Contractionary macroeconomics of Budget will not boost growth
Summary
Supply-side actions work with a time lag and can’t kick-start growth in a demand-constrained economy like India’s today
On 1 February, finance minister Nirmala Sitharaman presented her fifth successive budget, the last full budget in the second term of Prime Minister Narendra Modi. Over this period, the nature of the Union Budget has changed. It remains a statement of estimated receipts and payments presented to Parliament as stipulated in Article 112 of the Constitution. However, it is no longer seen as an instrument for the short-term macro-management of the economy. Instead, it has become a political statement of the government’s longer-term economic objectives. Yet, it does have macroeconomic implications and consequences.
There is a plethora of plaudits for this budget in the media. Economic orthodoxy is relieved that, despite elections on the horizon, fiscal profligacy and political populism are altogether absent. But a different perspective suggests that both of these could also be a cause for concern.
As a percentage of GDP, the gross fiscal deficit is projected to drop from 6.4% in 2022-23 (revised estimate or RE) to 5.9% in 2023-24 (budget estimate or BE), while the revenue deficit is projected to drop from 4.1% to 2.9%, so that the proportion of government borrowing used to finance consumption expenditure will drop from two-thirds to one-half. These levels should worry fiscal conservatives.
My concern is about the nature of fiscal adjustment. Between 2022-23 (RE) and 2023-24 (BE), the increase in total government expenditure is from ₹41.9 trillion to ₹45 trillion (7.5%), that in revenue expenditure is from ₹34.6 trillion to ₹35 trillion (1.2%), and that in capital expenditure is from ₹7.28 trillion to ₹10 trillion (37%). In comparison, nominal GDP is expected to increase by 10.5%. The increase in capital expenditure, particularly on infrastructure, is both necessary and desirable, but it is no substitute for private investment and consumption expenditure, given the reality that public investment is only one-fourth of total investment at 30% of GDP, while private final consumer expenditure is as much as 60% of GDP. Such budget allocations are bound to have a contractionary effect on aggregate demand in the economy.
The problem might be accentuated for three reasons. First, export demand is bound to be sluggish, as the world economy slows down in response to supply-side disruptions caused by the covid pandemic and Ukraine war, and by sharp hikes in interest rates by central banks everywhere to combat inflation. Second, private investment in India is driven more by the household sector than by the corporate sector, where investment has been less than buoyant despite booming profits and could now be crowded out by higher interest rates and government market borrowings to finance its deficit. Third, domestic consumption demand has been constrained by a slowdown in economic growth that started before the pandemic, and by a squeeze on incomes in rural India, as well as poor households in urban India, in recent years.
The proposition that India will be the fastest growing economy in the world this year, and the next, provides illusory comfort. The reality of the recent past is worrisome. During 2014-15 to 2018-19, Modi’s first term as PM, growth in GDP at constant 2011-12 prices was 7.5% per annum. This growth rate dropped sharply to 3.7% in 2019-20 and -6.6% in 2020-21, but rose from its low base to 8.7% in 2021-22. Yet, between 2018-19 and 2021-22, at constant 2011-12 prices, GDP increased by a mere 1.5% (at 0.5% per annum), while GDP per capita increased at about the same pace. Even if it remained unsaid, the government must be conscious of this sharp slowdown, and hopes that its big step-up in capital expenditure— ₹2.4 trillion on railways and ₹1.62 trillion on roads—would revive economic growth. This expectation will be belied because the utilization of capital-expenditure allocations on infrastructure moves at a slow pace and eases supply constraints with a time lag, so that it can stimulate growth over the medium-term. In the short-term, only consumption demand can drive growth. Alas, the budget might end up dampening that.
Income per capita is a statistical average that doesn’t measure the well-being of the poor. Given the reality that the post-pandemic recovery has been K-shaped, and that income inequality in India is now among the highest in the world, juxtaposed with rising unemployment and high inflation, it likely that in 2021-22 the poor were probably worse off than in 2018-19. The distress is greater in rural India as wages and farmer incomes have stagnated or declined in recent years. In this context, Budget allocations are a cause for concern. The MNREGA outlay has dropped from ₹1.1 trillion in 2020-21 to ₹0.98 trillion in 2021-22, ₹0.89 trillion in 2022-23 and ₹0.6 trillion for 2023-24 when, on average, its wages are two-thirds of market wages. For 2023-24, outlays for agriculture, rural development and PM Kisan stayed almost unchanged. Larger outlays in these would’ve supported essential consumption in rural India. This would not have been populism, but an economic necessity for the poor and thus a political compulsion for the government. The consumption demand so created could have stimulated growth.
The moral of the story is simple. Supply-side actions work with a time lag and can’t kick-start growth in a demand-constrained economy. If the Union Budget sought to revive growth, it might be an elusive quest.
Deepak Nayyar is emeritus professor of economics, Jawaharlal Nehru University
