BUDGET 2021–22
Fiscal Policy and Growth in a
Post-COVID-19 World
Public Sector Driven Growth
Sajjid Chinoy, Toshi Jain
Why was India’s growth slowing
in the run-up to COVID-19 and
how much fiscal space was used
to stem the slowdown? What is
the nature of India’s economic
recovery from COVID-19? How
does the budget seek to balance
fiscal support while reducing the
deficit? What was the underlying
fiscal impulse in the COVID-19 year
and what is it budgeted to be next
year? What are the implications
for debt sustainability and
fiscal–monetary coordination?
Finally, what are some paradigm
changes the budget seeks to
embark on and why is execution
so crucial this time? This essay
seeks to answer these questions to
make sense of growth and fiscal
dynamics in a post-COVID-19 world.
All views are personal.
Sajjid Z Chinoy (sajjid.z.chinoy@jpmorgan.com)
and Toshi Jain (toshi.jain@jpmorgan.com) are
the India economists at JP Morgan.
10
the pre-COVID-19 year, these fears combined with an increasingly impaired
financial sector to pull private consumption growth down to 5.3%—the lowest
since the global financial crisis (GFC).
T
While the contribution of private consumption to pre-COVID-19 growth is well recognised, that of the public sector is much
less so. Unbeknownst to many, government consumption growth had averaged
a sizzling 9% between 2014 and 2020 with
the pace increasing over time. In fact, since
2017 government consumption growth
has averaged 11%, rates not seen since
the GFC. In the pre-COVID-19 year, for
example, public administration grew at
almost four times the rate of the private
sector—proxied by core gross value added
(GVA) growth (Figure 1). These dynamics
help explain why the public sector’s borrowing requirements (PSBR s) have remained elevated in recent years and increased to almost 10% of GDP in 2019–20.
Despite the support provided by the
public sector, the slowdown in private consumption and the choppiness of exports
meant manufacturing utilisation rates had slipped to below
70% for three consecutive
quarters in 2019–20, inducing
a three-quarter contraction of
investment heading into the lockdown.
India therefore entered COVID-19 with
both private consumption and investment
slowing, necessitating much fiscal space
to be used even before COVID-19.
o understand the macroeconomic context of India’s first postCOVID-19 budget, it is important to
understand both the evolution of India’s
economy in the pre-COVID-19 years and
the nature of the economic recovery
from COVID-19.
First, gross domestic product (GDP)
growth averaged almost 7% between 2014
and 2020. Yet, that average masks significant temporal and sectoral heterogeneity.
Growth averaged almost 8% between
2014 and 2017—helped by a positive terms
of trade shock from lower oil prices—
before slowing discernibly for three
years to 4% in the pre-COVID-19 year.
Second, the drivers of growth in this
cycle were very different from the previous
cycle. Strong export growth (~16% a year)
had induced double-digit investment
growth (~11% a year) between
2002 and 2011. In contrast,
India’s growth post 2013 was
driven largely by consumption
—both private (well acknowledged) but also public consumption (largely
unrecognised). Private consumption averaged 7% in the six years pre-COVID-19, but
much of this was financed by households
taking on debt and running down savings,
as they were increasingly able to tap formal credit channels, and therefore, sought Recovering from COVID
to smooth lifetime consumption levels. That said, India’s near-term recovery from
Consequently, individual debt jumped COVID-19 is proceeding slightly faster than
from 19% to 28% of GDP between 2015 and the originally-envisioned double digit con2019, though still not high by emerging traction, aided by two phenomena. First,
market standards.
Figure 1: Growth Dynamics—Government Spending versus
Sector
By 2019, however, with Private
% oya
the economy in the midst of 12
Public administration
a three-year slowdown, risks 10
were mounting that house- 8
holds would begin to per- 6
ceive the slowdown as being 4
Core GVA
more permanent and ac- 2
(Private sector business cycle)
cordingly adjust consump- 0 12
13
14
15
16
17
18
19
tion downwards. Indeed, in Source: Ministry of Statistics and Programme Implementation.
1
february 27, 2021
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EPW
Economic & Political Weekly
BUDGET 2021–22
Figure 2: Household Expectations of Future Spending
Figure 3: Public Sector Borrowing Requirements (PSBR)
%, net response
% of GDP
15
90
COVID-19
80
12
70
9
60
6
50
3
40
March 2016
March 2017
Source: Reserve Bank of India.
