Trying to pull an elephant up a steep slope is no mean task, especially if it has ankle weights on. Similarly, our lumbering economy has been weighed down by the pandemic; a cyclical downturn characterised by overcapacity in the industrial sector and weak demand; a paralysed banking sector; and legacy issues with respect to attracting foreign investments. Now there is also the post-pandemic conservatism to deal with.
Therefore, finance minister Nirmala Sitharaman has used fiscal might, by accelerating public spending, to get the economy on steady ground and then hopefully running.
The highlight of the FY22 Union Budget has been to step up government spending, which will be funded by a substantial increase in government borrowing and by monetising assets. Much of the spend has already taken effect in FY21 and the FY22 Budget will keep the momentum going, with no dramatic cutback from the current year.
The government estimates nominal GDP growth of 14.4% for FY22, which seems reasonable given the low base, except public investments have a lower multiplier effect than private investments. Therefore, one has to retain healthy skepticism.
The climate for private capex anyway continues to be dull, more so because there has been further demand destruction following the pandemic. The Budget has not attempted to address this — other than the earlier interventions such as corporate tax cuts and focused fiscal incentives such as the production-linked incentive scheme (PLIS). Probably, it is just as well since fiscal incentives alone may not act fast enough. Such incentives have to first revive sentiment and then attract companies to invest, and thus drive growth. Public investments, on the contrary, see quicker and sure-shot results. To that extent, the finance minister seems to have prioritised public spending. But, the success of the current plan depends heavily on the government’s agility in raising resources, speeding up spending and executing projects.
Exactly in the same vein, the minister has ignored the need to stoke consumption. This is an acceptable compromise because, unless jobs growth is fixed, measures to encourage spending may not work. A notable oversight has been with respect to the urban poor, the section worst hit by the pandemic, and their troubles. The rollout of infrastructure projects should support them to an extent, but there is little respite offered to them otherwise.
Borrowing to spend
To drive this public-investment-led growth, the government is leaning heavily on borrowing. Its total fiscal deficit for the year is estimated at Rs.18.48 trillion or 9.5% (FY21 Revised Estimates) and for FY22 at Rs.15.06 trillion or 6.8% (FY22 Budget Estimates) will be funded largely through a bigger government borrowing programme. This year’s revised estimates indicate a market borrowing of Rs.12.74 trillion, 138% over the Budget’s earlier estimate (Rs.5.35 trillion).
With the government’s increased borrowing, there were fears that the private sector that needs both greater and low-cost access to credit could be crowded out of the debt market. Maybe that is why the government is choosing to borrow through expensive small-savings securities. The largest chunk of the borrowing or 64% of the total deficit, which is Rs.9.74 trillion, will be from the market while the next big piece will come from small savings securities.
Bankers argue that government borrowing though the small-savings route makes it more difficult for banks to attract deposits and prevents them from slashing deposit rates. But, banks have by and large been able to cut deposit rates and yet attract deposits at a healthy pace for the past couple of years. Since 2019, deposit growth has averaged more than 10% year-on-year.
While the government is showing a willingness to spend, it is not as generous as the newspaper headlines will have us believe. The headlines have been hyperbolic, declaring a massive government spending, when that really isn’t the true picture. If we look at the numbers, we will see why. Much of the fiscal action has happened in FY21 with an expenditure budget of Rs.34.50 trillion, up from Rs.30.42 trillion budgeted for the year. That leap was mainly driven by a food subsidy bill of Rs.4.22 trillion, including an exceptional payment of more than Rs.3 trillion to Food Corporation of India.
If one knocks off the food subsidy entirely from the equation, the effective increase in expenditure for next year is around Rs.2.12 trillion. Now, knock off the mammoth interest payment from that figure, and the number is down further to Rs.839 billion. Exclude interest and every subsidy — be it for food, fertiliser or petroleum — and the spending for next year stands 8% higher than the revised estimate of this year. Compared to the Budget estimates of this year, the increase is 11%. Therefore, the real spending the government is doing, to support demand and trigger growth, is not as aggressive as one may think. Perhaps, this is all the room the government has.
