While the Budget 2022-23 is presented as a “growth” support budget, under the hood it delivers a rather complicated message. To see that you have to decompress the budget and that means (with my apologies to the readers) wading through the numbers. But patience has its rewards.
Let’s start with the deficit for the current year. The budget estimates it at 6.9 percent of GDP. Even with falling privatization receipts, unless tax receipts – which rose 44% year-on-year through December – suddenly drop this quarter, the deficit is expected to be below 6.6% of GDP in a replay of the dynamic end of the year in 2020-21. Faced with such an eventual outcome, the deficit target of 6.4% of GDP for 2022-23 is hardly a consolidation.
But isn’t that what a pro-growth budget should do? Prima facie, yes, but not when you analyze the message it delivers. If the budget is any indication, then overall public sector borrowing (Center, State and UAP combined) will likely decline from 11.5% of GDP to 11% of GDP next year. This will have to be financed by the net savings of the private sector (savings of households and companies minus private investment) and external borrowing (the current account deficit). The arithmetic for this year looks like this: the budget deficit of central and state governments, which amounts to about 11.5% of GDP, is financed by 10% of net private savings and 1.5% of GDP through external borrowing (the current account deficit).
Thus, for the next fiscal year, private consumption and investment combined can only increase by 0.5 percentage point of GDP without increasing external borrowing. In other words, if India’s private consumption and investment are to increase by more than 0.5 percentage point of GDP, then foreign borrowing – the current account deficit – will necessarily have to increase. It has little to do with the economy. It’s just the tyranny of arithmetic.
In normal times, India struggles to finance a current account deficit of more than 2.5% of GDP without facing severe depreciation pressures on its currency. Doing so in a year when global financial conditions are set to tighten sharply as the US Fed pledges to raise interest rates and remove quantitative easing will be all the more difficult. This arithmetic had to be obvious to the government. Thus, by limiting effective consolidation to just 0.2 percentage point of GDP, the message is being sent that the private sector is not yet ready to lead the recovery in India and that, for the fifth consecutive year , growth will have to be driven by the public sector.
Why is it important that growth be led by the public or private sector? This is important for two reasons. First, the need of the hour is to generate not only growth but also employment. And the public sector doesn’t create many jobs, nor do companies, start-ups or infrastructure investments. Most jobs are created by SMEs. And it is the SMEs that have been hurt over the past five years. First by demonetization, then the troubled implementation of the GST, and now the pandemic. But the budget does not provide any significant support to this sector. It extends the ECLGS for another year, which for all intents and purposes is just a forbearance for banks that have provided loans to SMEs. This is unlikely to encourage SMEs, whose balance sheets have been seriously damaged in recent years, to start investing or developing employment.
The second reason is that growth through public spending has a high cost and is not sustainable beyond a few years. Pressures are already building with the steep rise in public debt over the past five years to almost 90% of GDP at present. This increase in debt puts continued upward pressure on interest rates and makes it all the more difficult to control government interest payments (currently 3.5% of GDP) without substantial purchases of obligations by the central bank. This, in turn, seriously complicates monetary operations and communications as it becomes difficult to determine whether the central bank is targeting inflation or bond yields.
The RBI will be tested. Gross government borrowing next year will be 14.2 trillion rupees, compared to 10.5 trillion rupees this year. If the private sector wants to revive even a little, it will have to borrow more. In this case, it is highly unlikely that the government could raise such a large amount without interest rates rising sharply, unless the RBI buys a substantial amount of bonds. This means that the RBI will be forced to add more liquidity exactly when it should reduce the high and excessive amount already in the banking system. As the US Fed prepares to hike interest rates aggressively in the coming months, this will test the RBI’s ability to juggle its multiple objectives. So far in the pandemic, he has done an admirable job of doing so. But this budget makes the act of juggling much more difficult and higher inflation or financial instability could be the victims.
There is one area where the budget seems to have created space to respond to potential requests for additional support, although not very transparently about it. Gross taxes are expected to decline to 10.7% of GDP from the 11.4% of GDP we expect this year (after adjusting for this year’s understatement, as noted earlier). Effective fiscal buoyancy (ie by how much taxes increase for a 1% increase in GDP) is therefore only 0.4 against an expected result of 1.8 this year. Therefore, there is a clear advantage to next year’s fiscal projections, which could be used either to reduce the overall deficit or to offset any reductions in excise duties that may be needed to stabilize retail oil prices in case of a global crude oil boom, for example, due to geopolitics.
Thus, while there is room for maneuver to deal with contingencies, the budget has complicated macroeconomic management and the continued emphasis on public sector-led growth raises concerns about the sustainability of such a policy. strategy with debt already at such a high level.
This column first appeared in the print edition of February 4, 2022 under the title “Unpacking growth”. The author is Chief Emerging Markets Economist, JP Morgan. These are his personal opinions