Union Budget 2021: Much cheer, some challenges

By Pranjul Bhandari, Paul Mackel & Andre de Silva

Indian Union Budget 2021-22: The government announced a larger than expected fiscal deficit for both FY21 and FY22:
1 A fiscal deficit of 9.5% of GDP for FY21, versus the budgeted target of 3.5% of GDP (HSBC: 7% of GDP).
2 A fiscal deficit of 6.8% of GDP for FY22 (HSBC: 5.8% of GDP; market expectation of 5.5% of GDP).
The fiscal deficit is now slated to reach c4.5% of GDP by FY26, (versus earlier target of 3% of GDP by FY24). The states will also be allowed to run higher deficits of 4% of GSDP in FY22 (and about 0.5% more if some conditions are met). All of this points towards higher borrowing. The government noted that it will borrow another Rs 800bn in the last two months of FY21. It also intends to borrow Rs 12.1trn in FY22 (HSBC: Rs 11.5-12trn, market expectation: Rs 11trn).

With this, we estimate that the public sector borrowing requirement of the government has risen from 8.5% of GDP in FY19 to a record 16.1% in FY21. Having said that, it is important to look into tax revenue assumptions, in order to get a more accurate estimate of deficit and borrowing. The government has assumed tax revenues contract 10% y-o-y in Q4FY21 (January-March 2021), versus +33% in the quarter earlier (October-December 2020). If instead, tax revenues were to grow by around 8% y-o-y in Q4FY21, it could lead to 0.4% of GDP high net tax revenues for the government. Coincidentally, this amounts to Rs 800bn, the exact amount by which the government aims to increase its FY21 borrowing. The government can then either cancel the extra borrowing, or carry it over as surplus cash balances to FY22.

Even in FY22, the assumption of tax buoyancy at 1.2 underestimates the revenue potential, in our view. Given the formalization of activity underway, if we get a tax buoyancy of around 1.6, net tax revenues will be 0.4% of GDP (Rs 840bn) higher. All of this means that the fiscal deficit and borrowing could be a shade lower than estimated in the budget, although still elevated (compared to the Rs 7.1trn gross market borrowing in FY20).

Some of the other numbers seem reasonable. For FY21, the government has assumed 103% y-o-y growth in expenditure in Q4FY21. We think most of it will be on food subsidy (expenditure under the National Food Security Act and procurement of food grains). Alongside, capex is also like to rise, with a focus on railways (capital acquisition and railways). For FY22, the nominal GDP growth of 14.4% y-o-y is lower than the 15.4% estimated in the Economic Survey. As mentioned above, the tax buoyancy of 1.2 underestimates the likely rise in revenues led by formalization. The disinvestment target of Rs 1.75trn is lower than the Rs 2.1trn budgeted last year, but still elevated, and will depend on market conditions and execution. As growth recovers, the mix of spending is budgeted to change—gradually moving away from social welfare, towards capex.

FY22: Impact on sectors and the macro-economy
1 Strong capex, weaker rural spend: The Centre’s capex thrust rose sharply in FY21 and is likely to rise further in FY22. Collating all expenditures in rural India, we find the rural thrust has come off a bit, following a large rise in FY21. This is understandable as the economy rebounds and migrant labourers return to their urban jobs. In particular, the outlays for the demand driven NREGA scheme has been reduced (Rs 730bn in FY22 versus Rs 1,115bn in FY21), even as outlays for the PM Kisan cash transfer programme remains unchanged at Rs 650bn.

2 Growth impact: With the expenditure and the fiscal deficit ratios falling in FY22, it seems at first glance that the fiscal impulse is negative. But this does not account for the improvement in the quality of expenditure. Indeed, we find that fiscal multipliers of capex far exceed that of current expenditure.

With capex rising (by 0.2% of GDP in FY22 and 0.6% of GDP in FY21), the growth impact may well be positive over a two-year horizon, even with a 2.3% of GDP fall in current expenditure in FY22.

3 Fiscal clean-up: One of the biggest innovations in the budget has been the fiscal clean up. Last year’s budget had come up with the concept of true fiscal deficit in which the government had attempted to add the off-budget items into the reported fiscal deficit. The true fiscal deficit was 1.1% of GDP higher than reported deficit in FY20. The main driver of this wedge was the unpaid bills to the Food Corporation of India. In today’s budget the government has decided to repay the dues to FCI once and for all. The true and reported fiscal deficit is likely to converge in FY22.

4 Debt woes: India’s government debt is likely to have risen to c90% in FY21. Incorporating today’s fiscal deficit data, the lowering of the debt could be rather gradual to about 85% of GDP in FY25. We believe that the scars of the pandemic will begin to show once the pent-up demand led rebound fades. Fiscal consolidation during that period can be difficult

Edited excerpts from HSBC Global Research’s India Budget 2021 (dated February 1)
Co-authored with Aayushi Chaudhary, Economist, and Priya Mehrishi, Associate, HSBC Global Research. Himanshu Malik, Asia-Pacific Rates Strategist, and Madan Reddy, Asia FX Strategist, The Hongkong and Shanghai Banking Corporation Limited

Bhandari is Chief Economist, India, HSBC Global Research, Mackel is Global Head of FX Research and Silva is Head of Global EM Rates Research at The Hongkong and Shanghai Banking Corporation Limited. Views are personal