Blueprint for a post-pandemic economy

The finance minister, by swiftly replacing with a tablet, the red-coloured cloth bag containing budget documents that she had famously described as the proud khata-bahi way of performing her most important job in parliament, has demonstrated that she is in step with an increasingly tech-savvy ambience. She also formalised a long-acknowledged fact that the annual budget is more an occasion and opportunity for the government of the day to showcase its economic and financial strategies and policies than a mere presentation of its bahi and khata (books of accounts). Also, going forward, the popular linking of budgets with announcements of lucrative sops and concessions, mostly on the direct taxes, is likely to be a thing of the past. However, as on earlier occasions, even the man on the street expected some addition to his or her disposable income from this budget as well.        

The popular linking of budgets with announcements of lucrative sops and concessions, mostly on the direct taxes, is likely to be a thing of the past.

If the response of the equity market in the hours following the budget is any indication, the finance minister received a thumbs up. It rose a decent 4-5% in a broad-based manner. The yield on government securities rose and their prices fell on concerns surrounding an additional Rs. 0.80 trillion market borrowing in the next two months.

The budget proposals met quite a few of the expectations that had accumulated over the last few weeks: large hike in the spends on public health and economic infrastructure, renewed focus on farmers and on capital expenditure, more structural reforms both in the real and the financial sectors, an increased push for disinvestment etc. The forecast on the setting up of a ‘bad bank’ for taking over the stressed loans of banks was divided, though. Fortunately, two much talked about possibilities that did not find a place in the budget are: levying of a Covid-19 cess on the income-tax payers and the widening of the range of the inflation target for the RBI from (4 +/- 2) % to (5+/-2) % to make room for further cuts in the policy rates.

Fiscal numbers

The budget deficit for 2020-21 at 9.5% of the GDP vis-à-vis the original estimate of 3.5% is a tell-tale sign of the extent and depth of the shock caused by the pandemic: while the gross tax revenue fell by 5.5% vis-à-vis 2019-20, the expenditure rose by 28.4%. Although, as per the finance minister’s speech, the combined amount of the three ANB packages implemented by the government to counter the contractionary effect of the pandemic was as high as at Rs. 27.1 trillion, constituting 13% of India’s GDP, it is not clear, at least intuitively, why the estimated fall in India’s GDP at around 8% in 2020-21 is going to be one of the sharpest among its peer group.

On the revenue side of the estimates for 2021-22, the growth in gross tax collection at 16.7% seems realistic, given the real GDP projection of 11%. However, going by the government’s past record in this regard, the disinvestment receipt estimated at Rs 1.75 trillion seems a trifle dreamy. Nevertheless, the adoption of a policy of disinvestment of public sector enterprises, in general, excepting only a few in four strategic areas is a path-breaking development that will mark an end to India’s disastrous dallying with the idea of the public sector enterprises controlling the ‘commanding heights’ of the economy. It is likely that the government will no longer aim to retain controlling stakes in the public sector enterprises in which disinvestment will happen. Further, the first-time use of the term ‘privatisation’ in the budget speech is noteworthy, as also the plan to privatise two public sector banks, apart from IDBI bank, and one general insurance company in 2021-22.

Despite the expected decent revival of tax receipts in 2021-22, albeit vis-à-vis a low base, as a proportion to GDP, they seem lacklustre. For example, the ratio of Gross Tax Revenues to GDP for 2021-22 at 9.9% would be lower than 11.2% recorded in 2016-17 and 2017-18. Similarly, the ratio of Direct Tax to GDP for 2021-22 at 4.9% would be less than around 6% in 2018-19, indicating again that the structurally higher reliance on indirect taxes is back.

In the Economic Survey of 2021, an entire chapter has been devoted to analyse the issue of debt sustainability from an Indian perspective. The sum and substance of that analysis is that as the real GDP growth rate of India has almost always exceeded its real interest rate, the country’s debt is sustainable, no matter what are the absolute or relative (to GDP) sizes of its debt. The chapter seems to make an argument that in situations like the current one when private investments are not readily forthcoming, the government should be able to borrow more or less in an unconstrained manner, including by way of money printing, if necessary, without any concern for inflation.

What it means in practice is that RBI will continue to buy government securities in large quantities through OMO as well as directly from banks, as in 2020-21, to support the government’s borrowing programme and also to keep the cost of borrowing low for the government. One would quickly add that this mode of fiscal dominance over monetary policy operations of the RBI will have a spin off benefit for the government: higher dividend payout from the RBI. The difficulty with this otherwise elegant proposition is that creation of real output sustainably by money printing is like a perpetual motion machine of the first kind. Something cannot be created out of nothing.                

Financial sector reforms

Among some of the welcome financial sector reform initiatives announced in the budget, the proposal to set up an asset reconstruction company (ARC) to take over the stressed debts of banks for the latter’s resolution/recovery has been discussed in the public space for quite some time. One obvious question that comes to mind is that in what ways is this new ARC going to be different from the extant ARCs in successfully taking over the NPAs of public sector banks which can rise to as high as 15-16% of their loans later in 2021.

A lurking fear is that this ARC itself may become a bad burden on the fiscal, unless a thoroughgoing set of supplementary reforms are undertaken to make the ecosystem for asset reconstruction effective and in sync with the best standards obtaining globally. There is still another issue: even if the government means business, the setting up of the ARC will take plenty of time. What happens in the interim? The public sector banks will need much more capital than the Rs. 0.20 trillion earmarked in the budget to provide for their NPAs and also to expand their businesses.                  

The finance minister’s job was cut out on this budget presentation day as she was required to do a fine balancing act among too many competing and complex considerations, given the current context. She shunned populist measures, sounded confident and reassuring, provided reasonably credible indications of the path to be followed by the government for growth-enhancing reforms in the days to come and signalled a resolve that the government is ready to convert the crisis caused by the pandemic into an opportunity. But fiscal consolidation now looks like a distant dream.   

(The writer is a former central banker and consultant to the IMF)