Budget indicates that growth will have to be public sector driven

• While the 2022-23 Budget is being heralded as a “growth” supportive budget, under the hood it delivers quite a complicated message.
• To see that one needs to unpack the budget and wading through numbers.

Fiscal deficit and consolidation

• The budget estimates current year deficit at 6.9 per cent of the GDP.
• Even with the lower privatisation receipts, unless tax revenue — having grown 44 per cent year-on-year till December — suddenly plummets this quarter, the deficit is likely to be lower at 6.6 per cent of GDP in a replay of the end-year dynamics in 2020-21.
• Against such an eventual outturn, the 2022-23 deficit target of 6.4 per cent of GDP isn’t much of a consolidation.

Matching borrowing with savings and investment

• If the budget is an indication, then the overall public sector borrowing (Centre, state and PSUs combined) will likely decline from 11.5 per cent of GDP to 11 per cent of GDP next year.
• This will need to be funded by the private sector’s net savings (household and corporate savings less private investment) and foreign borrowing (the current account deficit).
• The Centre and state governments’ fiscal deficit of around 11.5 per cent of GDP is being funded by 10 per cent of private net savings and 1.5 per cent of GDP of foreign borrowing (the current account deficit).
• So, for the next fiscal year, private consumption and investment combined can rise only 0.5 percentage points of GDP without increasing foreign borrowing.
• Put differently, if India’s private consumption and investment are to grow more than 0.5 percentage points of GDP, then foreign borrowing — the current account deficit — will necessarily have to increase.

Difficulties with current account deficit

• In normal times, India has found it hard to fund a current account deficit of more than 2.5 per cent of GDP without facing serious currency depreciation pressures.
• Doing so in a year when global financial conditions are poised to tighten sharply as the US Fed embarks on raising interest rates and removing quantitative easing, will be that much more challenging.
• This arithmetic must have been obvious to the government.
• So, by limiting the effective consolidation to just 0.2 percentage points of GDP, the message being sent is that the private sector is not yet ready to lead India’s recovery
• Thus, for the fifth year in a row, growth will need to be driven by the public sector.

Public or Private Growth: Why so much discussion?

• Whether growth is driven by the public or private sector, it matters for two reasons:
• First, the need of the hour is to generate not just growth but also employment.
• The public sector doesn’t create many jobs and neither do the corporates, start-ups, or infrastructure investment.
• The bulk of employment is created by SMEs who have been battered over the last five years; first by the demonetisation, then the troubled implementation of the GST, and now the pandemic.
• But the budget does not provide any meaningful support to this sector.
• It extends the ECLGS for one more year, which, for all practical purposes, is just forbearance for banks that have provided loans to SMEs.
• It is unlikely that this will make SMEs, whose balance sheets have been seriously impaired over the last few years, start investing or expanding employment.
• The second reason is that growth via public spending has a high cost and it isn’t sustainable beyond a few years.
• The pressures are already building with the sharp rise in government debt over the last five years to close to 90 per cent of GDP at present.
• This rise in debt exerts continued upward pressures on interest rates and makes the task of keeping the government’s interest payments under control (currently 3.5 per cent of GDP) that much harder without substantial bond purchases by the central bank.
• This, in turn, seriously complicates monetary operations and communications as it becomes difficult to untangle if the central bank is targeting inflation or bond yields.

Challenges for RBI

• The gross borrowing by the government next year will be a whopping Rs 14.2 trillion, up from Rs 10.5 trillion this year.
• If the private sector is to revive even a bit, it will need to borrow more.
• In this case, it is very unlikely that the government can raise such a large amount without interest rates rising sharply unless the RBI purchases a substantial amount of bonds.
• This means that the RBI will be forced to add more liquidity exactly when it should be reducing the high and excessive amount already in the banking system.
• With the US Fed set to raise interest rates aggressively in the coming months, this will test the RBI’s ability to juggle its multiple objectives.
• So far in the pandemic, it has done an admirable job doing so.
• But this budget makes the juggling act that much harder and higher inflation or financial instability could be the casualties.

Area of Budgetary support

• There is one area where the budget appears to have built some space to meet potential demands for additional support, although without being very transparent about it.
• Gross taxes are pegged to decline to 10.7 per cent of GDP from the 11.4 per cent of GDP we expect this year.
• The effective tax buoyancy is, thus, just 0.4 versus an expected outturn of 1.8 this year.
• Consequently, there is a clear upside to next year’s tax projections.
• This could be used to either reduce the overall deficit or to offset cuts in excise duties that might be needed to stabilise retail oil prices if global crude spikes, for example, because of geopolitics.

Conclusion

• While there is some space to meet contingencies, the budget has complicated macroeconomic management
• The continued emphasis on public-sector driven growth raises concerns about the sustainability of such a strategy with debt already at such a high level.