The household sector is much weaker after the pandemic. Small and medium-sized businesses, which have suffered in quick succession (since the first demonetization coup in 2016), are hanging by a thread.
Contact-based services, most affected by recurring and recurring blockages and virus-induced fear. At the same time, private investment must return for the growth momentum to pick up and be sustained.
While all these pockets of weakness predominate, ignoring them could hamper or delay the realization of the country’s growth potential. National Bureau of Statistics advance estimates for this fiscal year’s gross domestic product (GDP) suggest India’s economy would have grown just 1.4% above its pre-pandemic level (fiscal year 2020) in real terms.
A few contact-based services such as commerce, hotels, restaurants, and transportation will even lag behind. Clearly, this budget is expected to lift all boats, so that fiscal year 2023 ushers in a broad-based recovery. Yet the fiscal space is limited to do all that needs to be done.
With requests pouring in from all sides, it’s hard to say what the budget will ultimately do. So let’s cut to the chase and instead look at three things we think it definitely won’t do.
First, do not look for major changes to the tax structure.
Pandemic or no pandemic, every year there is a demand for income tax relief, especially from middle-class households. This year, the calls are indeed louder, given how jobs and incomes have suffered. In addition, purchasing power has eroded due to rising retail price inflation.
While the demand for tax relief is reasonable, the government’s budget calculations may not allow it to announce meaningful relief. On the one hand, tax collections are expected to slow in fiscal year 2023, year-over-year. This fiscal year saw strong nominal GDP growth (17.6% year-on-year) and, consequently, dynamic tax collections. However, the government will not have this leeway in the next fiscal year when nominal GDP growth is expected to slow to around 13%.
On the other hand, on the indirect tax front, any changes to the Goods and Services Tax (GST) rates are now the responsibility of the GST Board and not within the union’s budget. That said, the Centre’s focus has shifted to customs and import duties. So any relief that leads to lower import costs bodes well for manufacturers, who would otherwise have been constrained by high commodity costs. Similarly, further relief from excise duties on gasoline and diesel would significantly relieve consumers from inflationary pressure.
Second, don’t expect a strong fiscal correction for 2022.
The central government had forecast a budget deficit of 6.8% of GDP for this fiscal year. For the next fiscal year 2023, the government is unlikely to drastically cut spending to drastically reduce the budget deficit, even if tax revenue declines. This, despite pressures from rising interest payments and debt: the Center’s total liabilities are expected to increase to 58% of GDP in FY22 (from around 50% in FY20) . In addition, around 30% of outstanding central government debt (as of end-September 2021) matures within the next 5 years, implying increased repayment obligations.
We expect the government to follow only a gradual path to fiscal consolidation in fiscal year 2023.
The finance minister in last year’s budget speech outlined the government’s plans to achieve a budget deficit below 4.5% of GDP alone by fiscal year 2026. The Accountability Act budget and budget management, which requires the central government to aim for a budget deficit of 3% of GDP, is likely to be changed once again to lengthen the glide path longer. Our bottom-of-the-envelope calculations show that the government could create additional fiscal space of Rs 35 lakh crore over the fiscal years 2022-2026, by postponing the 3% fiscal deficit stage. This will leave room to accommodate additional spending, as the economy still needs government support to increase consumption and stimulate the investment cycle through capital spending (capex).
Third, do not plan capital expenditures for consumer support.
The previous two budgets had a clear focus on improving the quality of spending by increasing investment spending and focusing on medium-term reforms. Fiscal investments increased by more than 30% year-over-year in fiscal year 2021 despite the pandemic. For FY2022, a 26% increase has been budgeted, well above the average ten-year investment growth of 12% before the pandemic.
Infrastructure development under the Ministries of Housing, Roads and Highways, Railways and Rural Development forms a large part of these investment plans. But for stronger growth to materialize, the reforms announced so far must be pursued unabated. Moreover, only a sustained momentum in government investment spending can attract private investment.
This year, as consumption begs for a chance to revive: Per capita income growth was slowing even before the pandemic, rural wage growth remains subdued, and job losses and falling incomes during recurrent waves of Covid-19 weighed on household savings. A sustained recovery in consumption will prompt manufacturers to invest in expanding capacity to meet growing demand.
But, in the absence of a trade-off on the investment spending front and major income tax cuts, the government will need to consider targeted measures to redistribute income to the most vulnerable and those hardest hit by the pandemic, such as through the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA), PM-Kisan and/or PM Awas Yojana (PMAY).
Thus, if the budget can show an inclination towards measures to support consumption, this will not be done at the cost of a compromise on capex.
The EU budget is a key signaling instrument for the government to set out its intentions for the year to support the growth of the economy. For a significantly weakened economy after the pandemic, what is excluded will prove just as important as what is included in the budget.
What lies ahead is another fiscal tightrope, as the government seeks to balance near-term demand stimulus with medium-term growth potential.
Dipti Deshpande is Principal Economist and Amruta Ghare is Junior Economist at CRISIL