On February1, Finance Minister Nirmala Sitharaman will present what could turn out to be India’s most consequential Budget in years. What is the status of the post-Covid recovery process, and what are the concerns going forward? What should you look for in the Budget – and what should the Budget be looking at?
Ahead of the Budget, what is the state of the economy? How critical is the Budget with respect to what it can achieve?
GDP fell sharply when lockdowns restricted activities, and has bounced back once lockdowns were lifted, particularly as the infection-fatality rate of the coronavirus in India has turned out to be much lower than feared earlier. Further, some of the drivers of the economic slowdown preceding the pandemic appear to be reversing: for example, the credit crunch triggered by the failure of IL&FS in September 2018 had driven de-stocking across supply chains, hurting GDP. (As GDP measures activity, inventory build-up adds to it and conversely, inventory depletion lowers it.) In sectors like cars and two-wheelers, the transition from BS-IV to BS-VI standards had exacerbated this trend. The end of this de-stocking is helping demand for manufacturing. Separately, the urban residential real-estate sector, after struggling for more than five years, is also seeing a revival.
Aggregate government fiscal interventions, from both states and the Centre, have been worryingly pro-cyclical so far, that is, they were a drag on growth when private demand was weak, and are now adding to the recovery. In the September quarter, if government spending had not fallen 20% versus last year and had instead grown 20%, overall GDP would have been nearly unchanged, as against the 7.5% decline that was reported. A pick-up in government spending now is acting as a tailwind when private demand is also growing.
Some of this is hard to control: Most government departments cannot “work from home”, and struggled to function. Post lockdowns, they are trying to catch up on their annual targets.
Four key issues must be kept in mind as we assess the impact of the Union Budget on growth. First, the recovery is still fragile and uneven, and fiscal interventions are still necessary; second, there are constraints in the government’s execution capacity; third, state government budgets may matter more, as they together spend 70% to 90% more than the Centre; and fourth, the “Budget” has two distinct parts: the fiscal accounting, and the Budget speech. The latter, by laying out the medium-term roadmap, can significantly impact “animal spirits”, and thence growth.
What are the key numbers (deficits, growth, inflation and revenue projections) to look out for in the Budget? What signal will they provide?
The assumptions underlying the Budget start with nominal GDP growth, which itself is highly uncertain, unlike in earlier years. Consensus currently forecasts 9% real growth in FY2021-22, which, with 4% inflation, should mean 13% nominal growth. However, there is a possibility that real GDP growth itself could be 13% or higher, implying more than 17% nominal growth. Even without any tax buoyancy (that is, taxes growing faster than GDP, as they sometimes do in a recovery), it would provide significant fiscal space.
The 15th Finance Commission’s report is also likely to be tabled along with the Budget: this would affect how much of the gross tax receipts the Centre can retain and how much must be devolved to states, as also the allocations on important sectors such as defence, health and education.
The government then needs to budget for non-tax receipts, where the big decisions would be on expected receipts from spectrum sales (in case 5G auctions are planned), and on disinvestment, where execution on big-ticket disinvestment has lagged political intent. Government officials have signalled a change in the approach on disinvestment; some concrete medium-term targets would signal renewed government commitment to the process.
With regard to the fiscal deficit target, consensus currently expects it to be at 5.6% of GDP. This is significantly higher than the 3-odd per cent that was expected pre-pandemic, implying that the government can work with higher deficits for a few years.
The Budget may also revise medium-term fiscal targets like debt to GDP ratio over the next five years (the current target of 60% appears unrealistic), and a glide path for the annual deficit ratio.
On expenditure, assuming a 13% nominal GDP growth, non-tax receipts similar to that budgeted for FY2020-21, and the deficit ratio at 5.6%, government expenditure would grow by 18%. While that appears to be moderate growth, one must remember that more than three-fourths of central government spending is pre-committed: interest, salaries, pensions, subsidies, transfers to states, and other such heads. As these grow at their own steady pace, to achieve 18% growth in overall expenditure would mean nearly 150% growth in the non-committed heads.
Such growth levels appear easy in Excel sheets, but can challenge the spending capacity of the government. It is possible that the government would assume either a lower tax revenue growth, or a lower fiscal deficit target, in order to keep its expenditure growth assumptions credible.
With suppressed incomes and job losses post-Covid, should the government consider tweaking income tax slabs to boost disposable income and in turn, consumption demand? Should tax exemption limits be raised?
It is widely agreed that the pandemic has hurt lower-income households and smaller and informal firms. Given the limitations in the government’s ability to launch sufficiently targeted large schemes that help the urban poor and informal enterprises, steps that boost aggregate demand may be an alternative. Implementing recommendations of the Direct Tax Code committee would be a timely reform. As the number of households paying income tax is low, cuts to indirect taxes may also help.
Which sectors should the government focus on in the Budget to revive employment?
