Budget 2021: Consolidating under the cover of growth

By Sonal Varma & Aurodeep Nandi

Indian Union Budget 2021-22: The fiscal trends during FY21 turned a corner in the Oct-Dec quarter. The stronger pace of economic normalisation has translated into a sequential improvement in revenues. However, this increase is unlikely to reverse the unprecedented drop in collections. Overall, tax revenues (net) will contract by 7.2% y-o-y in FY21 after rising 2.9% in FY20; spending likely rose by a more muted 6.6% in FY21 after a 16% gain in FY20. Thus, the fiscal deficit may widen to 6.8% of GDP in FY21.

The economy is poised for a strong cyclical upsurge in 2021. A combination of factors should lead to a strong growth outturn in FY22 (real GDP growth of 13.5%, on our estimates). Consequently, we expect the government to assume nominal growth of 15% y-o-y from -4.2% y-o-y in FY21 (AE). An additional factor weighing on the Budget will be the disparity in the pace of recovery between organised & unorganised, goods and services sector, suggesting policy support.

However, the improving economic situation means that, unlike other countries that are in the midst of lockdowns, India does not have to worry about renewing survival-styled fiscal support. The government will probably draw down some of the ‘survival phase’ measures that it had announced this fiscal.

The deleterious impact of the pandemic on the informal economy will only likely appear statistically with a lag. India is most likely going through a classic K-shaped recovery.

So how much will the government really save? We estimate that the government will spend 1.8% of GDP on pandemic support measures in FY21. However, this does not mean that it is poised to regain equivalent fiscal space in FY22. Measures such as increased outlays for the universal employment guarantee programme, capital spending, higher fertiliser spend, affordable housing, will probably amount to ~0.9% of GDP, are likely to continue in FY22. The first installment of the newly introduced PLI scheme for manufacturing firms (~0.8% of GDP to be spent over five years), and almost 1% of GDP worth of spending from measures introduced in FY21 are likely to feature in the FY22 Budget.

We expect robust expenditures, rising by 9.5% y-o-y in FY22, after a less-substantial 6.6% in FY21. In light of the farm protests, it may also choose to expand PM KISAN. In terms of vaccination costs, news reports suggest the government is negotiating prices at a little over Rs 200 per dose. The total vaccine bill could cost 0.2-0.3% of GDP.

Consequently, we expect revenue expenditure growth to rise 8.7% y-o-y in FY22. Similarly, on the capex side, we expect outlays as a proportion of GDP to remain broadly similar at close to 1.9%. This implies a larger increase of 14.7% y-o-y in FY22 vs FY21 estimate of12.5%.

The govt should benefit from some relief on the revenue front on two factors: 1) a sharp rise in nominal GDP growth led mainly by higher real growth rather than inflation; and 2) the government is likely to retain higher excise duties on fuel products and possibly impose higher sin taxes and a potential ‘Covid-19 cess’. The latter, if imposed, would likely marginally weigh on consumer disposable incomes but, given the overall rise, should still improve tax buoyancy.

Overall, we assume direct tax buoyancy in FY22 at similar levels as FY19 and much better than FY20, when lower corporate tax rates hurt collections; this assumption is also supported by our view of higher household incomes. Overall, gross tax revenues will be Rs 21.7trn (9.7% of GDP) in FY22—16.2% higher.

There are three key sources of non-tax proceeds that are material to the fiscal bottom line. For the FY21 Budget, the RBI approved a dividend transfer of Rs 571bn. There are reports that the government is nudging public sector companies to declare higher dividends if they are unable to adequately add to capex, and that the rise in crude oil prices is helping public sector oil companies. Also, some public sector companies have been urged to consider share buy-backs.

Consequently, we expect the government to achieve proceeds close to 0.6% of GDP (budget target = 0.7%). For FY22, we assume the government will budget a similarly high number. Telecom-related revenues appear set to disappoint. FY21 has been a disappointment. High profile disinvestments such as LIC, Air India and BPCL will be pushed to FY22, implying a large disinvestment target (Rs 1,600bn).

We expect the fiscal deficit to be set at 5.3% in FY22. It may offer a range, consistent with suggestions of 15th FC, although this would require an amendment to the FRBM Act. We expect the govt to fund around 70% of the deficit through net market borrowing. With Rs 2.7trn redemptions lined up, this would suggest gross borrowing of ~Rs 11trn, down from Rs 13.1trn in FY21.

This budget is important from the perspective of sovereign ratings. Rating agencies are likely to revisit their assessments of India in Q1.

With rating agencies building in a consolidated fiscal deficit for FY21 at 12-13% of GDP and public debt above 85-90%, the deficit outturn in FY21 is likely to be better than expectations. However, agencies will be looking for a fiscal consolidation path that stabilises public debt at current levels and then trends lower.

It may offer a roadmap that lowers the deficit to 4% by FY26, still above the original glide path of 3%. Rating agencies will also likely evaluate its intent, as fiscal consolidation will be trickier in FY23, when nominal growth settles back down as govt will then have to either cut spending or expand its revenue base.

Many of the key themes in the FY22 Budget will emanate from Covid-19.

Govt will likely increase outlays on health and may offer I-T benefits related to hospitalisation expenses. Given the K-shaped recovery, we expect increased outlays for rural employment, nutrition, education and sanitation, and focus on improved public delivery. There will be additional allocations on procurement and distribution of vaccines.

It may specifically target sectors like construction, retail, etc, by offering regulatory easing, easing FDI restrictions and offering credit guarantee facilities; also likely to announce higher recapitalisation of PSBs.

The Budget will likely focus on boosting domestic manufacturing and encouraging exports to accelerate India’s integration in GVCs. It may also increase customs duties on imports of electronics and other products. Additionally, it may promote green industries and help MSMEs with ease of doing business, job promotion and skill development.

It is likely to increase its capital outlays for infrastructure projects, and address financing issues related to projects in the NIP by setting up a DFI.
Given the ongoing farmer protests, the govt is likely to reiterate its commitment towards MSP, while announcing incentives around fertilisers, food processing, logistics, irrigation, and R&D.

It may look to increase I-T exemptions while applying Covid-19 cess on high earners. Also, continued steps towards reforming corporate bond and capital markets are likely to be discussed.

Excerpted from Asia Insights, Global Markets Research, Nomura, dated Jan 19

Varma is chief economist, India and Asia ex-Japan, and Nandi is India economist, Nomura. Views are personal