Editorial 1. Choosing stability over populism
Recent Context: Recently, government introduced Budget 2023-24 in the Parliament which is regarded as fiscal consolidated and following the path of stabile growth.
Budget 2023-24: Following the fiscal conservatism, choosing macroeconomic stability over populism
- The government yet again showed its fiscal conservatism, choosing macroeconomic stability over populism:
- Many had feared fiscal giveaways last year too, given the politically important UP elections. This seems prudent, given the limited tolerance of financial markets globally to policy errors, and the economic damage market turbulence can cause.
- This is notwithstanding the increase in income tax slabs that helps a large majority of income-tax payers, as the foregone revenue of Rs 35,000 crore is only around a tenth of a per cent of next year’s GDP.
- The Union government’s commitment to the medium-term fiscal consolidation path was reiterated: A fiscal deficit of less than 4.5 per cent of GDP in fiscal year 2026.
- Given the strong tax buoyancy this year, the government could have taken a slightly lower tax-to-GDP ratio next year than the unchanged number it has assumed, but the benefits of greater digitisation and formalisation may continue, and lower tax rates often help tax compliance.
Areas of economy which are focused to reduce deficit
- Food and fertiliser subsidies had increased significantly during the previous three years, as had the expenditure on MGNREGA, as elevated unemployment increased demand for it.
- The allocations on all three fronts are lower for the next year as
- There is merger of the free-grains scheme with the PDS means that food subsidy can come down;
- The drop in global fertiliser prices necessitates less subsidy, and
- Demand for MGNREGA work has already come down as the job market has improved
- There is a risk that expenditure on all these fronts could eventually be higher, as energy prices could go up again, and headwinds to growth due to global problems could intensify. But the assumptions in the budget are reasonable on the current situation assessment.
Current Fiscal position of the government
- The general government debt to GDP ratio (which includes central and state debt) has fallen from 90 per cent in FY2021 to 83 per cent now, as nominal GDP growth has picked up, but it is still well above the 73 per cent seen pre-Covid, and the 60 per cent recommended by the FRBM Review Committee.
- For it to fall back to those levels, the primary deficit (fiscal deficit minus the interest payments) needs to fall to nearly zero.
- However, it is still near 3 per cent of GDP, and even at 4.5 per cent fiscal deficit in FY2026, the primary deficit would still be nearly 1 per cent of GDP.
- This requires deft fiscal management. Economies like India need to grow out of their fiscal problems and cannot shrink into them.
- This is because a faster moderation in aggregate expenditure would cause the economy to slow down, risking a downward spiral where the debt-to-GDP ratio starts to climb.
Frugal expenditure by government which promote economic growth with stability
- Allocations to railways and roads, as well as to schemes like Pradhan Mantri Awas Yojana and for energy transition should support growth both over the near term (via expenditure) as well as the medium-term (through cheaper logistics and greater energy self-sufficiency).
- It is encouraging to see the railways planning to spend Rs 2.9 lakh crore next year – their inability to invest rapidly and grow capacity has been a significant constraint on India’s growth. That they met their FY23 spending targets and asked for additional funds gives us a reason to be hopeful that they have turned the corner.
- In FY2024, the rise in spending is being financed through higher tax collections, with the deficit in rupees being largely unchanged:
- The fall in the deficit ratio is due to the growth in GDP. This process will likely continue for several years, and hopefully, in some years even the absolute deficit might come down, speeding up the process of fiscal consolidation.
- There may not be any room for fiscal profligacy for many years. In this regard, the demand to switch back to the old pension scheme for government employees, where taxpayer funds are used to guarantee benefits to a select group, is a risky one.
- Creating space for this level of borrowing is a challenge even if in a depressed economy savings are high and the demand for capital from businesses is subdued.
- Now that the net borrowing number has been relatively flat for three years and should hopefully be the same if not lower for the next few years, growth in the economy should make it incrementally easier to finance.
- That state governments this year may end up with an aggregate fiscal deficit of just 2.4 per cent of GDP versus the 3.4 per cent budgeted, given the surge in tax inflows and an inability to quickly ramp up spending, is also helping. The decline in bond yields on budget day is a sign, in our view.
Conclusion/way forward
- The turmoil in the global economy is likely to continue, as the impact of higher interest rates shows up in weaker demand for consumption and investment, and geopolitical tensions continue to disrupt energy supplies and trade.
- As the resilience of the domestic economy gets tested by global headwinds, deft fiscal manoeuvres are necessary while following path of stability.