March 2018
March 2019
March 2020
0
FY11
FY13
FY15
Source: Budget documents, JP Morgan.
However, India’s recovery needs to be
put into context. Despite expected doubledigit growth in FY22, the economic
recovery is expected to be incomplete. By
the first quarter of 2022 (calendar year)
the level of output would still be more
than 6% below the level forecasted
pre-pandemic.1
Second, alongside a faster-than-expected rebound exists evidence of discernible
labour market scarring. Across December
and January, for example, demand for
Mahatma Gandhi National Rural Employment Guarantee Act, 2005 (MGNREGA)—
which proxies for India’s unemployment
insurance in the rural economy—was
still about 45% higher than a year ago.
This suggests a paucity of opportunities
in the labour market, especially since
the fall in COVID-19 cases has likely reduced the hesitancy of labour to migrate
back to the cities in search for jobs.
These dynamics are also reflected in
the Centre for Monitoring Indian Economy
labour market surveys, which reveal
that the unemployment rate—holding
the labour force participation rate at
pre-COVID-19 levels—had risen from
about 7.5% pre-COVID-19 to almost 12%
in February 2021.
This is likely to result in a bifurcated
recovery. Households at the top of the
pyramid are likely to have seen their
incomes protected, and savings rates
forced up during the lockdown, increasing “fuel in the tank” to drive future consumption. Meanwhile, households at the
bottom are likely to have witnessed permanent hits to jobs and incomes, which
will hurt their consumption. These cleavages are already visible. Passenger vehicle
registrations (proxying upper-end consumption) grew 8% between October and
January while those for two-wheelers
contracted 10%.
With the top 10% of India’s households responsible for 25%–30% of total
consumption, near-term consumption is
getting a boost as this pent-up demand
expresses itself. To be sure, upperincome households have benefited from
higher savings for two quarters but this
is a one-time effect. To the extent that
households at the bottom have experienced a permanent loss of jobs and incomes, that could constitute a recurring
drag on demand if the labour market
does not heal faster. More generally, to
the extent that COVID-19 has triggered
an effective income transfer from the
poor to the rich, this will be demandimpeding in the steady state, because
the marginal propensity to consume at
the bottom is higher than that at the
top, just as the marginal propensity to
import at the top is higher than at the
bottom. Signs of this are already visible
in the Reserve Bank of India’s (RBI)
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vol lVi no 9
India was able to break the link between
mobility and the virus earlier than most
countries. Even as mobility and activity
began to recover post the lockdown,
COVID-19 cases peaked in September 2020
and began falling sharply thereafter. By
the end of January 2021, daily new cases
had fallen by 80% compared to their
September peaks, even as activity had
virtually recovered to pre-pandemic levels.
That said, COVID-19 cases have begun to
increase again in February, and avoiding a second wave will be key to the
economic outlook.
Second, after being very restrained in
the first six months of the pandemic,
central government spending has picked
up meaningfully since October, which will
translate into more central fiscal support
in the second half of the fiscal year.
Contextualising the Recovery
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february 27, 2021
FY17
FY19
FY21E
February consumer confidence survey,
where households have already signalled
a lower propensity to consumption in the
future (Figure 2).
Against this backdrop, can consumption growth sustainably go back to its 7%
pre-COVID-19 average? To be sure, the
global backdrop will improve with more
United States’ fiscal stimulus and progressively vaccinated developed economies.
But will an export pick-up, if juxtaposed
against uncertain domestic demand, be
enough to stoke a private investment
revival in India, given that manufacturing utilisation rates were sub-70% preCOVID-19 and have fallen to 63% during
COVID-19? Or will firms look through the
next few quarters and remain cautious
given the prevailing uncertainty?
The Budget’s Balancing Act
This was the macroeconomic backdrop
against which the 2021–22 budget was
presented. The central challenge of the
budget was therefore to ensure that:
(i) fiscal policy remains expansive, and
does not impart any large, contractionary
impulse in 2021–22 that could choke off
an incipient recovery; while (ii) simultaneously ensuring the headline deficit
consolidates in the coming years to preserve fiscal sustainability, since the total public sector’s borrowing requirements will have widened to above 15%
of GDP in FY21 and consolidated public
debt will increase to almost 90% of GDP
(Figure 3).