The FM has promised to bring down the fiscal deficit, gradually, by FY25 to 4%. The overshooting of the deficit and the rather slow glide path should have worried both the industry and investors, but considering the growth starvation in the economy, that has not quite been the case. It was as if the finance minister gave exactly what has been asked for and some more, hoping that the rating agencies will also be more understanding of the grave need for public spending to pull up the economy. Her response has been more or less in line with how most governments across the world are responding.
The Sensex has responded enthusiastically, hitting a new high, reversing the near 4,000 points fall in the preceding sessions. Actually, the stock market was on fire for various reasons apart from the elevated, spending-led growth, such as resolution of the bad assets problem that has been the ever-present bane of the banking system, removing hurdles in the way of credit-led economic growth and optimism around raising foreign direct investment (FDI) limit in the insurance sector to 74%. The surge was also triggered by nervous relief from anxiety about the Budget itself.
What, me worry?
Even the bond market responded unusually — the 10-year-yield rose just 15 basis points — without the alarm set off by high market borrowing by the government. While the market is lauding the government for taking this expansionary step, we must not forget that it is the central bank’s action in continuously cutting interest rates that makes the expansion possible.
The larger borrowing programme for next year will make it imperative for the government to up the heat on the central bank to keep a lid on rates. Any escalation in global rates and inflation, which looks unlikely at this point, may end up making credit costly but that is for the government and the central bank to co-manage — yes, the days of ‘independent’ central banks are long gone.
Ignoring the unforeseen, the market’s acceptance of the borrowing plan also stems from knowing that much of the deficit will go towards financing capital expenditure rather than revenue expenditure. Again, this is a far more defendable position, especially when it comes to convincing rating agencies against a potential downgrade.
On the revenue side, the tax revenue (net to centre) came in lower at Rs.13.44 trillion (FY21 RE), compared with FY21 BE of Rs.16.35 trillion, a slippage of 17%. The BE for FY22 has been set at Rs.15.45 trillion, up 14.94% from FY21 RE, in line with GDP growth. Those assumptions look fairly realistic.
The risk to this year’s Budget lines mainly in execution. Much hinges on how much resources the government is able to raise and, as mentioned earlier, how the central bank manages the government borrowing programme without tightening and crowding out the private sector.
The idea of allowing banks to sell-down/transfer bad assets through AIF (alternate investment fund) structure opens up another window for banks, particularly public sector banks to clean up the books. While this is a welcome step — AIF structure offers far more flexibility compared to the conventional ARC — it may be early to forecast how banks behave. Building consensus among different lenders to create asset pools so they can be sold through a competitive bidding process may itself be arduous, dotted with administration difficulties. Bankers may also be wary of striking a sale without consensus among all lenders for the morbid fear of transaction being judged in hindsight.
Thus this new route is certainly not a one-stroke magic mantra to clean up the system with instant capitalisation. The bank recapitalisation budget pegged at Rs.200 billion itself is tiny compared to the capital requirement for public sector banks, but privatisation of PSU banks offers some ray of hope. Again, the question here is what is saleable and if the government would want to put such assets on the block.
Besides the risk from a slow banking clean-up, there is the risk of disinvestment target, pegged at Rs.1.75 trillion, not being achieved. The government’s track record in strategic sales so far has been poor. Even in FY20, the actual proceeds from disinvestment was only Rs.500 billion.
However, there seems to be greater urgency to sell assets this time. That said, how assets are bundled and timed will make all the difference. On one hand, the pandemic has made companies wary of big spends, on the other, there are sectors that are still booming in India and are in investment phase. Especially since online retailers such as Amazon, Flipkart and now Reliance Industries with their deep pockets look to beef up infrastructure, the appetite for land and warehousing, and railway assets will grow. Real estate is a good sell too, and the government can unlock value in land especially with funds such as Brookfield and Blackstone fairly active in this space. Globally, low interest rates are nudging investors to take bigger risks.
A big chunk of the disinvestment target can be met if LIC, which has been inching towards the auction block for some time now, is able to garner the valuation it is estimated to command. A 10% disinvestment at a market value of Rs.10 trillion can alone bring in Rs.1 trillion.
The numbers seem big but achievable. The bill has been placed. Whether it has passed with flying colours or has failed without a whimper will be known next year.