Experts were passionately divided over whether the government must spend its way out of the slowdown, cutting itself some slack in meeting fiscal deficit targets, or stay austere and not take its eyes off structural (supply-side) reforms.
The government has chosen middle ground—which we believe was the pragmatic thing to do.
Given the limited fiscal room, the budget has continued to script the reforms narrative, increased budgetary support to capital expenditure while reducing reliance on extra-budgetary spending through public sector undertakings.
Fewer tax exemptions will reduce enforcement costs for the taxman and ease compliance for the taxpayer. Also, steps to ease friction in the financial sector and focus on infrastructure as well as agricultural markets will require continuous attention, and will bear fruit in coming years if pursued relentlessly.
With that broad understanding, let’s size up the budget under two sub-heads:
The budgetary assumptions and fiscal arithmetic
As widely expected, the final fiscal deficit print has veered off the path laid out by the Fiscal Responsibility and Budget Management Act. At 3.8% of gross domestic product (GDP) compared with the budget estimate of 3.3% for 2019-20, it leaves little room for big spends.
To address this, the government has tried to create fiscal room for 2020-21 in two ways: by relaxing the deficit target from the committed rolling target mentioned in the last budget, and by looking to mobilise revenue aggressively through asset sales and privatisation.
Some relaxation in the target to nudge up growth was inevitable, and more realistic.
The deviation is intended to be transient and pushes ahead the aspirational target of fiscal deficit at 3% of GDP beyond fiscal 2023, for which the rolling target is now set at 3.1% of GDP. Given that this target has been achieved only once in the last three decades, why not substitute it with a more realistic one? Switching to a realistic target is important from the fiscal credibility point of view.
Further, the budget sets the fiscal deficit target for the next fiscal year at 3.5% as against 3.0% set in the three-year rolling goal set in the last budget. So, fiscal consolidation has been pushed ahead to make way for increased spending.
But can the budget meet this year’s deficit target without cutting expenditure? In the last two budgets, revenue collections were way short of target. Tax collections (fiscal year 2020 revised estimates) fell 3% short of the budget target and the fiscal slippage was minimised by cutting expenditure mainly on the revenue account, considering capital expenditure is set to exceed the budget target.
That said, the nominal GDP growth assumption of 10% for fiscal year 2021 appears achievable as the economy is expected to mildly recover and inflation, too, is likely to stay above the 4% mark.
But the tax revenue growth of 12% implies tax buoyancy of 1.2 versus 0.5 achieved this fiscal year. So achieving the target itself will require extra tax effort as this is above the last 10 years’ average of 1.
The tough ask is the ambitious divestment target of ₹2.1 trillion, which could slip unless the government frontloads its efforts. In 2019-20 too, the government is set to miss its divestment target by 38%, despite reasonably healthy market conditions. If that repeats, it could add another 0.35 percentage points to the budget deficit in fiscal year 2021.
Food subsidy is understated as it is now increasingly being met through extra-budgetary resources.
Post-budget growth outlook
From our perch, achieving over 6% growth in fiscal year 2021 appears to be a tall order. But if there is one lesson learnt in the last decade, it is that policymakers and market participants find it hard to anticipate the timing and speed of a turnaround. Growth forecasts are heavily influenced by the macroeconomic environment prevailing at the time they are made.
With that caveat, we still expect GDP growth at 6% assuming normal monsoons and Brent crude oil at $60-65 per barrel. Monetary policy would provide some support to growth, mainly through improved transmission.
The budget has maintained focus on schemes with higher propensity to whet consumption, such as PM-Kisan and the Mahatma Gandhi National Rural Employment Guarantee Scheme. Rural road construction gets a significant 39% boost in planned spending. This will support household consumption demand in rural areas, which are benefitting from improving terms of trade and rise in food inflation. Capital spending continues to get more attention, and rightly so.
On the inflation front, we expect the consumer price index (CPI)-based inflation rate to end this fiscal year at over 4.5%. CPI inflation breached the Reserve Bank of India’s upper limit of 6% and touched 7.4% on-year in December 2019 largely due to volatile components such as food, while core inflation remained subdued at 3.8%. However, the impact of transitory factors (like vegetable prices) should correct and we expect consumer inflation to average 4% in fiscal 2021. The budget is non-inflationary, as it does not have the spending muscle to push India’s growth above the economy’s potential in the near-term.
In all, the recovery in fiscal year 2021 will benefit from a weak base effect, but at best, it will be a grind up. The limited ability of fiscal and monetary policies to juice up the economy, slow resolution of stress as well as risk aversion in the financial sector, and a slowing and inward looking global economy are, after all, a lot to contend with at one go.
Dharmakirti Joshi is Chief Economist, CRISIL