How does the budget seek to achieve
this balance? To understand the underlying fiscal stance of the budget, one
needs to dig deeper to better understand
both this year’s fiscal out-turn and next
year’s planned consolidation. The headline deficit of 9.5% of GDP in FY21 was
much higher than markets’ expectations
11
BUDGET 2021–22
of 7% but largely because food subsidies
that were expected to remain and/or be
added on the Food Corporation of India’s
(FCI) balance sheet were brought back
onto the centre’s balance sheet, in a welcome effort at greater transparency. In
particular, food subsidies under the revised estimates (2.2% of GDP) were 1.7%
of GDP higher than that was budgeted
(0.5% of GDP), both because free grains
and pulses were used as COVID-19 relief
and because previous FCI liabilities were
moved back on the budget. In forecasting a fiscal deficit of 7% of GDP, most
analysts had presumed any increase
over budgeted food subsidies would be
parked on the FCI’s balance sheet, like
was the case in recent years. The fact
that it was not, explains a lot of the gap
between the actual and expected deficit.
The rest of the difference is explained by
FY21 revenues being budgeted conservatively in the revised estimates—as we
enumerate below—with the actual deficit in FY21 expected to print closer to 9%
of GDP.
As a consequence, the fiscal consolidation to 6.8% of GDP in FY22 does
not appear as daunting as the headline
numbers suggest. Because of the aforementioned increase in food subsidies,
and the clearing of older fertiliser arrears,
the on-budget subsidy bill surged from
1.3% of GDP in FY20 to 3.3% of GDP
in FY21 but much of this increase is
budgeted as a one-off, with next year’s
subsidy bill pegged at 1.7% of GDP.
Therefore, about 70% of the planned
consolidation from 9% to 6.8% of GDP
is expected to be achieved by the
one-off increase in subsidies dissipating
next year.
Decoding the Fiscal Impulse
To construct the underlying fiscal impulse,
therefore, one needs to look at trends in
expenditure net of interest and subsidies.
This core spending grew at almost
20% in the pre-COVID-19 year, such that
its ratio to GDP jumped from 8% in the
year before COVID-19 to almost 9% in
2019–20. This grew further to 10.8% of
GDP in the COVID-19 year, underpinned
by 16% growth in spending and the projected 4% contraction in GDP. However,
this spending is budgeted to grow at
12
9.2% in FY22—lower than the 14.4%
budgeted growth of nominal GDP—and
therefore is budgeted to contract as a
share of GDP from 10.8% in FY21 to
10.3% in FY22.
More generally, expenditures—net of
interest and subsidies—have grown by
almost 3 percentage points of GDP across
FY20 and FY21, from 8% to 10.8%, but
are budgeted to reduce to 10.3% of
GDP in FY22. This would still keep expenditures relatively expansive, about
2 percentage points higher than the preCOVID-19 levels.
To extract fiscal impulse for FY22,
however, one needs to net out all automatic stabilisers—on the revenue and
expenditure side—and then adjust for
any tax changes. To that end, we net out
MGNREGA allocations—which is equivalent to unemployment insurance and
therefore a prototypical automatic stabiliser—on the expenditure side. The cut
in corporate taxes in FY20 and the increase in excise duties in FY21 (which
raised a large 0.7% of GDP in revenues)
is then adjusted, to generate the true
fiscal impulse.
Table 1 presents the results. The fiscal
impulse in the pre-COVID-19 year was
about 1.3% of GDP followed by an impulse of about 1% of GDP. If the budgeted
forecasts fructify, the fiscal impulse in
FY22 will be slightly negative at -0.2%
of GDP.
More generally, fiscal policy has injected an impulse of about 2.3% of
GDP across FY20 and FY21 from which
about 0.2% of GDP is being withdrawn
in FY22, keeping the budget relatively
expansive.
Several caveats apply, however. First,
in a pandemic year, it is not clear
how meaningful the concept of a fiscal
impulse is vis-à-vis fiscal relief. From
that standpoint, one must also focus on
the increase in automatic stabilisers
(MGNREGA and free grains and pulses),
which increased by almost 1% of GDP.
MGNREGA is budgeted lower in FY22 but,
given the state of the labour market, demand could remain elevated. It will be
important to fully fund MGNREGA and increase its allocation if needed. If increased MGNREGA allocations are at the
expense of other expenditure, then that
would make the underlying fiscal impulse more contractionary in FY22. So, it
is important that the expenditure envelope is increased to accommodate any
higher MGNREGA demand.
