Budget 2022-23: Hits and misses

Outlining the hits and misses of the Budget 2022-23, Rajeswari Sengupta contends that the capital expenditure push by the government seems to be a step in the right direction, while the rationale behind the continued focus on protectionism is questionable. In her view, the Budget appeared to lack a coherent growth strategy, which was the need of the hour – especially given the high levels of government debt.

The 2022-23 Budget came across as a simple, uncluttered Budget which did not get into any complex restructuring of the tax regime, and instead seemed to focus on increasing government expenditure to boost investment and economic growth. However, there are a few incoherencies in the Budget that are worth highlighting.

It is important to grasp the macroeconomic context in which the Budget was presented. Four points are particularly significant. First, economic activity seems to be back to its pre-pandemic level. But we have now lost two years of growth. This can prove very costly for an emerging economy like India, especially since it was not faring well before the pandemic (Sengupta 2020, Subramanian and Felman 2019). There are measurement problems in the official GDP (gross domestic product) data, but all reliable indicators show that the economy had been slowing down for decades preceding the pandemic. Investment by the private sector had been stagnant, consumption demand had been weakening, and export performance was poor. Apart from government consumption expenditure, all other engines of growth were languishing, and unemployment had gone up. Secondly, even during the current economic recovery, one of the main engines of growth – private investment demand – has continued to be sluggish, and capacity utilisation has not improved. While export performance has been impressive, much of this can be attributed to recovery of the developed economies from the pandemic and hence might prove to be a transient phenomenon once their growth slows to more sustainable levels. The increase in the value of Indian exports was also partly due to rising prices rather than increase in volumes.

Third, as suggested by anecdotal evidence, the recovery from the pandemic has been unequal, with recovery led by the large companies. On the other hand, the vast number of medium, small, and micro enterprises, and a large proportion of households have been adversely affected by the pandemic. They continue to reel under the repercussions of the shock. Finally, the global macroeconomic environment is significantly more hostile now compared to the pre-pandemic period. The developed world is experiencing its highest inflation in four decades. This will prompt their policymakers to withdraw the additional liquidity they had pumped into the financial system during the pandemic, and to raise interest rates. This in turn will affect emerging economies like India in two main ways: (i) It will lead to capital outflows from Indian financial markets – this has already been happening in anticipation of the rate hikes by the developed country central banks; (ii) It will aggravate the possibility of India importing inflation – prices are already rapidly rising on major Indian imports, including oil and commodities.

This shows that the Budget was presented at a highly critical juncture. The two key questions confronting the economy now are as follows: (i) How can high, sustainable growth be ensured?, and (ii) What is the fiscal strategy of the government?

Analysed against this background, the Budget was characterised by both hits and misses.

Economic growth: Investment

Given the sluggishness of private investment demand, it was widely anticipated that the government would increase capital expenditure (capex) in the Budget in keeping with its announcement last year when capex spending was increased by 34.5%. In keeping with the expectations, the Budget included an increase in capex by 35.4% for FY2022-23¹.

The choice that the government had in order to stimulate demand in the economy was either to increase its consumption expenditure (that is, expenditure on the revenue account) or to increase capex. The decision to opt for the latter was a relatively better move. An increase in capex is associated with a bigger multiplier effect compared to an increase in consumption expenditure, and is therefore a better instrument for creating jobs, increasing demand, and boosting growth. As per the government, the higher capex spending is also expected to encourage the private sector to start investing, as demand and hence capacity utilisation pick up.

The quality (that is, the nature) of government spending is also important because it is related to the government’s debt repayment capacity. While consumption expenditure merely adds to the existing stock of debt, capex generates productive assets and hence enables the government to repay its debt. This is particularly important in the current situation because government debt has increased manifold during the pandemic period..

Economic growth: Exports

At the same time, there was a glaring incoherence in the Budget with regard to a strategy for growth, and this is related to exports.

Unlike our Asian counterparts such as Bangladesh, Vietnam, or China, India has always missed the bus when it came to using exports as a major instrument for enhancing growth. But now there is an historic opportunity to join the club of great exporting nations as foreign firms are increasingly looking for diversification opportunities away from China. Accordingly, one important growth strategy in the Budget could have been to openly signal the willingness of the government to encourage foreign companies to come to India to produce and export.

What did the Budget do in this regard? It announced the removal of more than 350 import duty exemptions; phasing out of concessional tariffs on capital goods and project imports – which would face a 7.5% tariff; and increase in import tariffs on several items such as solar cells, headphones, etc. Import tariffs have been going up since 2015 and this Budget has continued that policy.

Why is this a problem? When international firms decide whether to produce in and export from India, one important factor they consider is whether they would still be able to access the different products that they need from their supply chain across the globe, as they do in China. A good example is an Apple iPhone, the manufacturing of which uses components from the US, Germany, Japan, South Korea, Taiwan, and many other places. Import duties hamper this process because they increase the cost of importing, and hence disrupt the production chain. The Budget, by continuing the move towards a protectionist environment, has conveyed to foreign firms that doing business in India is going to be costly and difficult for them.

