For most of the last nine months, the central government has been near universally criticised for exercising excessive caution in fiscal spending. Several reasons were cited: A fear of rating agencies, the risk of putting pressure on the currency, and an apprehension that the impact of fiscal spending on growth would be low while activity restrictions were in place. By committing to higher headline fiscal deficit targets and a much more gradual path to fiscal consolidation than had been expected, and announcing several multi-year spending programmes, the government has clearly signalled that it was the last of the above reasons that held it back.
Headline deficit numbers are high also due to another remarkable and commendable change: More transparency. The Centre got rid of the “off-budget” items, including them all in the budget. For example, a meaningful part of the food subsidy incurred by the Food Corporation of India used to be outside the reported deficit till last year, when it was disclosed as an off-budget deficit. This year, even that complexity has been done away with. This was an opportune year to do so, as financial markets globally are primed for governments reporting large fiscal deficits.
While assessing the logic behind some of the assumptions made in the budget to arrive at revenue and expenditure projections, it is important to keep in mind the heightened forecast uncertainty. For example, in its recent forecast revision, the IMF revised India’s real FY22 GDP by nearly 5 per cent: It was earlier projecting FY22 to be 2.4 per cent below FY20, but now forecasts a 2.6 per cent increase. The government appears to have used a real GDP level 2 per cent higher than FY20, an extremely conservative number, in our view. It is possible, if not likely, that as growth continues to pick up, real FY22 output could be 5 per cent or 6 per cent higher than FY20. If so, nominal growth, which is real growth plus inflation, could be 13 per cent or 14 per cent higher.
The government’s tax revenue assumptions suffer from this conservatism. Surprisingly, in the revised estimates for FY21, the implied tax collection growth in the last three months is lower than the growth seen in the first nine months. This is when, after a bleak first half of the fiscal year, the last few months have seen a surge in tax collection, as seen most recently with the January GST numbers. The annualised growth in taxes in FY22 over FY20 is a bleak 5 per cent. For observers used to tax projections in prior budgets which were generally too optimistic, this is perplexing. A similar excess of caution is visible in the budgeting of non-tax revenue receipts, like the somewhat anaemic assumptions on proceeds from spectrum sales.
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Revised estimates for expenditure in FY21 are Rs 4 trillion, nearly 2 per cent of the GDP higher than initially budgeted, and an expenditure-to-GDP ratio that is the highest in 30 years. At a glance, this seems achievable: The food subsidy bill is Rs 3 trillion higher than initially budgeted, and rural development (which includes MGNREGA where the allocation was raised significantly during the year), fertiliser (subsidy arrears are to be cleared) and roads account for most of the rest of the increase. However, given the total spending in the first nine months, it implies in the remaining three months, expenditure should be more than double the spending of the fourth quarter last year. This seems to be a tough ask, even if some of this spending may be big-ticket items like clearing fertiliser subsidy arrears. Even then, it signals the government’s commitment to supporting aggregate demand through fiscal means.
The total expenditure budgeted for FY22 is expected to be unchanged from the revised levels for FY21, with the large pandemic-triggered allocations replaced by greater allocations to water and sanitation and healthcare (mainly vaccination). It is difficult for the government to quickly increase productive expenditure by large sums. In a normal year, nearly nine-tenths of the total spending is non-discretionary — interest payments, salaries and pensions, defence, transfers to states, and subsidies (which have their own rhythm). While it is somewhat easy to increase direct transfers, like the government made early in the pandemic-driven lockdowns — like free grains and direct cash transfers — scaling up capabilities in productive areas, say for new healthcare capacity, universal access to drinking water, or new dedicated freight corridors, takes time.
In some ways, what the government did not do is as important while assessing its focus on the quality of expenditure: Despite being acutely aware of the plight of the urban poor, given the lack of efficient channels to provide direct help, the government is relying on boosting economic growth, which can then create opportunities for them. Similarly, it resisted the temptation to levy a “COVID tax”, perhaps aware that such levies do not yield much income, and instead hurt investment and consumption sentiment.
The creation of the new Development Finance Institution (DFI) and the plan to privatise two public sector banks as well as a government-owned insurance company also indicate that it is conscious of the shortage of capacity in the financial system and is now willing to act on it. The confirmation of the disinvestment strategy should help reaffirm the political commitment shown several years ago, when the government sold its stake in several large firms.
By projecting a fiscal deficit ratio of 4.5 per cent of the GDP for FY26 to anchor the financial markets, the government has bought itself time to ramp up schemes that boost medium-term growth. Prudently, allowing state governments to have higher deficits for the next two years, particularly for capital expenditure, the Centre has also recognised their role in supporting aggregate demand.
The 2022 budget reaffirms the growth focus of the government that had first been revealed with the launch of the Production-Linked Incentive (PLI) schemes. These schemes signalled a turn in India’s industrial policy. Not only is the government’s willingness to give monetary incentives to firms for meeting production targets unprecedented, so also is the plan to focus on a few large firms, instead of the usual government preference for distributing benefits equally, and without any performance targets. Inefficiencies are likely to creep into these schemes over time, as they generally do, but for now, they promise a significant boost to investment sentiments.
Aware of its own limitations in boosting aggregate demand, the government is carefully supporting industrial as well as consumer sentiment to take the economy back to the pre-pandemic path.
This article first appeared in the print edition on February 2, 2021 under the title ‘Relying on growth’. The writer is co-head of APAC Strategy and India Strategist for Credit Suisse
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