Second, capex—with much higher
multiplier effects—is pegged to grow
from 2.3% to 2.5% of GDP (Table 2). Its
revenue expenditures that are being cut
which typically have lower multiplier
effects. So, any stimulus in FY22 is
largely on the changed composition of
spending. The fiscal impulse in FY22
could end up being positive if, in fact,
the capex is executed and the higher
multipliers play out.
Table 2: Central Government Budget
(% of GDP)
FY20
FY21R
FY22B
Net tax revenues
6.7
6.9
6.9
Gross taxes
9.9
9.8
9.9
Gross taxes ex excise
8.7
7.9
8.4
Non-tax revenues
1.6
1.1
1.1
Asset sales
0.3
0.2
0.8
Total receipts
8.6
8.2
8.9
Revenue expenditure
11.6
15.5
13.1
Interest
3.0
3.6
3.6
Subsidies
1.3
3.3
1.7
Capital expenditure
1.7
2.3
2.5
Total expenditure
13.2
17.7
15.6
Total expenditure
ex interest, subsidy
8.9
10.8
10.3
Fiscal deficit
-4.6
-9.5
-6.8
Source: Budget documents, JP Morgan.
Table 1: Fiscal Impulse
% of GDP
FY19
FY20
FY21RE
FY22BE
1
2
3
4
5
6
7
8
8.0
0.3
7.6
8.9
0.4
8.6
0.9
0.4
10.8
0.6
10.3
1.7
10.3
0.3
10.0
-0.2
Central expenditure (net of interest and subsidies)
MGNREGA
Spending adjusted for MGNREGA (1-2)
Annual change in spending (3)
Add: 2019 corporate tax cut
Subtract 2020 excise duty hike
Fiscal impulse (4 + 5 – 6)
Automatic stabilisers and relief measures (8a + 8b)
8(a) Higher MGNREGA allocations
8(b) Free foodgrains distribution
1.3
-0.7
1.0
0.9
0.2
0.7
-0.2
Source: Government documents.
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BUDGET 2021–22
Figure 5: Debt Dynamics under Different Growth Scenarios
Figure 4: Debt Determinants—Primary Deficit (r-g) Differential
% of GDP, both axes
4
6
Primary deficit
3
3
r-g
(Increase is less favourable)
2
% of GDP
100
Nominal GDP 8%
90
0
-3
80
1
Nominal GDP 9%
-6
0
-9
-1
-12
Nominal GDP 10%
60
-15
-2
1997
2000
2003
2006
Source: Budget documents, JP Morgan.
2009
2012
Whether authorities can execute the
budgeted expenditure, however, will
depend crucially on whether revenue
estimates materialise. Any shortfalls in
revenue could force expenditure cuts,
given the budgeted deficit of 6.8% of
GDP is already more expansive than
bond markets had anticipated.
Key to the fructification of budgeted
revenues in FY22 will be whether authorities can pull off the sharp increase in
budgeted asset sales to 0.8% of GDP in
FY22—from 0.2% of GDP in FY21—for
which execution will be critical, as we
discuss below.
That said, tax revenues have been
budgeted relatively conservatively, in a
welcome departure from the past. Revised estimates peg this year’s gross taxes at 9.8% of GDP. But for that to happen, taxes, net of excise, will need to
contract by 20% in the last quarter. To
put this in context, these taxes grew
at 25% in the quarter just gone by. So, it
is very likely gross taxes will end up
about 0.5% of GDP higher this year. Not
only is this a welcome departure from
the past when revenues were consistently overbudgeted, but it sets the base
for next year. On this higher base, to
meet next year’s tax revenue target
will entail a tax buoyancy of 0.8 on a
nominal GDP assumption of 14.4%, which
seems conservative, especially given the
increased formalisation that COVID-19
has spawned.
In fact, it is likely that both nominal GDP
growth will exceed budgeted assumptions
and tax buoyancy could be higher than
0.8 in the midst of an economic rebound,
barring a second COVID-19 wave. Therefore, it is likely that tax revenues in
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2015
2018
50
FY00
Aggressive Asset Sales
But Conservative Tax Targets
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FY03
FY06
FY22 could exceed budgeted targets,
which creates some revenue buffer if
either asset sales do not materialise or
excise duties have to be rationalised on
rising crude pieces. That said, increased
excise duties after the fall in crude pieces
in 2020 created a large source of revenue (0.7% of GDP). Correspondingly, rising crude pieces in 2021 constitutes a
key fiscal risk for FY22 given the reliance
on those revenues.
