Providing a macroeconomic overview of the Union Budget 2021-22, Niranjan Rajadhyaksha and Sharmadha Srinivasan contend that it is based on realistic assumptions of nominal GDP growth, is reasonably aimed at fiscal expansion rather than premature austerity, makes fiscal policy more transparent, and has a welcome focus on capital spending. However, they believe that it also sets the stage for higher public debt ratios that will complicate the management of the economy.

The initial fiscal response of the Modi government to the pandemic was a conservative one. Much of the action was aimed at protecting the supply side of the economy through income support to enterprises, credit guarantees, and a loan moratorium. The Reserve Bank of India (RBI) flooded the money market with liquidity to help firms deal with the liquidity shock. These initial moves were based on the analytical assumption of the Finance Ministry that a broader demand stimulus would be ineffective in the early stages of the national lockdown, given the high marginal propensity to build precautionary savings in the midst of a massive negative shock to the economy such as Covid-19. Early data does show a sharp increase in the financial savings of households in the first quarter of the current fiscal year. 

The 2021-22 Budget announced by Finance Minister Nirmala Sitharaman on 1 February is a switch in the policy strategy – now that the economy has begun to recover, even though there is evidence of persistent pain in smaller enterprises as well as parts of the labour market. Government spending had begun to pick up since September 2020. Government consumption expenditure is likely to increase by 17% in the second half of the financial year 2020-21, compared to a contraction of 3.9% in the first half. However, the first advance estimates by the Central Statistical Organisation show only a small increase in the contribution of government consumption expenditure in the GDP (gross domestic product) for the entire year. 

The 2021 Economic Survey, released before the Budget, has made a strong case for a countercyclical fiscal policy¹ to support aggregate demand. The government has delivered a demand stimulus in the Budget, the size of which is hard to fault given the nascent stage of economic recovery. The Budget has already been dissected in detail by economists immediately after it was announced. This post will highlight some of the key features of the Budget, but also look forward to a few emerging macroeconomic policy challenges that lie ahead for both the government as well as the RBI.  

The Budget is based on reasonable assumptions about nominal GDP growth (14.4%)² for 2021-22. The Indian economy is expected to expand by 14.4% in nominal terms, one percentage point lower than what the Economic Survey has forecast. Tax revenue is expected to grow in tandem with the growth in nominal GDP, which means that tax buoyancy is modest. In fact, budget estimates of tax collections in 2021-22 are lower than the budget estimates for 2020-21, which is before the pandemic hit. The new budget thus, has an inbuilt buffer in case both nominal GDP growth as well as tax collections outperform. Another buffer is that the budgeted Rs. 71,383 crore drawdown from excess cash balances with the RBI is only a fourth of the estimated excess cash with the RBI in January 2021. 

Government spending

Total government spending in 2021-22 is budgeted to be almost unchanged compared to the revised estimates for the previous year. However, it is 14.5% higher than the budget estimates³ of 2020-21. In other words, the growth in government spending would seem bigger once the extra spending on specific programmes such as MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act)⁴ during the pandemic is brought back to more normal levels. The funding for MNREGA has come down from Rs. 1.15 lakh crore in the revised estimates for 2020-21 to Rs 73,000 crore in the budget estimates for 2021-22. A similar reduction in funding is seen in case of the Pradhan Mantri Awas Yojana.⁵ On the other hand, an extra Rs. 1.15 lakh crore has been budgeted for capital spending as well as Rs 35,000 crore for the vaccination programme that has recently begun. Compared to the revised estimates of last year, overall expenditure on capital⁶ has increased by 26% while that on revenue has been reduced by 2.7%. 

Another exceptional item in the revised expenditure estimates for 2020-21 is the 267% increase in food subsidies over and above the budget estimates for that year. A large part of that is because of the decision to pre-pay the loans that the Food Corporation of India had taken from the National Small Saving Fund, a positive for budget transparency since it reduces off-budget borrowing that left the outside world guessing about the true figures of public sector borrowing. Stagnant defence spending despite the escalation of border tensions with China, as well as a lower budget to the Pradhan Mantri Kisan Samman Nidhi⁷ – at a time when farmers in a few states have taken to the streets – is worth noting. 

Fiscal expansion and macroeconomic management

The government has budgeted a fiscal deficit of 6.8% of GDP in 2021-22. This is higher than consensus estimates, which has unsettled the bond markets. The fiscal deficit is expected to come down to 4.5% of GDP only in 2025-26. What this means is that India will have relatively loose fiscal policy for at least the next three years. The public debt-GDP ratio will be close to 90% this year. In its report released on the same day as the budget, the Fifteenth Finance Commission said that it expects public debt to be as high as 85.7% of GDP in 2025-26. Interest payments of the central government as a percentage of its net tax revenues is likely to be 52.4%, nearly 10 percentage points higher than what it was a decade ago. 

The extended fiscal expansion will create important challenges for macroeconomic management, even assuming a sustained growth recovery. The immediate challenge is that the RBI will have to decide whether to go ahead with its attempt to suck excess liquidity out of the money market or continue with the expansionary monetary policy in order to prevent borrowing costs from rising. In other words, it will need to take a call on whether it wants to equilibrate the money market via quantities or prices. The longer-term challenge is a return of fiscal dominance (large government debt and deficit), as the need to accommodate the higher public debt interferes with the main operations of an inflation-targeting RBI. 

The new budget presented by the Finance Minister is based on realistic assumptions of nominal GDP growth, is reasonably aimed at fiscal expansion rather than premature austerity, makes fiscal policy more transparent, and has a welcome focus on capital spending. However, it also sets the stage for higher public debt ratios that will complicate the management of the economy and will likely test the ability of the Finance Ministry and the RBI to coordinate their actions in the coming years. 

The authors gratefully acknowledge research support by Anushka Bhansali.

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Notes:

1. A countercyclical fiscal policy refers to the strategy of the government to counter a boom or a recession through fiscal measures.
2. This is a full percentage point lower than what the Economic Survey has forecast.
3. Budget estimates refers to the amount of money allocated in the budget to any ministry or scheme for the coming financial year. Revised estimates are mid-year review of possible expenditure, and need to be authorised for expenditure through parliamentary approval or by re-appropriation order.
4. MNREGA guarantees 100 days of wage-employment in a year to a rural household whose adult members are willing to do unskilled manual work at the prescribed minimum wage.
5. Pradhan Mantri Awas Yojana is an initiative by Government of India in which affordable housing will be provided to the urban poor with a target of building 20 million affordable houses by 31 March 2022.
6. Revenue expenditure is expenditure for the normal running of government departments and various services, interest charges on debt incurred by government, subsidies and so on. Capital expenditure refers to expenditure that create assets or reduce the liability of the government.
7. Under the Kisan Samman Nidhi scheme an income support of Rs. 6,000 per year in three equal instalments is provided to small and marginal farmer families having combined land holding/ownership of up to two hectares.