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Five questions: The Budget big picture

Finance Minister Nirmala Sitharaman has bet on significantly ramping up capital expenditure to start a virtuous cycle of growth. The strategy has obvious benefits in normal times — but India’s economy is still Covid-scarred, demand is weak, and capital assets have a long gestation period

Written by Udit Misra | New Delhi |
Updated: February 2, 2022 3:10:52 pm
Budget, budget 2022, budget 2022 update, budget 2022 summaryThe standout feature of Budget 2022-23 is that the government has chosen to significantly ramp up capital expenditure while largely restricting revenue expenditure. (Illustration: Suvajit Dey)

As Finance Minister Nirmala Sitharaman rose to present the Union Budget for 2022-23 on Tuesday, she was faced with several competing demands. On the one hand, the government’s fiscal deficit (or total borrowings from the market) was a concern. On the other, there were demands for continued support to the weaker sections of the economy.

If she spent more to provide direct financial support to various sections of society, the fiscal deficit, which was already more than twice the prudential norms, would worsen. If she tried to sharply curtail expenditure, it might hurt vast sections of the economy that are already struggling in the wake of Covid-induced disruptions.

In the end, she chose a strategy that substantially ramps up capital expenditure or capex (that is, expenditure towards making new productive assets) while largely holding back revenue expenditure (that is, expenditure to meet day-to-day expenses).

While prioritising expenditure for building capital assets is a macro-economically sound strategy in normal times, it remains to be seen whether this will work for India as it comes out of the Covid-induced setback with significant scars.

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What were the challenges facing the economy?

India’s GDP growth rate had been decelerating since 2017-18 with unemployment touching a four-decade high. Data released on January 31 showed GDP growth in 2019-20 was just 3.7%. It was at that point that the Covid-19 pandemic hit.


Between a sharp contraction and an equally sharp recovery, the next two financial years (FY21 and FY22) essentially amounted to the loss of two full years of incomes and jobs. Also, the recovery in aggregate GDP hides the pain in large sections of the economy. Most surveys and data point to a K-shaped recovery, which has meant that economically weaker sections still have significant scars.

Engines of growth (In Rs crore)

As the second chart above shows, while overall GDP has recovered, the most important component of GDP — private final consumption expenditure (PFCE), or the money that people spend in their individual capacity — which accounts for 56% of all GDP, is below the pre-Covid pandemic level.

The picture appears worse when one looks at per capita levels of GDP and PFCE (chart 3). The average PFCE (or expenditure) is below 2018 levels. Also, these are still arithmetic mean figures. They suggest that a large section of the population is below even this average level. People are spending less because employment levels have seen a secular decline since 2016 (chart 4); Covid only made matters worse.

Charts 3, 4, 5

Weak PFCE meant that the other big engine of GDP growth — investments or Gross Fixed Capital Formation — would remain weak. That is because weak demand has led to low capacity utilisations (chart 5) and that takes away any incentive from private businesses to invest in new capacities, create new jobs and income streams for people.

The only other engine was the money government spends. But too much spending here was ruled out because the fiscal deficit was already twice the prudential norms.

The question before the Finance Minister was: What would be the trigger for growth in the coming year?

So what was the Budget’s strategy she chose?

The standout feature of Budget 2022-23 is that the government has chosen to significantly ramp up capital expenditure while largely restricting revenue expenditure. This capex push will get reflected in the “investments” component of the GDP. The chief advantage of capital expenditure is that it gives much higher returns to the overall GDP.

According to different studies, one rupee spent towards capital expenditure can give returns between Rs 2.5 and Rs 4.8 (over periods ranging from 1-7 years), while money spent on the revenue account, such as giving direct cash transfers to the poor, tend to give returns between Rs 0.54-Rs 0.98 (that is, less than a rupee).

Capital expenditure provides better returns not just by creating new jobs but also by creating new productive assets that boost future productivity.

Here’s how the government hopes this capex push will play out and lead India’s economic recovery: New roads, ports etc., will not only create new jobs but will also reinvigorate several other industries through forward and backward linkages. For instance, apart from new labourers, a new bridge will need cement, iron and steel, etc. It will increase the demand for engineers and other technical and managerial professionals.