Debt Sustainability
While the budget has admirably attempted to consolidate without generating
a large, contractionary impulse in FY22,
it has also laid out a more relaxed fiscal
path than was expected. The centre’s
fiscal deficit is pegged to narrow to
4.5% of GDP by FY26, suggesting about a
0.5% a year consolidation for every year
after FY22. Similarly, state deficits are
pegged to narrow back to 3% by FY24.
What this suggests, however, is that the
PSBR could still be at an elevated 9% of
GDP even by FY26.
With public debt likely to approach
90% of GDP at the end of FY21, what
does this stipulated fiscal path mean
for debt sustainability? The trajectory
of debt is likely to be more important
than its level in the post-COVID-19 years
as a barometer of fiscal sustainability.
Therefore, a prerequisite of any mediumterm fiscal framework must be to ensure
that debt/GDP first stabilises at these
levels and then gradually begins to
come down.
To achieve this, however, the importance of medium-term growth cannot be
overstated. To see this, consider how
debt evolves (equations 1 and 2 below):
D(t+1) = Dt * (1+r)+ PD(t+1)
vol lVi no 9
FY09
FY12
FY15
FY18
FY21
FY24
FY27
FY30
where D(t) is the absolute debt stock at
time (t); r is the average interest rate on
the debt, and PD(t) is the primary deficit
at time t.
Transforming this into debt as a percent of GDP (d) and rearranging terms,
we find that
r–g
d(t+1)-d(t) = d(t) *
+ pd(t+1)
1+g
where d(t) is debt/GDP at time t; g is
nominal GDP growth; r is the average
nominal borrowing cost; and pd(t) is the
primary deficit as a percent of GDP at
time t.
The evolution of debt-to-GDP essentially depends on three variables: the
primary deficit (fiscal deficit ex-interest
payments), nominal GDP growth, and
the cost of serving the debt. The latter
moves much more sluggishly because
the average maturity of India’s debt stock
has progressively increased. It therefore
takes several years for the entire debt
stock to be repriced. In contrast, changes in the primary deficit and nominal
GDP flow through immediately.
The evolution of the debt therefore
comes down to the primary deficit (pd)
and (r-g)—the difference between cost
of servicing the debt (r) and nominal
GDP growth (g) (Figure 4). The higher is
the difference between nominal GDP
growth and cost of servicing, the greater
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BUDGET 2021–22
Figure 6: Gross Taxes to GDP
Figure 7: Direct versus Indirect Taxes
% of GDP
12
% of GDP
6
11
5
10
4
Direct
9
8
2003
3
2005
2007
2009
2011
2013
Source: Budget documents, Fifteenth Finance Commission.
the depreciation of the existing debt
stock. That said, the new global fiscal orthodoxy that debt is sustainable as long
as nominal GDP growth (g) exceeds borrowing costs (r), is only true when primary deficits disappear or are very modest, and therefore not yet applicable to
India where primary deficits will be very
elevated post-COVID-19.
Debt Stabilising Growth Rate
But even as primary deficits will need to
be progressively brought down to preCOVID-19 levels, how growth evolves in
the coming years will have an overbearing influence on debt dynamics. For
starters, debt/GDP is expected to approach
90% at the end of FY21 but then reduce
to 85% of GDP at the end of FY22 if India
experiences strong nominal GDP growth
next year. What happens next depends
squarely on growth dynamics. If India’s
medium-term nominal GDP growth
settles at 8% (real of 4.5%–5%), even a
rapid fiscal consolidation would not be
enough to prevent debt/GDP rising for
the rest of the decade towards 95% of
GDP by the end of the decade. Instead, if
nominal growth settles at 10% (real of
6.5%–7%) debt/GDP would first stabilise and then start declining towards
80% of GDP by the end of this decade,
even if the fiscal consolidation is more
gradual. Nominal medium-term growth
of about 9% is needed to stabilise debt/
GDP at about 87%–88% (Figure 5).2
Therefore, now that authorities have
thrown down the fiscal gauntlet, it is
critical that all stakeholders ensure that
the requisite 9%–10% nominal GDP growth
is delivered consistently to preserve fiscal
sustainability. Furthermore, even as fiscal
policy is being appropriately countercyclical at the moment, it must be equally
nimble in the other direction. When the
14
Indirect
2015
2017
2019
FY12
FY13
FY14
FY15
FY16
FY17
lndirect taxes do not include GST compensation cess.
