Examining the 2021-22 Union Budget with a political economy lens, Yamini Aiyar contends that the policy choices reflects Government of India’s propensity to centralise rather than to devolve, and a shift away from welfarism.

Following the presentation of the Union Budget 2021-22 by Finance Minister Nirmala Sitharaman on 1 February, economists have carefully scrutinised the fiscal math and debated the economic rationale behind the policy choices. Beyond the fiscal math, the Budget offers important insights into the political-economy contours of the pathways through which the central government hopes to nurture India’s economy back to health after the unprecedented Covid-19 shock. In this post, I reflect on the political economy of the choices made, and assess their implications for India’s economic recovery going forward.

Macro-fiscal position

The Budget choices need to be understood against the backdrop of the Government of India’s macro-fiscal position. First, as Rathin Roy has argued, for some years now the central government has been suffering from a silent fiscal crisis. This has been caused by large revenue shortfalls (amounting to 0.7% of GDP (gross domestic product) in FY2019-20), and failure to meet disinvestment targets. Together, these trends have pushed the government to increase borrowing to meet committed revenue expenditures.¹ The slippage in fiscal deficit targets that in turn, prompted the opacity in the Budget math by increasing off budget liabilities,² are symptoms of this fiscal crisis. 

Second, for decades, the union government has used instruments like the centrally sponsored schemes (CSS) and central sector schemes (CS) to finance expenditure that are constitutionally in the domain of state governments. In 2015, the Finance Commission sought to change this practice by mandating a hike in the states’ share in the divisible pool of taxes, from 32% to 42%. Despite this push, actual transfers to states have been in the range of 33%-35% of Gross Tax Revenue, on account of an incremental increase in cess and surcharge. Moreover, union government expenditure on CSS and CS have grown in this period. Hence, India has been moving in the direction of greater centralisation, despite the Finance Commission push for greater devolution. Third, states have demonstrated far greater fiscal discipline than the Centre, keeping their revenue deficit³ in check while improving own tax revenue collections and meeting fiscal deficit targets. 

India thus, entered the pandemic not only on the back of a slowing economy but also with the macro-fiscal position of the central government being somewhat precarious. Despite a weak macro-fiscal position, the impulse to centralise is rooted deeply in the political economy. Thus the Centre’s need to borrow to meet its recurring expenditure commitments, has only grown.  

Political economy of centralisation

The central government’s economic response to the pandemic and the choices made in the FY2021-22 Budget have only served to deepen this political economy of centralisation. With the economy in complete freeze after the lockdown was announced, the pressures to increase public spending were significant. Moreover, state governments – who were at the frontlines of the pandemic response – were in urgent need of fiscal support to meet expenditures. Rather than deploying its fiscal and monetary powers to support states, the Centre chose to centralise its fiscal response (limited as this was, a point I discuss below) through the Pradhan Mantri Garib Kalyan Yojana.⁴ States have been forced to rely on market borrowing. At the same time, the Centre received a revenue bonanza by raising excise duty (not shareable with states) on petroleum. The total cess collection in FY2020-21 was as high as 18% of gross revenue receipts while the share of the states in the divisible pool of taxes dropped from 32% in the budgeted estimates⁵ to 28.9% in the revised estimates for 2020-21. 

Going forward, India’s path to recovery will likely deepen centralisation. Despite a stated commitment to the Fifteenth Finance Commission recommendation of maintaining vertical devolution⁶ at 41%, the share of the states in net tax receipts is only 30% in the Budget for FY2021-22. Moreover, the Centre announced a new agriculture and infrastructure cess while lowering customs duties on select products, which will have a direct impact on the revenues of states. The final nail in the coffin for States is the decision in the budget to put States back on the path to fiscal discipline at great speed, while giving the center more wiggle room. The Budget leans on the Finance Commission recommendation to push states toward fiscal consolidation at a faster pace than it has planned for itself – states are expected to bring their deficit down to 2.8% by 2023-24 versus 4.5% by 2025-26 for the Centre.

