 2023-24?

The key macro question is, as explained earlier, about the fiscal deficit. Most outside analysts expect the government to achieve its Budget Estimate of 5.9% (of GDP) in the current financial year (2023-23).

The following three charts are borrowed from a recent research note by Pranjul Bhandari (Chief Economist, India and Indonesia, The Hongkong and Shanghai Banking Corporation) and her team.

Chart 1

Chart 1 shows the fiscal deficit data for both the Union government (the red bits on the bars) and the states (the grey parts). Most analysts expect the Union government to achieve the target for the current year while pegging the target to 5.3% for the next financial year.

Chart 2

Just for perspective, the prudential norms set by the Fiscal Responsibility and Budget Management (FRBM) Act, set a limit of 3% of GDP for fiscal deficit. Of course, the Covid pandemic forced governments across the world to spend more, but what this chart also tells us is that the Modi government has not once met the prudential norms of fiscal health.

Charts 2 and 3 show how the government has managed to beat last year’s Budget Estimates of income generation to achieve the fiscal deficit target.

“Gross tax revenue buoyancy is likely to come in at 1.6 in FY24 versus a budget estimate of 1.0 (see charts 2 and 3). The reason for this is a rapid rise in income tax (29% y-o-y), corporate tax (20%), and GST revenues (10%). On a net basis, tax revenues are 0.4% of GDP higher than budgeted,” states the HSBC note.

Chart 3

The tax buoyancy ratio shows how a government’s tax revenues respond to GDP growth. From the perspective of an individual taxpayer, the salience of a higher tax buoyancy ratio is that means the government can raise higher revenues without raising tax rates.

What about 2024-25?

From the macroeconomic perspective, there are four main, albeit interconnected, concerns of the Indian economy.

1. How to boost the consumption levels of an average Indian?

It may not appear so but the fact is that the aggregate of all the money spent by all the Indians in their personal capacity accounts for almost 60% of India’s annual GDP. Data shows that a large portion of India’s population continues to hold back spending, and this, in turn, drags down economic growth.

2. How to incentivise investments by private sector firms?

Tepid growth in people’s consumption levels typically means that the private sector refrains from spending in creating fresh capacities. To be sure, such investment-related spending accounts for over 30% of India’s GDP. For the time being, the government has been investing to boost both this component as well as the first one. But there are limits to how long the government can keep doing it by borrowing money.

3. How to reduce fiscal deficits?

As explained earlier, there is a reason why economists advise governments to live within their means. Sustained periods of fiscal profligacy can often be akin to a cure that is worse than the disease.

4. How to contain inflation?

For the most part, the responsibility of containing inflation lies with the RBI, which is the monetary policy authority. A central bank contains inflation by raising interest rates and reducing demand for goods and services. But as the events of the past five years have shown, inflation can often go up because of supply mismatches. The reasons can vary from unseasonal rains to geopolitical tussles between countries far far away. The fact remains: RBI (and, for that matter, any central bank) doesn’t have any answers for such “cost-push” inflation. Often, it is incumbent on the governments — either by reducing taxes or through better management of existing supply — to contain inflation caused by such supply disruptions.

What do you expect from the forthcoming Budget? Share your views and queries at udit.misra@expressindia.com

Until next time,

Udit