Source: Fifteenth Finance Commission.
recovery gets more entrenched, policy
support should be withdrawn with equal
speed and alacrity. The more relaxed fiscal
glide path should be treated as a ceiling,
with the actual path tied intimately to
the pace of the recovery.
Importance of Tax Reforms
The need to consolidate the fiscal deficit
without hurting growth in the coming
years also brings into sharp focus the
importance of tax reforms in boosting
revenues, so that deficit consolidation is
not tantamount to a commensurate reduction in expenditures—especially capital
expenditures—which could hurt mediumterm growth.
Tax reforms that simplify tax adherence, improve compliance and bolster
efficiency will have a crucial role to
play in the years to come. Despite the
size of the economy tripling in nominal
terms over the last decade—which
should have brought more people into
the tax net and generated more revenues given the progressivity of direct
taxes—gross taxes as a share of GDP,
which had increased from 10% of GDP to
12% of GDP in the high-growth years before the GFC, have not recovered to their
pre-GFC peaks. Instead, gross taxes/GDP
have averaged 10.5% of GDP over the
last decade—a good 1.5 percentage
points of GDP below their pre-GFC peak
(Figure 6).
To be sure, direct taxes began to
firm from 2016, increasing from 5.4% of
GDP to almost 6% by 2019—levels seen
before the GFC—before falling to 5.1%
in the pre-COVID-19 year, likely both on
account of a slowing economy and the
corporate tax cut. In contrast, indirect
taxes have consistently underperformed.
To be sure they had begun to increase
till 2017, but have fallen a full percentage
FY18
FY19
FY20
point since 2017, reflecting, in part,
goods and services tax (GST) underperformance. The latter reflects both the
effective GST rate (~11.8%) remaining
much below the estimated revenue neutral rate (RNR) of 14% and subpar compliance (Figure 7).
All in all, tax reforms in the coming
years are key to boosting revenues to
both support higher physical and social
infrastructure spend and simultaneously
allow the deficit to be consolidated.
Absent this, fiscal consolidation in a
post-COVID-19 world will necessarily entail a sustained negative fiscal impulse
that could hurt medium-term growth
and thereby, paradoxically, imperil
fiscal sustainability.
The Fiscal–Monetary Tango
With fiscal policy stepping up to the
plate, monetary policy must slowly take
a back seat. The combination of a more
relaxed fiscal path and domestic private
sector savings normalising after the
COVID-19 surge (reflected in the current
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BUDGET 2021–22
account moving from a surplus of over
1% of GDP this year to a deficit of that
magnitude next year3) is likely to result
in equilibrium bond market yields rising,
especially with global yields also firming on reflation expectations. But that
appears a cost worth incurring if, in fact,
the budget can pull off a meaningful
public investment push. In the near term,
the RBI may focus on ensuring this
new equilibrium is reached in a nondisruptive manner. Given the current
slack in the economy, it is understandable
if fiscal and monetary are temporarily
complementary. But as confidence in
the recovery grows, fiscal and monetary
must quickly become substitutes—with
the RBI progressively normalising liquidity to ward off financial-stability and
fiscal-dominance concerns—so as to safeguard macroeconomic stability.
Budget’s Paradigm Changes
Budgetary math apart, it is important
to step back and not miss the forest for
the trees. The budget has embarked on
several paradigm changes. The first is an
effort to reimagine the public sector’s
balance sheet. The leitmotif of the budget
is a big thrust on infrastructure spending
and public investment. If the budgeted
numbers are realised, capex would have
grown from 1.6% of GDP pre-COVID-19 to
2.5% in two years. With India’s investment/GDP ratio falling by 5 percentage
points over the last decade and private
sector manufacturing utilisation rates
sub-70% even before COVID-19 (falling
further to 63% during the pandemic), a
sustained public investment push—with
its large multiplicative effects—is a muchneeded impetus to reinvigorate growth
and create jobs. It is the certainty of
sustained public investment that is likely
to crowd in private investment. It is the
certainty of investment-led employment
that is likely to reduce household precautionary savings.
But this is only one half of the story.
