Budget 2022: Economists' View On The Budget’s Textbook Formula For Growth

Budget 2022 takes forward several themes from the last year—an emphasised focus on capex and a very gradual fiscal consolidation.

<div class="paragraphs"><p>A textbook sits on a desk during a mathematics class at the Vinschool, operated by Vingroup JSC, in Hanoi, Vietnam, on Thursday, Dec. 5, 2019. Photographer: Yen Duong/Bloomberg</p></div>
A textbook sits on a desk during a mathematics class at the Vinschool, operated by Vingroup JSC, in Hanoi, Vietnam, on Thursday, Dec. 5, 2019. Photographer: Yen Duong/Bloomberg

The Budget 2022 takes forward several themes from the last year—an emphasised focus on capex and a very gradual fiscal consolidation.

India’s budgeted capital expenditure for the upcoming fiscal saw a jump of more than 35% to Rs 7.5 lakh crore. The budget pegged the FY23 fiscal deficit at 6.4% and higher-than-expected gross borrowings at Rs 14.95 lakh crore.

With the focus on capex and with revenue expenditure budgeted to increase by less than 1% in FY23, QuantEco Research said the quality of spending is expected to be the “best in near two decades”.

Credit Suisse, however, said all the increase in capex may not all be fresh funding. “A large part of capex growth (is) an interest free loan to states and off-budget spending brought in,” Neelkanth Mishra, India strategist at Credit Suisse, said.

Muted Impact On Growth

The government’s fiscal policy since the pandemic began has prioritised growth and fiscal transparency over fiscal consolidation, in the hope that robust growth is achieved in the medium term, which would help with debt sustainability, Nomura said in a note.

Still, the pick-up in fiscal impulse is modest.

We estimate the fiscal impulse at about 0.77 percentage points in FY23, marginally up from 0.68 percentage points in FY22.
Sonal Varma & Aurodeep Nandi, India economists, Nomura

The research house, however, sees challenges due to execution, risk of pruning capex due to higher revenue expenditure and other growth headwinds—domestic and global. Nomura estimates real GDP growth at 7.8% year-on-year in FY23, below the government’s forecast of 8.0-8.5%.

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Short On Structural Reforms

“Deficit targets presented in the Union budget are a bit higher than our forecasts when we affirmed India’s ‘BBB-’/negative sovereign rating in November,” said Jeremy Zook, director and primary sovereign analyst for India, Fitch Ratings. “Our expectation of modest fiscal outperformance in FY22 from last year’s budget target appears unlikely to materialize, with the budget flagging a revised deficit of 6.9% of GDP against our 6.6% forecast.” The planned 6.4% of GDP FY23 deficit is also higher than Fitch’s previous 6.1% forecast.

Beyond the capex drive, the budget was short on major growth-enhancing structural reform announcements, Zook said.

The gradual pace of fiscal consolidation continues to place the onus on nominal GDP growth to facilitate a downward trajectory in the debt ratio, which is key to resolving the negative outlook on the sovereign rating. Fitch ratings estimates GDP to grow by 10.3% in FY23, higher than most others.

The planned acceleration in the infrastructure capex drive will likely provide a fillip to near- and medium-term growth, if fully implemented. “We will be assessing whether the capex drive’s growth impact is sufficient to offset the higher-than-expected deficits and keep the debt ratio on a slight downward trajectory.”

“From a ratings perspective, we see India as having limited fiscal space as it has the highest general government debt ratio of any ‘BBB’-rated emerging market sovereign at just under 90% of GDP.”

A Realistic Budget

The fall in tax buoyancy from 1.4 in FY22 to 0.9 in FY23 is reasonable as lower oil taxes for the full year kick in, said Pranjul Bhandari, chief economist at HSBC.

While the rise in capex by a large 0.4% of GDP in FY23, (after cleaning off the Air India impact from FY22 numbers), would normally have been a rather large increase for the central government to implement, a bulk of it will be funds made available to states in the form of interest free loans. As such the increase seems possible to get done, Bhandari said.

But a higher-than-budgeted nominal GDP number could statistically push the fiscal deficit ratio lower and gross market borrowings could be lower than the Rs 15 lakh crore estimated. Though lower than budgeted, the overall borrowing will still likely be elevated, leading to bond market pressure.

Bond Index Inclusion A Big Miss

The budget focused on inclusive growth driven by tech and spending push, BofA Securities said in a note. While the reform push was on point, the budget was silent on any tax tweak to enable the inclusion of India bonds on global indices, which was keenly awaited. “This disappointed the bond markets as they reeled under the pressure of higher than expected borrowings.”

Quality Of Fiscal Spending To Improve

“We like to look at the revenue deficit/fiscal deficit ratio (the lower the ratio, the better) to gauge the quality of fiscal spending,” Kaushik Das, chief economist at Deutsche Bank, said. “Since FY17, which recorded a low of 59.1%, the revenue deficit/fiscal deficit ratio has moved up to 79.7% in FY21, indicating a deterioration in the quality of fiscal spending, exacerbated by the pandemic.”

The FY23 revised estimate pegs the ratio at 59.6%, similar to the FY17 lows and lower than the FY22 revised estimate of 68.4%, he said. “If the FY23 target of 59.6% is achieved, it will result in a significant improvement in quality of fiscal spending.”

Responsible Fiscal Expansion

The budget exercise over the past few years has undertaken the important initiative to progress along the path of transparency, Suyash Chaudhary, head of fixed income at IDFC Mutual Fund, said.

This has had multiple facets—bringing below-the-line financing above the line, clearing up arrears, and projecting conservatively. This has meant that fiscal expansion since the pandemic has in fact been even more responsible than what the headline numbers indicate, once these items are adjusted for.

Also, alongside building more credibility, it has provided important fiscal flexibility for the government; perhaps for the first in many years. This means that instead of wondering a little after mid-year as to how deficit targets will be met and what revisions to market borrowing may have to be undertaken, the bond market has instead been able to look forward to almost boring predictability on the numbers landing in the area of where they were projected. The current budget takes this exercise in transparency forward.

Watch the conversation with HSBC's Pranjul Bhandari and Nomura's Sonal Varma here