The budget got its growth focus right but challenges still remain

The budget has struck while the iron is hot, both on reforms and the fiscal math. Less than a year back, the Indian economy was facing the worst slowdown in a decade. The pandemic made it the worst in seven, and necessitated strong fiscal action that, for once, everyone thought was far more pressing than staying true to the earlier fiscal deficit glide path.

The budget then did what would have been unthinkable had the pandemic not occurred—veer off the Fiscal Responsibility and Budget Management path by as much as 3.8 percentage points for next fiscal, almost double the budgeted borrowing, and altogether redraw the path of fiscal consolidation, stretching the timeline to reach a higher-than- earlier deficit target by fiscal 2025-26.

While the spending lift has brought overall expenditure back on the pre-pandemic trend level (using budgetary estimates from fiscals 2015 to 2020), the same could not be done for revenue.

That’s because revenue depends on gross domestic product (GDP), which will take time to normalize. Also, revenues have been conservatively estimated. Nominal GDP in fiscal 2022, even at the 14.4% growth assumed in the budget, is below the pre-pandemic trend level by nearly 10%. Gross tax revenues are estimated at about 30% below trend value even in fiscal 2021-22.

So while fiscal policy is expected to remain growth-supportive and the deficit to narrow gradually to 4.5% of GDP by 2025-26 from 6.8% in 2021-22, reversing the trend of revenue underperformance is crucial to achieve even the relaxed fiscal targets.

That said, the deficit levels also look worse for a good reason—enhanced transparency. The budget relies less on below the line/off-budget items for funding investment and more on direct capital expenditure allocations. It also puts an end to the practice of funding the Food Corporation of India’s shortfall via borrowings from the National Small Savings Fund and replaces it with budgetary allocation. How does the math work out for growth?

The budget assumes a realistic nominal GDP growth of 14.4% for 2021-22, roughly translating to 11% in real terms, as projected by the Economic Survey. Taking the budgetary response into account, Crisil has also upgraded India’s growth outlook to 11% from 10% projected in early December. What really pans out for the coming fiscal will not only be shaped by these fiscal measures, but also by exogenous/luck factors, such as crude oil prices and monsoons.

Crude prices are expected to move to an average of $53 per barrel in 2021 from $42.3 in 2020. Even at such levels, they are not a big threat. But monsoons need to be closely tracked as India has seen more than two consecutive years of normal monsoon (as we now have) only once in the past two decades.

Any abnormality will have some bearing on GDP growth as well as rural spending, which is expected to decline about 35% over the budgetary estimate for 2020-21.

Crucially, there are also the states, which account for 58% of overall government spending and 63% of government capital expenditure. So growth will be predicated on their ability to follow a counter-cyclical fiscal policy too this year. For now, the budget provides some support to capex for states.

Investment has been a casualty for the past few years—as a percentage of GDP, it fell to 29.8% in 2019-20 from 34.3% in 2011-12. It is estimated at 27.6% this fiscal. At the heart of the budget is the government’s counter-cyclical approach to address this till such time the private sector is dormant. The tilt towards capex, budgeted to increase 26% over last fiscal’s revised estimate, versus a fall in revenue expenditure of about 3% is positive for growth.

Public investment is shown to have a higher ‘multiplier effect’ than consumption. Add to that the findings of a recent International Monetary Fund study (Gaspar, et al, 2020) that positive spillover effects of public investment only amplify during periods of uncertainty, and what we have is more bang for the buck.

Despite low overall capacity utilization rates, private sector investment, particularly by large corporates, should be the first to pick up. Large companies have done well this fiscal and also de-leveraged. So they can be expected to lead an investment revival once the recovery gains a stronger footing.

However, the large companies-led better-than-expected recovery is yet to percolate to benefit micro, small and medium enterprises. Better focused support would have gone a long way in helping them and adding jobs.

What can also spoil this story is the impact of a huge borrowing programme of ₹12 trillion on bond yields. They have already zoomed 13 basis points since the figures came out on 1 February. We expect the 10-year G-sec yield to rise to 6.2% by March 2021 and 6.5% by March 2022. An influx of state development bonds can also be expected as state deficits widen. That should give the Reserve Bank of India (RBI) reason to worry. To be sure, the monetary policy announcement that follows the budget should gain breathing space from low inflation in December that is likely to remain so in January as well.

North Block has done what it must. All eyes are on Mint Road now.

Dharmakirti Joshi is chief economist at CRISIL