A Budget that is medium term growth-oriented

The most commendable aspects of the FY23 Union Budget are that it eschews populist spends despite the oncoming State elections, choosing instead to focus on the medium term and trying to establish process reforms to increase India’s potential growth rate. While capital expenditure spends have been increased over 24.5% yoy over FY22 RE, revenue expenditures are up only 0.9%. Capital spending is up by almost Rs 1.5 lakh crores (lc) to Rs 7.5 lc.

But the government will find raising resources a challenge

The macroeconomic context for the Budget and the overall fiscal policy stance is likely to be challenging. Although India’s growth – inflation tradeoff is likely to become more favourable in FY23, multiple risks are emerging. India will face much tighter external financial conditions in 2022. Many of the G-10 central banks are expected to start raising their policy rates and roll down their balance sheets. IMF forecasts a slowdown in global economic and trade growth in 2022. China remains a wildcard, with signs of a marked slowdown, and policy stimulus likely resulting in some further hardening of metals and ores prices. Crude oil markets are likely to remain tight in 2022, particularly with reviving travel.

CPI inflation in India is expected to moderate from an average 5.4% in FY22 to 4.8% in FY23, but there are many upside risks, both global and domestic. If domestic recovery is quicker and more broad-based, this is also likely to result in input costs passed on to end-user prices.

Although India’s growth – inflation tradeoff is likely to become more favourable in FY23, multiple risks are emerging

The major constraint for the Budget is arranging the resources for the outlays on the various programmes. The gap between the receipts and expenditures – the Fiscal Deficit – is projected at a slightly higher than expected 6.4% of nominal GDP at Rs 16.6 lc, but the recourse to market borrowings through bonds is higher than expected, as a result of which benchmark bond yields have risen sharply in the past couple of days. Note that many of the buyers will have a lower appetite for bonds in a rising interest rate environment. Banks, for instance, are expecting a higher credit offtake in FY23, and this will constrain the space for buying bonds. In addition, RBI will probably be unable to support the borrowing programme through Open Market Operations bond purchases, given the constraints of the expected monetary policy normalisation process. In addition, State government fiscal deficits are likely to be high, particularly since the compensation cess transfers from the Centre will be in June 2022.

There is room for reducing the borrowing quantum however. First, the Budget projections are based on a nominal GDP growth projection of 11.1% for FY23. Our view is that India’s real GDP will grow at 8.3% in FY23, post an expected 9% this year. The Economic Survey forecasts growth at 8-8.5%, the IMF considerably higher at 9%. With inflation around 4.5-5%, the actual growth is likely to be higher at 13-14%. This will open up space for garnering additional tax revenues. Corporate tax revenue growth, for instance, is projected at just over a modest 13% and this is also likely to be exceeded, but probably at a much lower rate than the expected eye-popping 39% yoy in FY22; corporate earnings growth is expected to remain strong in FY23.  

If domestic recovery is quicker and more broad-based, this is also likely to result in input costs passed on to end-user prices

In addition, the projected dividend is a modest Rs 1.14 lc (vs a robust Rs 1.47 lc in FY22) and we expect this to be significantly overshot, with strong dividend payouts by both RBI and public sector financial institutions. It is difficult to comment on the modest disinvesment target of Rs 65,000 crores, since this is subject to financial market conditions, which are likely to be volatile

On the borrowings numbers, the gross borrowing target of Rs 14.95 lc will be reduced by the switch of some securities maturing in FY23 with longer dated bonds; this amount is around Rs 60,000 crores. Of crucial importance will be the drawdown of cash surplus of the Centre, which is budgeted at a small Rs 752 crores for financing this deficit. Our calculations based on current balances and a likely revenue and expenditure profile over February-March FY22 suggest this surplus could potentially be much higher.

Over a longer horizon, augmenting resource mobilisation has to become a priority for the Centre. Gross tax revenues have hovered between 10-11% of GDP in the past 5 years. On the other hand, sequestered expenditures constitute a uncomfortably high share of total receipts. The Finance Commission recommended devolution to States of non-cess receipts are currently 42%. “Committed” expenditures – interest payments, salaries and pensions – have remained a high share of the residual receipts of the Centre, averaging 57% during FY18-FY22. Food and fertiliser subsidies have averaged another 22%. There are other “quasi-committed” expenditures. This allows very little flexibility in using fiscal levers to achieve broader objectives.

Broadening the taxpayer base is critical, but difficult given the evolving income distribution. The increasing formalisation of the economy, tax analytics and taxpayer databases suggest this is going to be feasible over a period of time. In the interim, the focus must be on non-tax revenue sources. The Asset Monetisation Plan comes to mind, and divestment of non-strategic assets must be aggressively explored.

India’s medium term growth outlook is looking increasingly better. The private sector capex cycle is beginning to increase. Balance sheets of corporates and financial intermediaries are much stronger. The massive structural changes that have happened over the past few years – formalisation, digitalisation, widespread adoption of technology – provide large potential opportunities. The Centre and State governments have an opportunity now which should not be lost.

(The writer is the Executive Vice President and Chief Economist, Axis Bank Views are personal)