The impetus to centralise also had a direct impact on the nature of relief offered to the poor, who suffered disproportionately through the pandemic. As is widely acknowledged, India’s fiscal stimulus has been remarkably small. At one level, the Centre’s historic fiscal mismanagement gave it limited room to manoeuvre. Bringing off-budget borrowing back on the books, and failure to meet disinvestment targets, contributed significantly to the 9.5% fiscal deficit, as per the revised estimates for FY2020-21. Equally, the centralisation impulse, constrained the choices available to the central government. Targetting difficulties was the oft-repeated argument for not giving generous income support throughout the pandemic, and for the FY2021-22 Budget choice of focussing on physical infrastructure over ‘handouts’ (to quote officials from the Finance Ministry). This is an excuse. The reality is that there are innovative tools that can be deployed but this would require state and local governments to lead the way. On first principles alone, they are far more effective at targetting than the central government can ever be. The propensity to centralise closed off the option. It also legitimised the choice of a focus on infrastructure over expanded income support in the FY2021-22 Budget despite the realities of the unequal economic impact caused by the ravages of Covid-19 on India’s poorest.

Shift away from welfarism

Centralisation apart, the Budget furthers an important political shift in the economic narrative of the Modi government. Prime Minister Narendra Modi’s first term in office was marked by a ‘welfarist’ orientation – visible in the plethora of schemes for sanitation, housing, gas cylinders, and so on. Without debating the effectiveness of these schemes, there is no doubt they played an important role in the 2019 elections, and were emblematic of the central government’s approach. Since the start of the pandemic, this welfarist-focussed politics has taken a backseat. The government’s stubborn refusal to loosen its purse strings and provide direct fiscal support – and instead rely on monetary policy levers – is evidence of this shift. Rather than expanding, government expenditure contracted, picking up only in November 2020. Importantly, the increased total expenditure in FY2020-21 (from Rs. 30.4 lakh crore BE to Rs. 34.5 lakh crore RE) includes Rs. 1.5 lakh crore of prepayment of past dues to the Food Corporation of India. The emphasis on physical infrastructure over continued expansion of the food subsidy and MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act)⁷ (the two pillars of the Covid-19 relief measures) in the FY2021-22 budget, and the absence of any direct support to migrant workers and the urban poor, points to a decided shift away from the welfarism of the past. A new political economy approach is now being crafted. 

As several commentators, including on Ideas for India, have noted, India’s poor will disproportionately bear the costs of this shift away from expanded welfare support toward physical infrastructure. The gains from increased investments in physical infrastructure will not immediately translate into employment and increased wages for the poor. There are continuing governance challenges, which despite announcements of a ‘bad bank’ and Development Finance Institution (DFI), will not be addressed overnight.  

India’s post-lockdown economic recovery is showing signs ofs deepening structural inequality. Economic activity has reached near pre-pandemic levels but this is largely profit-led. Large, listed firms have profited at the cost of small firms and the informal sector. The scars in the labour market, particularly informal labour, run deep. The shifting political economy underlying the policy choices made at the peak of pandemic and in its aftermath in the 2021-22 Budget, suggest that these scars will likely deepen in the years to come. 

Notes:

1. 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.
2. The practice of masking the real fiscal deficit through off-budget borrowing. Off-budget borrowings are those borrowings by state-owned firms that are not part of the official budget calculations.
3. The difference between total revenue and total expenditure of the government is referred to as fiscal deficit and is an indication of total borrowings needed by the government. While calculating the total revenue, borrowings are not included. A revenue deficit arises when the government’s actual net receipts are lower than the projected receipts.
4. Finance Minister Nirmala Sitharaman announced a Rs 1.70 lakh crore relief package under the Pradhan Mantri Garib Kalyan Yojana to provide relief to the poor during the Covid-19 pandemic.
5. 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.
6. Vertical devolution is the distribution of the net proceeds of taxes of the Centre between the Centre and the states.
7. 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.