When done on a large scale, such expenditure will leave people with more income and that, in turn, will boost the aggregate demand — the PFCE component. That fresh demand will further incentivise the private sector to boost investments of their own and, in fact, take the lead on future investments.

Thus, according to the Budget’s strategy, a capex push by the government can dig India out of the current slump and create a virtuous cycle of growth. In time, as tax revenues from new economic activity increase and as private sector investments become self-sustaining, the government will retreat from its leading role in investments, thus bringing down its borrowing requirements.

How is this strategy different from what has been done by countries such as the US?

Countries such as the US unleashed a massive fiscal response to the Covid crisis. That involved a lot of money flowing out of government coffers to people’s accounts. In India, most of the help was either in the form of free foodgrain, the rural employment guarantee scheme, and credit guarantees (not actual money flowing to small and distressed firms; just guarantees on the loans they may take). As such, there is no comparison between the direct financial help that developed countries provided (even in percentage terms), and what India provided.

It is for this reason that most estimates suggest a sharp increase in poverty and inequality in India post-Covid. In contrast, the US was among the countries that have seen a genuine ‘V-shaped’ recovery, getting back to the pre-pandemic growth path, not just the level.

But countries such as the US too have ended up facing a problem: inflation. When lots of money flowed into people’s hands, the aggregate demand recovered far too quickly even as supply disruptions persisted, thus creating historic levels of inflation.

It is another matter that even with depressed demand, India too has seen fairly high inflation over the last two years.

Similar to the capex push in India, in the US, President Joe Biden has been pushing for an ambitious $1.9 trillion plan called Build Back Better, aimed at growing the US economy “from the bottom up and the middle out”.

Will the capex push in the Budget succeed?

Few would argue against the merits of higher capital expenditure by the government because of the obvious benefits, especially at a time when all other engines of growth are struggling. Moreover, there are several points that suggest such an investment cycle will sustain.

In a recent research note analysts at Nomura observed: “At face value, a number of preconditions appear to be in place. The government has announced various reforms, including the national infrastructure pipeline (NIP), the production linked incentive scheme, lower corporate taxes and privatisation. Corporates have deleveraged their balance sheet during the pandemic. The corporate debt-equity ratio has fallen broadly across industries from 0.79 in FY19 and 0.82 in FY20 to 0.63 in FY21.”

Add to that the creation of a bad bank, which will enable the banking system to be ready to give loans when the private sector demands them.

But there are reasons why this may not succeed. That’s because these are not normal times. There are deep scars in the economy, especially in the informal sector (which accounts for 90% of all jobs), and aggregate demand is still quite weak. Capacity utilisation levels are far below the point where companies may contemplate ramping up investments.

Economists such as Ravi Srivastava of the Institute for Human Development and Radhicka Kapoor of ICRIER believe that success of this strategy would depend on the way these projects are implemented. Both economists pointed out that such capital assets have long gestation periods, and the expected benefits to the common people may take time to accrue.

To the extent that these projects are of a local nature — rural roads instead of a big highway — they may be more effective in providing relief to the weaker sections of the economy. “Given the extent of pain in the economy, this Budget needed to stand on two legs. Capex is fine but the government also needed to provide more direct relief here and now,” Srivastava said.

This was the ninth Budget under PM Narendra Modi. Is there a pattern emerging?

Over the past eight years, the Modi government has employed very different economic strategies, without suggesting a settled ideological anchor. Before 2017, he berated farm loan waivers, but just before the UP elections took the lead in promising them. Similar U-turns were seen with regard to programmes such as MGNREGA, doing away with the land acquisition Act, or the recent repealing of the farm laws. In the run-up to the 2019 elections, direct cash transfers were made to farmers under PM-KISAN — politics of dole of the kind he had long criticised.

Likewise, in last year’s Budget, privatisation and disinvestment were the biggest themes — but this year they are completely missing.

And, if the Prime Minister believed in a government investment-led growth strategy, it is not clear why this was not done in 2019-20 itself instead of giving a Rs 1.5 lakh crore worth corporate tax cut to firms, who simply pocketed the money — either to pay off their debts or improve their bottom lines.

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First published on: 02-02-2022 at 04:00:50 am
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