PremiumA week from now, Finance Minister Nirmala Sitharaman will present the second consecutive Union Budget with an eye on free-flowing spending taps to prop up the fragile economy. But imminent bond redemptions in the coming years present one big hurdle. As bond yields rise, the Centre’s task is well cut out: put a lid on market borrowings in 2022-23 and embark upon the fiscal consolidation path, even if at a slow pace—all while not losing sight of the spending needs that are far from over.
Healthy tax collections, which are likely to continue into 2022-23, could provide some wiggle room to keep up the capital expenditure. That, and a faster-than-expected nominal GDP growth, put the government in a fiscally comfortable position in 2021-22 so far. Fiscal deficit was only 3% of the estimated full-year GDP till November. However, two supplementary demands for grants brought into Parliament by the government, with a net cash outgo of ₹3.2 trillion, could very well eat into the fiscal space in the remaining months.
Loosening the fiscal deficit target to allow spending is no longer an option. Rather, Sitharaman will be expected to tighten it to rein in debt. More worryingly, a third of the additional spending is on account of subsidies. While economists are in favour of keeping the emphasis on capital expenditure, avoidable revenue expenditure may come under scrutiny. Citing the need to rebuild fiscal credibility “as the dust from the pandemic slowly begins to settle", analysts at QuantEco called for a “phasing out of pandemic-era exceptional expenditure support".
All this places the upcoming Budget against a tricky backdrop.
Redemption pressures
The present economic scenario could allow the government to cut its fiscal deficit target to around 5.8-6.5% next year as against the budgeted 6.8% for this year. However, more than the fiscal deficit, all eyes will be on gross borrowings this time.
Gross borrowings comprise both the amount borrowed in a given fiscal year and the repayment dues. In 2022-23, bonds worth about ₹3.8 trillion are due for redemption. Even in the coming years, repayment obligations are set to stay high, as pointed out by the Reserve Bank of India (RBI) in its December financial stability report. This means gross borrowing will remain exceptionally high, notwithstanding fiscal consolidation.
In such a scenario, the government needs to find ways to boost revenues to support spending on capital accounts. Big-ticket disinvestments, which look unlikely this year, may offer additional revenue support. The government may also require the RBI’s support to carry out switches to bring down redemption pressures.
Need to diversify
Bond yields are already on the rise and the imminent monetary policy tightening by the RBI will only increase the government’s cost of borrowing. But this does not mean the Budget should cut down on the much-needed spending.
“Expenditure thrust has to be there for a couple of years," said Anubhuti Sahay, Head (South Asia), economics research, Standard Chartered Bank. “But whatever room is available for fiscal consolidation has to be taken, along with diversification of the sources of funding."
For one, the government has been looking to pave the way for India’s inclusion in global bond indices to diversify funding sources and ease pressure on domestic markets. The matter is stuck as managers of bond indices want a waiver on capital gains tax on bond transactions. Some of the required tax changes should come in this Budget to diversify borrowing, Sahay said. India’s entry in global bond indices could lower borrowing costs by 30-50 basis points, estimates Morgan Stanley.
Spend, Spend, Spend
All said, the challenging backdrop against which the Budget will be presented should not keep the government from increasing capex markedly, economists said. “The government can effectively rely on a growing economy to drive the increase in revenues over the next two to three years for fiscal consolidation," said Rahul Bajoria, chief India economist at Barclays. N.R. Bhanumurthy, vice-chancellor at B.R. Ambedkar School of Economics University, concurs. “The government needs to generate more resources to spend more, and not cut spending, to meet deficit aim," he said.
The most sustainable way to achieve this is by reverting to the original Fiscal Responsibility and Budget Management Act to pave the way for higher revenue generation by raising the growth potential, Bhanumurthy added. The last Budget had omitted the mention of debt-to-GDP ratio. Perhaps, a credible medium-term pathway can be chalked out to bring down debt-to-GDP ratio in the coming few years. This can be done more effectively by increasing the GDP.
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