While the pandemic firefight will dictate India’s near-term outlook, the Union Budget will seek to strike a balance between growth and consolidation objectives. The economy is in a transition phase, characterised by demand shifting from goods to services and need for restoring jobs, as a fall in the national unemployment rate masks a lower labour participation rate as well as an employment rate that is still to return to pre-pandemic levels.
Add to this, the stage is being set for an investment revival, with the central and state government at the driver’s seat, given a host of catalysts in the pipeline, including strengthening of the infra institutional architecture, climate commitments, expanding the presence of new age companies, boost high-value manufacturing exports, amongst others. Finally, global policy conditions are tightening after two years of extraordinary stimulus and bloated central bank balance sheets. For India, monetary and fiscal policy are likely to complement each other this year, dialling back on the stimulus bent demonstrated in the past two years.
Despite the higher spending demands in FY22, we expect the Rs 2-2.5 lakh crore overshoot in revenues to help absorb the shortfall, apart from the government surplus cash position with the central bank and as well unspent balances with the ministries. An additional cushion is from the higher nominal GDP of 0.3% of GDP, which is likely to help keep the deficit within the budgeted -6.8% of GDP. The revenue deficit vs gross fiscal deficit ratio, however, continues to question the quality of the spend.
We pencil in a 60 bps consolidation in the fiscal deficit for FY23. On forward-looking measures, the Budget speech is likely to point to a higher allocation towards capital expenditure, which has a higher multiplier for growth compared to revenue spends. We expect this to be demonstrated by an increase in capex spending by a third, marking a pickup to 2.4 per cent of GDP vs 1.7 per cent in FY12-FY20. Next, market observers will keenly watch for a path towards the inclusion of government bonds into global indices, through changes in the taxation framework as well as clearing the way for Euroclear eligibility of government bonds.
Thirdly, moves to backstop the manufacturing push by higher PLI allocations, while also building in the green goals with an emphasis on sectors such as solar cell and solar module manufacturing. On the taxation front, buoyant equity markets lower the scope of changes in the capital gains tax or STT. Tax rates and structure for individuals was undertaken within the last two years,so we don’t expect further changes in this space, but relief might be expressed via an increase in standard reduction or moves to lower mortgage costs.
Beyond the FY23 math, market participants will look for medium-term macroeconomic projections, including the revised Fiscal Responsibility and Budget Management Act (FRBM). At the FY22 Budget, the government projected the fiscal glide path to lower the deficit to -4.5 per cent of GDP by FY26, implying an average of 60 bps reduction in the deficit annually. We expect the target to be maintained, indicating that the authorities are keen to preserve ongoing fiscal consolidation, but without adverse cutbacks which will be negative for growth.
Despite a narrower fiscal deficit as a % of GDP, the absolute deficit will remain wide, necessitating sizeable gross market borrowings of around Rs 12.5-13 lakh crore, at multi-year record highs and setting the stage for an unfavourable start for the bond markets next year. Apart from the impending demand-supply mismatch from high issuances, other factors troubling domestic bonds are a sharp rise in US Treasury yields, domestic sticky inflation, high crude prices and gradual policy normalisation by the central bank. Outside of a resumption in operation twists or purchases under the market stabilisation bonds, borrowing costs are bound to rise further.
(The author is Senior Economist, SVP at DBS Bank, Singapore)
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