Union Budget 2021: A growth-focused, credible Budget

Indian Union Budget 2021-22: The Union Budget FY22 clearly chose to boost growth, at the cost of budgeting higher-than-expected fiscal and primary deficit for both FY21 and FY22. Overall, this Budget will be seen as a ‘growth-supportive one’, which intends to maintain higher fiscal support for the economy to ensure that the ongoing growth recovery gains traction through FY22. We highlight a few aspects of the Budget:

—Fiscal, revenue and growth targets: We had expected the government to show a revised estimate figure of 8% of GDP for FY21 and 5.5% of GDP projection for FY22, though we ourselves had factored in 6% of GDP fiscal deficit projections for FY22. The government projections pertaining to fiscal deficit turned out to be higher relative to our own estimates. FY21 fiscal deficit was revised up to 9.5% of GDP (from 3.5% of GDP provisional estimate) and the FY22 fiscal deficit target was set at 6.8% of GDP.

The good thing about this Budget is that authorities have kept the projections realistic and, in this regard, there is limited risk of any upward slippage to the 6.8% of GDP fiscal deficit target. The nominal GDP growth assumption of 14.4% year-on-year is realistic and probably builds in some risk factors that could potentially emerge during the course of FY22. The overall revenue estimate projection of 23% year-on-year growth and 16.7% year-on-year growth projection for gross tax revenue look credible and will most likely be met. The disinvestment target has been taken at Rs 1.75 trillion (or 0.8% of GDP), which was lower than market expectations (Rs 2.1 trillion), but this is a prudent strategy, in our view, as a large shortfall like in the case of FY21 could jeopardise the fiscal arithmetic easily and lead to an unhealthy uncertainty-premium being priced in by the markets persistently.

—On-balance sheet versus off-balance sheet expenditure: The upside surprise to fiscal deficit estimates has been mainly on account of higher expenditure. FY21 expenditure was revised up to 17.7% of GDP, from 13.5% of GDP budget estimate, to account for higher on-budget food subsidies and fertiliser arrears and also as a signal that government expenditure momentum will remain strong in January-March 2021 and beyond. Relative to the high expenditure base of 17.7% of GDP, total expenditure is expected to moderate to 15.6% of GDP, as per the FY22 budget estimates, which will still result in 1% year-on-year growth. The government has seen to it that at least the same level of expenditure is maintained for FY22 in absolute terms, so as to ensure that the fiscal stance does not become restrictive for growth.

The allocation for FY22 capital spending is Rs 5.5 trillion (2.5% of GDP), 26.2% year-on-year higher than the FY21 revised estimate of Rs 4.39 trillion or 2.25% of GDP. The entire spending allocation for food subsidies has also been provided on-budget in FY22 (Rs 2.43 trillion or 1.09% of GDP), instead of funding part of it from the NSSF corpus, as was the usual practice in the last few years. Consequently, the allocation for extra-budgetary resources (EBR) has been reduced to only Rs 300 billion for FY22 or just 0.1% of GDP, compared to Rs 1.48 trillion (0.73% of GDP) in FY20 and Rs 1.26 trillion in FY21 (0.65% of GDP). Basically, what the authorities have done is restate the off-balance sheet spending as on-budget spending, which has led to an increase in budget deficit and market borrowing relative to expectations. Despite the increase in on-budget fiscal deficit, we welcome this move as it gives a much clearer picture of the fiscal position and helps to usher in transparency.

—Small savings: Apart from market borrowings, India’s dependence on funding its fiscal deficit through the small savings component has increased significantly in the last few years (26% of fiscal deficit was funded through small savings in FY20 and the same trend is estimated to persist in FY21 and FY22 as well).

—Debt sustainability: The latest Economic Survey points out that India does not need to worry significantly about public-sector debt sustainability risks, as nominal GDP growth will continue to be in excess of nominal interest rate in the coming years, with FY21 being an exceptional year experiencing a reversal of this dynamic, leading to a significant increase in the public sector debt/GDP ratio. We agree with the thesis that a robust nominal GDP growth rate matters more than any other parameter for India’s debt sustainability trajectory, and as long as growth rate remains higher than interest rate, debt/GDP will follow a declining path. However, the slope of the decline in debt/GDP trajectory will depend on the extent of the growth-interest differential and also on other parameters such as fiscal consolidation effort (compression of primary deficit), and in this regard the medium-term glide path provided by the authorities to bring the fiscal deficit below 4.5% by 2025-26 is encouraging.

—Sovereign downgrade risks: Do the higher budget deficits raise the risk of any potential sovereign ratings downgrade? In our view, this is extremely unlikely as India has shown significant progress in economic recovery since the last year’s downgrade (to negative outlook) by rating agencies, with the macro landscape likely to look even better in the coming period as growth momentum gains traction and the government reduces the fiscal deficit to 6.8% of GDP in FY22, from 9.5% of GDP in FY21. What may happen is that the global rating agencies who have a negative outlook on India’s sovereign rating may delay changing the outlook back to stable or positive, to look for more evidence regarding the sustainability of recovery, but we don’t think there is any credible justification for a further downgrade to India’s sovereign ratings from the current levels.

The author is India chief economist, Deutsche Bank