Implicitly, higher capex spend is being
paid for by disinvestment and privatisation. This can be seen by looking at
increases in capital expenditures and
asset sales between FY22 and FY20. If
the budgeted estimates are realised,
public capex would have increased by
Economic & Political Weekly
EPW
february 27, 2021
0.8% of GDP across two years, and asset
sales would have increased by 0.6% of
GDP in those two years. Effectively,
therefore, 75% of the increased capex is
being financed by asset sales. Qualitatively, non-core public sector assets that
do not generate positive externalities—
and in fact potentially distort the sectors they compete in—are expected to
be replaced with much-needed physical
and social infrastructure, which typically emanate positive externalities and
necessarily suffer from under-provisioning by the private sector. If successfully executed, and we underscore the
importance of execution below, this will
be akin to a productivity-enhancing asset
swap on the public sector’s balance sheet.
The second intellectual departure is
how the budget envisions infrastructure
financing. In stark contrast to the public–
private partnership model—where the
private sector had to grapple with upstream implementation and regulatory
risk, which it has often struggled with—
infrastructure will now be financed off
public sector balance sheets and, once
operational and viable, will be monetised so as to recycle proceeds into the
next project. In theory, this is the appropriate division of public–private risk
sharing. It marries the public sector’s
ability to better mitigate upstream risk
while banking on the glut of global
liquidity potentially attracted to downstream projects.
All told, the budget has embarked on
important intellectual departures from
the past. But realising them will involve
deft execution in the post-COVID-19 year.
The Importance of Execution
Ultimately, the budget’s impact on shaping the macroeconomic narrative will
depend on the speed and efficacy of
implementation on both sides of the
ledger: simultaneously building and
selling public assets. If, for example, the
budgeted asset sales are not executed,
pressure could increase on cutting
expenditure, making the fiscal impulse
more contractionary and creating headwinds for the recovery. Similarly, it will
be important to front-load disinvestment
and strategic sales to take advantage of
buoyant equity markets before global
vol lVi no 9
central banks become more cautious.
Separately, it will be equally important to
identify shovel-ready projects to deliver
the promised public investment in time,
while the private sector is still healing. An
inability to deliver on public investment
or financial sector reforms could impact
animal spirits in the private sector.
All told, the budget must be commended for embarking on several paradigm shifts and attempting to balance
fiscal consolidation with support for the
recovery. But its success, and in turn the
sustainability of India’s recovery, will
now come down squarely to policy execution and coordination.
Notes
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2
3
The pre-pandemic growth trajectory presumes
a relatively conservative 5.5% annual average
growth.
In project debt dynamics, the assumed fiscal
path is consistent with what was laid out in the
budget. The centre’s fiscal deficit is pegged at
6.8% in 2021–22 after which it consolidates by
0.5% of GDP each year until reaching 4.5% of
GDP in FY26. The consolidated state fiscal
deficit consolidates by 0.5% of GDP until
reaching 3.0% of GDP in FY24, after which it
remains unchanged.
Recall that the current account balance of an
economy also reflects overall saving–investment
(S–I) gap. In the COVID-19 year, despite the
large widening in the fiscal deficit (a widening
of the public sector’s S–I deficit), the current
account moved into a meaningful surplus as
the private sector’s S–I surplus surged on
precautionary savings, lockdown-induced constraints on consumption, and a lack of investment appetite. This was particularly evident
in household financial savings which jumped
to 21% of GDP in 2Q20 compared to 7.9% of
GDP in 2Q19. In conjunction with the current
account moving into surplus, foreign capital
flows have also been strong in 2020–21. This
resulted in a large balance of payments (BoP)
surplus—reflective of the domestic and foreign
savings available to the economy—which meant
that the equilibrium rates remained low
despite jump in fiscal deficit. In 2021–22, opposite dynamics will be at play. Economic normalisation will entail household savings rates
partially mean reverting after the pandemicyear surge and private investment rates rising
from their lows. Consequently, the private
sector’s savings–investment surpluses will
narrow meaningfully compared to the previous year. Despite the government deficit narrowing (resulting in a lower S–I public sector
deficit), the economy-wide current account
will witness a swing towards deficit of more
than 2%-pts. These same dynamics—a lower
domestic savings rate and normalising investment—driving a current account deficit, should
therefore result in higher equilibrium interest
rates in the economy. In theory, foreign
savings—through capital inflows—could offset
the changing domestic dynamics, but capital
flows are unlikely to rise from last year’s level,
especially with the Fed expected to telegraph
some tapering by the end of 2021.
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