What the Union budget got right, and what it missed

The economy has clearly rebounded from the shock of the pandemic in 2020-21. Gross domestic product (GDP) in the current year will be about 1.6% higher than the pre-pandemic level, but since our population has also increased, per capita GDP will still be below the level in 2019-20. The aggregate picture also doesn’t tell the full story: some sections have done well, but others have not. Real incomes of the bottom 50% are still lower than in 2019-20.

The best way of ameliorating this distress is to get back to rapid and inclusive growth, but how fast can the economy grow in 2022-23? The budget projects nominal GDP growth of 11.1%. If inflation is limited to say 4%—an optimistic assumption, given rising global commodity prices—real growth could be around 7%. The economy has the capacity to grow by 7%, but will it? It had slowed down before the pandemic, with the growth rate in the last two years before covid averaging 5%. Returning to growth at this level will do little for the bottom 50%. Getting to 7% growth is therefore important and calls for some special efforts. Has the budget helped?

Both private consumption and private investment are higher now than in the pandemic year 2020-21, but are still below the 2019-20 level. The budget recognizes that demand is still weak and so it projects a fiscal deficit of 6.4% in 2022-23—lower than in 2021-22, but on the high side.

Increasing public investment in infrastructure is the right way to stimulate demand. Inadequate infrastructure is a major factor limiting India’s competitiveness and higher public investment in infrastructure will help increase our growth potential. Crowding out private investment is not a problem because capacity utilization remains low. Private investment will pick up only after utilization levels rise, which may happen in the course of 2022-23.

The budget provides an impressive 36% increase in capital expenditure in 2022-23 over the revised estimate (RE) for the current year (adjusting for an accounting adjustment that inflates the RE figure). Much of this is by increasing long-term loans to states for this purpose from ₹15,000 crore in the RE for 2021-22 to ₹1 trillion in the BE of 2022-23. The impact on the ground will depend on states being able to identify and implement eligible projects on this scale. Utilization could be maximised if the government (a) announces the share of each state in this total kitty, and (b) starts discussions on the conditions that will apply with a bias towards giving states flexibility. It could also declare that if states do not submit proposals for utilizing the amount allocated to them within a specified period, their entitlement would be shifted to states that can use the funds. Latecomers can get their entitlement next year.

The budget provides no specific stimulus for private consumption. This is the right approach, since consumption demand will recover on its own if growth takes place. But reducing the provision for MNREGA jobs from ₹98,000 crore in the RE for 2021-22 to ₹73,000 crore could have been avoided. This is a demand-driven scheme, and the finance ministry should urge all states to spend freely on it in the first half of the year with a firm assurance that more funds will be provided if needed.

Growth in the medium term will be driven by a revival of private investment. This depends on maintaining macro stability in a world that looks uncertain, continuing reforms that will promote efficiency, and creating a pro-investment environment.

Tax reform is an important area of reform, especially to reassure people about macro stability in the medium term. India’s tax-to-GDP ratio has been stagnant for years and experts believe it could be easily increased by 4 to 5 percentage points of GDP.

The finance minister has done well to opt for stability in direct taxes, despite demands for rejigging the system to deal with rising inequality. There may be a case for taking a relook, but this should be done once growth has resumed—not at a time when there is a great deal of uncertainty.

The priority area for tax reform is the goods and services tax (GST). We need to reduce the number of exemptions, cut the number of rates, and include items such as petroleum, electricity, real estate and alcohol. This can only be done by the GST Council, but I wish the finance minister had informed Parliament what she would like the Council to do, thus giving political parties an opportunity to express their views. States have complained that the Centre’s promise to compensate them for shortfalls in GST collections has not been kept. They have also argued that the compensation scheme, scheduled to end in June 2022, should be extended for five more years. Perhaps the GST Council would accept a compromise solution, extending the scheme by three years along with a reform of the rate structure.

Customs duties is another area where reforms are needed. The past few years have seen an increase in duty rates on several thousand items in response to demands for increased protection by various business interests. While this seems consistent with an Atmanirbhar approach, many experts argue (rightly in my view) that this is ill advised. It raises our cost structure and will prevent us from integrating with global supply chains precisely at a time when there is growing interest in restructuring these supply chains to reduce dependence on China. Perhaps the Prime Minister’s Economic Advisory Council should be asked to look into this issue and its report could be released for public discussion.

A clear mis-step in the budget is the proposed retrospective amendment (effective from 2005) clarifying that cesses cannot be claimed as business expenses. It has been done to overcome two high court rulings against the tax department’s position. We should have made this amendment prospective, but for past cases we should have waited for a Supreme Court pronouncement. What has been done feels like a rerun of the infamous “Vodafone amendment". I wonder if the finance minister was briefed that her predecessor, Arun Jaitley, while criticizing the United Progressive Alliance (UPA) over Vodafone, had specifically said the National Democratic Alliance (NDA) government would never do such a thing.

Banking reform is another area on which the budget says less than it should. The present slow growth of commercial credit through public sector banks (PSBs) is not consistent with a strong revival of growth. Several key banking reforms have stalled. The Insolvency and Bankruptcy Code, a potentially game-changing NDA reform, got stuck in implementation and its operation was then held back because of the pandemic. The alternative ‘bad bank’ route for handling non-performing assets by selling these to an asset reconstruction company owned by PSBs, aided by a separate resolution company owned by private banks, has yet to be operationalized. Two PSBs were supposed to be privatized, but this has been delayed. Most importantly, there is no indication whether steps will be taken to free PSBs from the finance ministry’s control, as recommended by the P.J. Nayak Committee. A clear game plan of progress on these would help.

Finally, no assessment of the budget is complete without commenting on the fiscal deficit, so here goes. The projected 6.4% of GDP for 2022-23 is undoubtedly high, but it does show an improvement over the 6.9% estimated for 2021-22. If revenues in the next fiscal year do better than expected—and this is likely—we should use the slack to increase expenditure in other areas, especially MGNREGA and health, rather than trying to ‘improve’on the 6.4% target.

The fiscal deficit problem has to be solved over the medium term. Admittedly, our credibility is low, since successive governments have promised medium-term corrections and failed. But that is a subject for a separate op-ed altogether.

Montek Singh Ahluwalia is former deputy chairman, Planning Commission, and currently distinguished fellow at the Centre for Social and Economic Progress