Editorial 2. Union Budget 2023 big picture: Capex push, tax reform
Recent Context:
- Even though it is the last full-fledged Union Budget (for 2023-24) before the Lok Sabha elections of 2024, Finance Minister Nirmala Sitharaman chose to stick to the growth strategy that she first unveiled in 2019 when she announced a historic corporate tax cut.
This growth strategy had two prongs.
- One, incentivise the private sector in the economy to invest in the productive capacity and thereby create jobs and push growth
- The second part was about the government’s role in the economy. Here, the mantra has been minimum government. That, in turn, meant increasing the capital expenditure on the one hand, and raising more revenues via disinvestment and privatisation on the other.
- This was done to ensure that the government maintains fiscal prudence and doesn’t splurge on populist schemes
What is the current state of the Indian economy?
- Even before Covid, the Indian economy was suffering from a secular deceleration in growth. In the financial year 2019-20, which ended in March 2020, the economy grew at 3.7%.
- RBI’s research shows that India’s potential growth rate that rate at which it can grow without inflation becoming a problem has been falling over the past two decades.
- In the 2003-08 phase, which was India’s highest growth period ever, the potential growth rate was 8%. Between 2009 and 2015, it fell to 7%. As the Economic Survey said, by the time Covid hit India, the potential growth rate had fallen to 6%.
- The GDP is calculated by looking at the spending by four different segments of the economy.
- Of the four main engines of GDP growth private consumption which refers to what Indians spend in their personal capacity accounts for 56% of GDP. These expenditures had grown by just 8% over the FY20 levels.
- The second biggest engine for growth (accounting for 33% of India’s GDP) are the expenditures towards investments, which involves firms, both big and small, and the government’s spending on creating productive capacity, such as building a road. These were up 15% over FY20 levels.
- The third engine (accounting for 11% of GDP) is the everyday expenditures of the government (such as salaries). This spending is expected to be just 7% above FY20 levels.
- The fourth engine is called Net Exports (Imports minus Exports) and since imports are higher than exports, this has been pulling down the GDP, especially as exports have faltered due to the global slowdown.
- Over the next three years — FY21 to FY23 — the economy suffered a technical recession as well as a protracted period of high inflation.
- Most economists have argued that the biggest problem is that private consumption is weak. That’s because people have been suffering one blow to their income after another, and this has over time led to tepid demand.
- In the absence of demand, businesses have stayed away from investing heavily. Even the modest 15% increase over the past three years is largely towards replacing old investments, not making new ones.
What has the Budget tried to achieve in this situation?
- Faced with slowing domestic growth rate, global recession fears, persistently elevated prices, unemployment worries, high fiscal deficit. Finance minister decided to stay the course with the strategy she adopted in 2019.
Raising capital expenditure:
- Capital expenditure is the money that is spent on building productive assets such as roads, bridges, and ports. This has a greater return to the economy, and every Rs 100 spent leads to a Rs 250 gain for the economy. Revenue expenditure, on the other hand, returns less than Rs 100.
- The Budget has raised capital expenditure by the government to Rs 10 lakh crore — this is more than double the Rs 4.39 lakh crore of 2020-21.
Sticking to fiscal prudence:
- The FM has assured that the fiscal deficit (market borrowing by the government) will fall to 5.9% of the GDP. This is expected to have a salutary impact on the broader economy, as it suggests that money will be available for private entrepreneurs to borrow and invest.
New Personal Income Tax regime is now the default:
- Salaried Indians were expecting some relief on the income tax front. The FM provided it but in the so-called new personal income tax regime, which was introduced in 2020 but did not have many takers.
- The FM has used the incentives to popularise the income tax regime while also declaring that it will now be the default scheme. Until last year, it was optional, with the proviso that once you adopted it you could not go back to the old income tax regime.
Will the Finance Minister’s Budget strategy work?
- The Economic Survey released on Tuesday made a tacit admission that between 2014 and 2022, India’s economy hadn’t grown at the rate it was expected to.
- The Survey blamed unexpected shocks such as Covid pandemic and the war in Ukraine, apart from the old problems of banks being saddled with non-performing assets (loans that are not getting repaid) and companies that took on too much debt.
- It argued that 2023 would finally change India’s fortunes, and that for the remainder of the decade, India would see a growth surge similar to that witnessed from 2003 onwards.
Conclusion:
- Therefore, In Budget 2023-24, Government has stuck to the growth strategy that she first unveiled in 2019: stay on the path of fiscal prudence and incentivise the private sector to invest more in the economy’s productive capacity.