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The first budget presented after the covid pandemic by finance minister Nirmala Sitharaman is best seen as the third stage of the strategy followed by the Narendra Modi government to support the Indian economy.

The first stage tried to protect the supply-side of the economy through income support, food aid and a loan moratorium. The idea was that the productive capabilities of the economy should not be permanently damaged. The second stage saw a modest increase in government spending, as the economy began recovering from the depths of the first half of 2020-21, though there is still pain in unorganized enterprises as well as parts of the labour market. Most of the fiscal expansion in FY 2021 came from a fall in tax revenues, rather than an increase in government spending, or automatic stabilizers rather than a strong fiscal impulse.

The third stage of the economic strategy has now been unveiled—a fiscal stimulus to ensure that the supply shock is not replaced by a demand shock. It is worth noting that the government expects to collect fewer taxes in fiscal year 2021-22 than it did before the pandemic hit. This is no surprise, considering the size of the Indian economy in April 2022 will broadly be similar to what it was before the lockdown. Extra spending will thus be supported by borrowing rather than taxes. The fiscal deficit will be higher by around 7 trillion compared to the budget estimates presented last year. This is a risk worth taking, given the current economic situation.

The increase in public spending has rightly been focused on infrastructure as well as public health. The finance minister has budgeted an extra 1.15 trillion for capital spending. And another 35,000 crore for the vaccination programme that is being rolled out across the country. There is another reason why the government has done well to focus on new projects rather than recurring revenue spending. The sharp rise in tax revenues over the revised estimates for 2020-21 is likely to be a temporary bonanza in a recovering economy, and the money is best spent on items that do not involve recurrent spending.

This is also evident in the structure of the spending budget. The finance minister had to sharply increase spending on select welfare programmes during the worst months of the pandemic. Spending on the rural jobs scheme, the national social assistance programme, the housing scheme and fertilizer subsidies have now been normalized. Many of them are back to pre-pandemic levels, and thus below the revised estimates for 2020-21. The status quo on defence spending is surprising, especially given the threat of continued Chinese aggression at the border. The decision to cut spending on the PM-Kisan income support scheme comes at a time when farmers from a few northern states have taken to the streets.

The budgeting assumptions seem to be conservative. The budget papers show that nominal GDP will grow by 14.4% in FY 2022, which is a full percentage point lower than the figure given in the Economic Survey, for reasons not clear at the time of writing this column. The tax revenue numbers are not based on bloated assumptions about tax buoyancy.

A possible buffer is the modest drawdown of surplus cash balances of the government with the central bank. The budgeted drawdown of 71,383 crore is only a fourth of the estimated 3 trillion of excess cash that the government holds with its banker. Another plus, especially in terms of transparency, is the decision to prepay around 1.5 trillion of food subsidy-related loans of Food Corp. of India, which were borrowed outside the budget from various small savings schemes. The food subsidy will now be funded through the budget.

There are a few worries as well. The budgeted fiscal deficit for next year, and hence the Centre’s market borrowing programme, are higher than consensus estimates. This has unsettled India’s bond market at a time when the Reserve Bank of India has begun sucking liquidity out because of financial stability concerns. The bond market’s reaction has thus been very different from that of the stock market. The coordination between fiscal and monetary policies is likely to be unusually important in the coming months, though the recent decline in inflation could provide some breathing space.

The finance minister has also announced a slew of policy changes—from privatizations to a new development finance institution, and from the rationalization of centrally-sponsored schemes to setting up a ‘bad bank’ to deal with toxic loans sitting on the books of commercial banks. These are welcome moves. One positive surprise is that there has been no large push to increase import tariffs. It remains to be seen whether this is a temporary breather or a more meaningful relook at protectionism. The latter would be welcome. However, the finance minister has not been able to resist the usual temptation to tinker with tax rates here and there, and impose a new cess that will not be shared with the states. Some habits die hard.

Finance minister Sitharaman has pulled off a good budget in an extremely tough situation. Her numbers seem conservative. There are welcome policy changes. Much now depends on two factors. First, the ability of the government to actually deliver on the big capital spending push that has been announced. Second, the ability to credibly stick to the fiscal stabilization path that has been laid out for the next few years.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics

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