Fiscal Strategy: Borrowing programme

With regard to the fiscal strategy, two elements stood out in the Union Budget. During the pandemic, the central government deficit went up substantially. Even now, the Budget has projected a higher-than-anticipated deficit of 6.4% for FY2022-23. This deficit will be financed by a high level of borrowing.

Let us put this in context. Globally, developed country central banks are starting to tighten their monetary policy stance. In India, consumer price index (CPI) inflation has been running close to the 6% upper limit of the RBI’s (Reserve Bank of India) inflation targeting band. And inflation now faces additional pressures from rising global crude oil and other commodity prices, as well as rising inflation in the developed countries.

Accordingly, the RBI is slowly shifting its monetary stance. It has discontinued its government bond buying programme, whose objective was to make it cheaper for the government to borrow. Most likely, it will follow this step by raising interest rates sometime during FY2022-23.

Financial markets had hoped that, even as the RBI ended its bond purchases, foreign investors would increase theirs. Specifically, they had hoped the government would announce tax exemptions that would facilitate the inclusion of government bonds in global bond indices. Once this was done, global investors who tracked these indices would be forced to make large purchases of Indian government bonds. However, the Budget did not make any announcement in this regard.

In other words, just at a moment when demand for government securities looked like it was going to be weak, the Indian government announced a huge increase in supply. Unsurprisingly, rates on 10-year government securities have gone up to 6.9% since the announcement of the Budget.

And this is far from the only consequence. Over the coming year, the large borrowing programme will potentially have several repercussions. The interest burden on the Budget will continue to rise. Interest expenses already consume more than 40% of the central government’s revenue, the result of a consolidated government debt-to-GDP ratio of close to 90%, its highest level ever. And since the government is continuing to borrow large sums, as per the Budget, interest expenses are expected to continue to increase, by a whopping 38% between FY2020-21 and FY2022-23. If in addition the borrowing causes interest rates to rise, this will only aggravate the government’s debt service problems. The government’s borrowing announcement also puts pressure on the RBI. If the RBI resumes buying government securities in order to keep interest rates in check, this will inject even more liquidity into the system, and make it difficult for the RBI to control inflation as credit demand picks up. If, on the other hand, the RBI tightens monetary policy, bond rates will harden, making it costlier for the government to borrow. If rates continue to rise due to the government’s borrowing programme, then this might crowd-out the private sector as capacity utilisation improves and demand for credit increases. It remains to be seen which effect will dominate in the end – private sector getting crowded-in because of the capex push of the government, or private sector getting crowded-out because of the growing costs of capital.

Fiscal strategy: Medium-term programme

In addition to the massive borrowing plan, another notable feature of the Budget was the lack of a medium-term fiscal strategy.

Given the burgeoning debt burden, the government should have laid out a plan, indicating how and when it is planning to bring its deficits and debt back down to pre-pandemic levels. But the Budget did not touch upon any such strategy. Two issues stand out in this context.

The best way to restore the fiscal position is through rapid economic growth, as this would increase people’s incomes, thereby ensuring ample revenues for the government while reducing the need for it to spend on social programmes like MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act)¹. But it is doubtful that a strategy of protectionism, even one accompanied by a capex push, will succeed in reviving private investment and generating robust growth.

In the absence of a coherent growth strategy, one way to pay down debt would have been through disinvestment. Yet, the Budget did not make any new, big announcements for disinvestment. In fact, revenues from the disinvestment programme are projected to decline drastically from the Rs. 1.75 lakh crore budgeted for FY2021-22 to a meagre Rs. 65,000 crore in FY2022-23. In the 2021-22 Budget the government had also announced an asset monetisation programme of Rs. 6 lakh crore but no further mention of this programme was made in this year’s Budget. These raise concerns about the privatisation plans of the government and the disinvestment strategy going forward.

Conclusion

In a nutshell, given the domestic and global macroeconomic context, the capex push by the government in the Budget seems to be a step in the right direction. However, the rationale behind the Budget’s continued focus on import substitution and associated protectionism is questionable. In view of this, the Budget appeared to lack a coherent growth strategy, which was the need of the hour – especially given the high levels of government debt.

In view of the massive borrowing programme announced in the Budget, relaxation of capital controls to encourage greater foreign investment in government bonds has become imperative. The RBI has made some announcement in this regard when it presented its monetary policy on 10 February 2022, but much more needs to be done given the quantum of borrowing requirement.

The government has taken a bet that the capex push would lead to jobs and growth. If it pays off, then it would be favourable for the economy. But if not, then the economy would be left with a high fiscal deficit, a large amount of debt, growing inflationary pressures, and potentially a rising current account deficit which would not be a good combination of macroeconomic indicators at a time when the US Federal Reserve is about to start tapering.

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Notes:

However, the true extent of the increase in capex remains debatable.
MNREGA offers a guarantee of 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.