Budget 2021 shows govt is set for a fiscal push. Baton has once again passed to the RBI

The Union Budget for FY22 is a budget to consolidate (C), spend (S) and revive (R). We call it a CSR budget. It is a matter of transparency that the budget has moved clearly from off-balance-sheet funding to headline-deficit funding and that possibly explains the surge in fiscal deficit in the current fiscal at 9.5 per cent of GDP. Our estimates show that by excluding such off-balance-sheet funding, the headline-fiscal deficit declines to 8.6 per cent of GDP. We still, however, believe this fiscal deficit is on the higher side and positive surprises await us in May.

First, we would like to highlight the unfortunate debate in the public domain regarding the off-balance-sheet numbers that obfuscate the Rs 4.1 lakh crore jump in expenditure in FY21 as purely an accounting exercise of a shift of off-balance sheet spending. This is data ignorance. A closer look at the food subsidy, juxtaposed with outstanding FCI liabilities shows that Rs 1.2 lakh crore (0.6 per cent of the GDP) is a pure accounting shift, while the rest Rs 1.9 lakh crore is new spending this fiscal. Hence, the incremental spending in FY21 comes to around Rs 2.9 lakh crore (net of Rs 1.2 lakh crore/ 1.5 per cent of the GDP). Interestingly, the government has also spent an additional Rs 62,638 crore on fertiliser subsidy, the entire amount of which has been front-loaded. This 1.5 per cent of the GDP is thus the direct fiscal impulse in FY21 — still higher than the market consensus of the estimated direct fiscal impact of 1 per cent of GDP in May 2020.

However, the jump in expenditure in FY22 is noticeable as the pie has decisively shifted towards capital expenditure with a budgeted raise that is 4.6 times larger than the trend increase in the last two decades. In real terms also, this jump is 3.7 times higher than the decadal average. The proposed capital expenditure amounts to 3.4 per cent of the GDP if we also include allocation for capital expenditure for autonomous bodies. Assuming an Incremental Capital Output Ratio (ICOR) of 4.5, one can expect a GDP growth contribution of 0.8 per cent on account of the capital expenditure. The other number in the budget that deserves admiration is the significant decline in extra budgetary resources of the government and PSUs. All this augurs well even for rating agencies if we go by purely fiscal transparency as a rule.

Besides the positive initiatives in the financial system, the most notable development is the announcement of setting up an Asset Reconstruction Company (ARC) and an Asset Management Company (AMC) to clean up NPAs in the banking sector. The approach is to set up an AMC, which in partnership with an ARC, takes over large stressed assets (total estimated value at approximately Rs 3.5 lakh crore) spread across multiple banks that have a clear potential for turnaround. An operational turnaround of the asset creates value for the overall system. Our estimates show that with banks currently having a provision coverage ratio (PCR) of 85 per cent, the total capital locked up could be Rs 5,000 crore, which is much lower than Rs 25,000 crore when the PCR coverage was lower than 40 per cent. This also means that the equity capital that can be put by the banks in this new venture should not be ideally more than Rs 10,000 crore. That could plough back Rs 1 lakh crore into bank profitability even if we assume a modest recovery at 43 per cent — the same as through NCLT.

The AMC/AIF-led approach could enable a move towards true price discovery, consolidating debt into one single entity ensuring faster decision-making, freeing up blocked capital/funds and an operational turnaround of assets. A better price discovery could be ensured by having an independent investment committee comprising of senior management professionals. For the record, we also expect quite modest NPAs because of COVID after full recognition.

The Union budget also has a proposal to increase the FDI limit in insurance companies to 74 per cent from the present 49 per cent, with Indian management control. The government had raised the limit to 49 per cent from 26 per cent in 2014, but it took more than a year for the necessary guidelines to be put in place. However, the process was relatively faster when FDI in insurance intermediaries was liberalised to 100 per cent in 2019. It is expected that fresh capital will bring a new wave in technical know-how, innovation, and new products to the advantage of consumers, pushing up insurance penetration in the country. However, we must ensure that foreign investors become interested in the Indian insurance sector as the current FDI used limit is at 33.8 per cent in private insurers.

The government is also set to introduce a Development Financial Institution (DFI). A DFI, aimed at providing debt financing to greenfield infra projects, will be able to divert long-term savings into much-needed capital for the infra sector.

A final thought. With the government set for a fiscal push, the baton has passed to the RBI, which did a commendable job during the pandemic. Overall, monetary and fiscal policies need ideal co-ordination for macroeconomic management. In practice, this co-ordination sometimes reminds us of the “Game of Chicken”, where each player (in our case the central bank and the government) may not prefer to cooperate, which always results in the worst possible outcome. In the real world, fiscal dominance is generally the rule and monetary dominance turns out to be the exception. If the central bank pursues its monetary objectives by not accommodating debt financing in its strategy, the macroeconomic outcome may be worse for both the fiscal and monetary authorities, as well as for the economy. Fortunately, the RBI and government have worked in perfect harmony during the pandemic. As it continues, we can have a stable interest rate regime which will be rewarding for all, particularly the government. So why not now allow retail participants to purchase government securities, like gold bonds, under their Aadhaar number?

This article first appeared in the print edition on February 4, 2021 under the title ‘Consolidate, spend, revive’. The author is Group Chief Economic Advisor, State Bank of India. Views are personal

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