As the dust settles on India’s Budget, it’s time to step back and reconstruct the forest from the trees. Budgetary math apart, the bigger picture reveals a budget embarking on three paradigm shifts from the past.
The first is an effort to re-imagine the public sector’s balance sheet. The leitmotif of the budget is a big thrust on infrastructure spending and public investment. If the budgeted numbers are realised, capex would have grown from 1.6 per cent of GDP pre-COVID to 2.5 per cent in two years. With India’s investment/GDP ratio falling by 5 percentage points over the last decade and private sector manufacturing utilisation rates sub-70 per cent even before COVID (falling further to 63 per cent during the pandemic), a sustained public investment push — with its large multiplicative effects — is a much-needed impetus to reinvigorate growth and create jobs. It’s the certainty of sustained public investment that is likely to crowdin private investment. It’s the certainty of investment-led employment that is likely to reduce household precautionary savings.
But this is only one half of the story. Implicitly, higher capex spend is being paid for by disinvestment and privatisation. Effectively, therefore, non-core public-sector assets that don’t generate positive externalities — and, in fact, potentially distort the sectors they compete in — are expected to be replaced with much-needed physical and social infrastructure, which typically emanate positive externalities and necessarily suffer from under-provisioning by the private sector. If successfully executed — and we underscore the importance of execution below — this will not be a case of selling the family silver to pay a credit card bill. Instead, it will be akin to a productivity-enhancing asset swap on the public sector’s balance sheet — an approach we have long advocated on these pages (see ‘India’s New Deal moment‘, IE, January 11).
The second intellectual departure is how the budget envisions infrastructure financing. In stark contrast to the PPP model — where the private sector had to grapple with upstream implementation and regulatory risk, which it often struggled with – infrastructure will now be financed off public sector balance sheets and, once operational and viable, will be monetised so as to recycle proceeds into the next project. In theory, this is the appropriate division of public-private risk sharing. It marries the public sector’s ability to better mitigate upstream risk while banking on the glut of global liquidity potentially attracted to downstream projects.
The third shift is towards more conservative and transparent fiscal accounting. There has been much focus on bringing the Food Corporation of India (FCI) liabilities back on the budget. Less appreciated is the conservatism with which tax revenues have been budgeted for. Revised estimates peg this year’s gross taxes at 9.9 per cent of GDP. But for that to happen, taxes, net of excise, will need to contract by 20 per cent in the last quarter! To put this in perspective, they grew at 25 per cent in the quarter just gone by. So it’s very likely gross taxes will end up 0.5 per cent of GDP higher this year. Not only is this a welcome departure from the past when revenues were consistently over-budgeted, but it sets the base for next year. With nominal GDP expected to grow in double digits, it’s likely taxes, net of excise, will experience a higher-than-unitary-elasticity to growth, especially given the increased formalisation that COVID has spawned. Tax collections are, therefore, likely to exceed budgeted levels in 2021-22. It must have been tempting to budget for higher revenues and, commensurately, show higher expenditures next year. Instead, this conservatism is most welcome. It behooves a very uncertain macroeconomic environment and creates some buffer if crude prices keep rising or other revenues don’t materialise. Credible accounting over time will bring down risk premia in bond yields, and paradoxically generate a stimulative impulse.
All told, the budget has embarked on three important intellectual departures from the past. But realising them will not be without challenges.
The most obvious is execution. Ultimately, the budget’s impact on shaping the macroeconomic narrative will depend on the speed and efficacy of implementation on both sides of the ledger: Simultaneously building and selling public assets. It will be important, for instance, to front-load disinvestment and strategic sales to take advantage of buoyant equity markets before global central banks become more cautious. It will be equally important to identify shovel-ready projects to deliver the promised public investment in time. With debt likely to rise to almost 90 per cent of GDP this year, it’s now incumbent on all stakeholders to consistently deliver the 10 per cent nominal GDP growth that’s needed to first stabilise debt at these levels and then bring it down. Viewed from this lens, rarely has there been a budget where execution is so vital.
Second, while fiscal policy is being appropriately counter-cyclical at the moment, it must be equally nimble in the other direction. When the recovery gets more entrenched, policy support should be withdrawn with equal speed and alacrity. The more relaxed fiscal glide path should be treated as a ceiling, with the actual path tied intimately to the pace of the recovery.
Finally, with fiscal policy having thrown down the gauntlet, monetary policy must slowly take a back seat. The combination of a more relaxed fiscal path and domestic private sector savings normalising after the COVID surge (reflected in the current account moving from a surplus of over 1 per cent of GDP this year to a deficit of that magnitude next year) could result in equilibrium bond market yields rising — but that is a cost worth incurring for a meaningful public investment push. In the near term, the RBI may focus on ensuring this new equilibrium is reached in a non-disruptive manner. Given the current slack in the economy, it’s understandable if fiscal and monetary are temporarily complementary. But as confidence in the recovery grows, fiscal and monetary must quickly become substitutes — with the RBI progressively normalising liquidity to wardoff financial stability and fiscal dominance concerns — so as to safeguard macroeconomic stability.
The budget must be commended for embarking on important paradigm shifts. But its success, and in turn the sustainability of India’s recovery, will now come down squarely to policy execution and coordination.
This article first appeared in the print edition on February 8, 2021, under the title “Making Budget work”. The writer is Chief India Economist for J.P. Morgan