Housing and construction continue to be large job-creators for unskilled or semi-skilled workers. Even as the residential real-estate industry revives after several years of slowdown, continued or even enhanced support to affordable housing projects would help in job creation. Infrastructure construction also creates jobs, and supplementing the National Infrastructure Pipeline (NIP) with new projects can boost the outlook for jobs.
Separately, the government has already announced allocations to Production-Linked Incentive (PLI) schemes for several labour-intensive sectors such as food processing and man-made textiles. These may not have any fiscal allocations in FY2021-22, but rapidly getting them to execution can help.
Consensus is also converging on lack of capacity in the financial system being a hindrance to growth once the economy is fully open. Reforms to enhance this capacity would support the growth outlook over the medium-term, and thus boost job creation too.
Healthcare is likely to be a key focus area for expenditure allocation. What kind of schemes can help the benefits reach the masses?
Several epidemiologists have strongly recommended that the lacunae exposed by the pandemic should be addressed promptly. In addition to a budget for vaccination, supplementing primary healthcare capacity and improving its quality can help the country be better prepared for future epidemics. Similarly, given the large share of private healthcare, and that a meaningful part of private facilities had to be shut down during the pandemic, the system must prepare to utilise them better in future episodes. A speedy rollout of the National Digital Health Mission —with a national digital ID, registries for medical facilities, practitioners and medical records, etc — can help. State governments too, need to boost their focus on capacity-building.
While actions that focus on disease prevention, such as affordable housing, provision of water and sanitation to the urban poor, may not be classified as healthcare, they are as important in epidemic control, as the surges in urban slums have shown.
Revenue collections have slowed down in the post-Covid year. Will a new tax/surcharge/cess be a sensible choice to boost government revenues?
As the economy has rebounded, tax revenues are growing too, not just for the Centre, but also in several states. We have already seen several months of strong GST collection growth, and direct taxes should be picking up too, as companies’ and individuals’ assessment of full-year income now would be higher than what they thought likely till September. Healthy tax growth should continue into the new fiscal year.
Further, given the need to prioritise growth — required not just for alleviating poverty but also to keep debt-to-GDP ratios sustainable — and relatively high market expectations for the fiscal deficit ratio, new taxes and surcharges would not make sense. A tenth of a percentage point change in the fiscal deficit ratio can add Rs 20,000 crore to expenditure. Surcharges may not add as much — and in the process, by increasing tax rates, risk a fall in compliance.
There are expectations of further reforms in the banking/financial sector. What could the government deliver on that front?
Lack of capacity in the financial system is one of the structural problems in the Indian economy. If nominal GDP growth needs to be 12% a year for several years, growth in formal credit needs to be 14% to 15%. If public sector banks (PSBs), which are still a large part of the financial system, do not have the incentives to grow, the system cannot expand at that pace. The government can choose to privatise some PSBs, or separate ownership from management for all PSBs by creating a bank investment company. It can also create a well-capitalised Development Finance Institution (DFI) to support financing needs as the NIP is expanded.
While the monetary stimulus and liquidity injection from the RBI largely supported the economy this year, should the government go for a direct fiscal stimulus to hasten the recovery process?
While growth in the economy in FY2021-22 can be meaningfully higher than current consensus estimates, the level of output would still be substantially below what may have been expected pre-pandemic. Pro-growth fiscal interventions can help the recovery, particularly if prudently targeted – on the urban poor, informal firms, healthcare capacity, affordable housing, or infrastructure construction.
Can — and should — the government utilise the euphoria in the equity markets to privatise PSUs at a much bigger scale, which could deliver efficiency gains and the resources for supporting the economy?
The government needs to restructure its balance sheet by shifting its asset ownership away from mines, smelters, refineries, and too many financial firms, to providing better healthcare, education, urban infrastructure, defence, social security, and other such needs. A robust equity market provides a good opportunity to exit current holdings. The government must also re-evaluate its approach to disinvestment: an incessant trickle-feed of stocks in government companies instead of strategic sales have made them lag the overall market.
Should the government provide direct support to sectors still affected by the pandemic, such as hospitality, tourism, aviation?
While such support may be necessary for some firms, plans must also take into account the ability to objectively target this aid.
There are incipient signs of inflation rearing its head. Will this have a bearing on the Budget?
Sustained high fiscal deficits when monetised by the central bank tend to cause inflation, so the medium-term fiscal consolidation path must keep inflation as a consideration. However, the current spurt in commodity prices are a global phenomenon, and have little to do with India’s fiscal choices.
Neelkanth Mishra is Co-Head of Equity Strategy, Asia Pacific, Credit Suisse, and is widely acknowledged as one of the best analysts of the Indian economy. He has been an adviser to several government committees, such as the 15th Finance Commission and the FRBM Review Committee, and is part of CII’s economic advisory council. Before joining Credit Suisse, Mishra, who studied computer science at IIT Kanpur, worked for Hindustan Unilever and Infosys.