Ahead of the release of the Union Budget for FY2023-24, Chetan Subramanian reveals his expectations about the government’s key priorities and how they could balance multiple objectives. He discusses the past year's focus on capital expenditure, which is likely to continue. He also highlights the need to focus on incentivising affordable housing; making appropriate allocations to states; and ensuring employment growth to boost consumption. Expenditure on rural infrastructure and healthcare are also expected to be priorities, with continuity in allocations likely to remain a trend.
The Finance Minister will soon have the unenviable task of presenting the budget in a year where the global economy, facing unprecedented inflation, will almost certainly experience significant contraction. The situation domestically, while relatively better, still presents its share of challenges in the form of high inflation, tightening monetary policy, anaemic private capital expenditure growth, and a rising current account deficit. Fiscal policy in such a scenario will have to serve as a complement, and not a substitute for monetary policy. Healthcare, job creation, and social sector initiatives are also likely to be key priorities. The Finance Minister will have to delicately balance these multiple objectives, while also ensuring macroeconomic stability.
In the budget for FY2022-23, the focus was squarely on capital expenditure: the government increased its allocation by a massive 35.4% (to Rs. 7.5 trillion) in an effort to revive the economy from the ravages of the pandemic. The government justified its emphasis on capital expenditure (capex) instead of revenue expenditure by pointing to its estimates of significantly higher multipliers associated with the former. The benefit of the capex multiplier is that in addition to giving an immediate boost to demand, it also lowers logistic costs and crowds in private investment expenditure. Capacity building and reducing logistic costs would also help mitigate inflation. Therefore, it can be expected that the emphasis on capital expenditure will continue in FY2023-24.
The real estate sector is a critical component of capital expenditure. The budget should focus on incentivising affordable housing, as it has the potential to create significant employment. Currently, the biggest bottleneck for affordable housing is land availability. Government land should be made available to develop large-scale affordable housing or integrated townships in and around employment clusters. There should be an effort to speed up the creation of the residential mortgage-backed securities (RMBS) market. NBFCs that provide last-mile funding for affordable housing projects will be able to monetise their loan portfolio through RMBS. Additionally, the government has set 2070 as the target year for having net-zero emissions. Buildings constitute about a third of all greenhouse gas emissions. The majority of the building stock in the country is at least 10-15 years old. Supporting the creation of new, ‘green’ buildings will not be enough to meet our targets; we need to retrofit the older buildings to make them environmentally sustainable. The government should create a small task force to steer this and directly incentivise businesses to take this up.
Despite the significant rise in capex by the Centre last year, spending by the states remained sluggish and unequal. Therefore, the Centre must incentivise states to support growth by boosting capital expenditure to create jobs. The central government last year announced Rs. 1 trillion in 50-year interest-free loans to states, over and above the normal borrowing, to help them finance infrastructure spending. Such allocations, with implementation incentives, should be continued in the current fiscal year.
The sluggish growth of private capital expenditure has been an area of concern for several years. Incentives such as lowering the corporate tax rate have not been successful in reviving the capex cycle. Although firms have used the tax cuts to de-leverage and improve their balance sheet position, the creation of new assets, has been elusive. The last few months have brought some cheer on this front, as we have seen healthy capacity utilisation rates. CMIE reports also indicate that bank credit has picked up and is perhaps at an all-time high. However, these increases in borrowing by industry have yet to translate into an increase in assets on companies' balance sheets. As CMIE data suggests, most of the borrowing appears to have been in order to meet working capital requirements.
The unsustainability of demand, given the headwinds that the global economy is facing, is perhaps one reason for the reluctance to expand capacity aggressively. The slowdown in the world's major economies would mean the export outlook is bleak. Therefore, sustained consumption expenditure growth is a prerequisite for increased capex. While consumption has made a robust recovery, it has still been the slowest sector to recover. Rural consumption growth has remained weak owing to rising input costs and terms of trade turning against the agriculture sector. Unlike many advanced economies, where surplus savings during the pandemic and generous stimulus packages have sustained consumption demand, India will need healthy employment growth to boost consumption.
The prime candidate for generating employment is the MSME sector. This sector contributes to about 33% of India's GDP, 45% of the country’s exports, and creates 120 million jobs across all industries. One of the critical bottlenecks MSMEs have faced in their growth has been ready access to credit. The Emergency Credit Line Guarantee Scheme (ECLGS) introduced by the government did play a crucial role in sustaining MSME lending during the pandemic; this year’s budget should consider extending the scheme.
The FinTech market, which, in turn, owes much of its success to the unique Indian approach to providing digital financial infrastructure as a public good, has also facilitated easier access to credit for the MSME sector. For instance, one of the critical challenges MSMEs face is the lag between receivables and payables. Anecdotal evidence suggests that TReDS, an electronic platform for facilitating the financing/discounting of MSMEs’ trade receivables, played a critical role in credit financing to the MSMEs during the pandemic. There is, therefore, a case to be made for providing some GST relief to critical firms in this sector.
From all accounts, the Production Linked Incentive (PLI) scheme has attracted investments, with over 50% of those flowing into new-age or green technologies. The scheme is, in general, well-designed and expected to better integrate the Indian industry with global value chains. There is, however, room for improvement in achieving some of the objectives of the PLI. While the PLI was restricted to large firms, it was expected that manufacturing capacities and MSMEs would evolve around them as ancillaries. To the extent that import content in some of the PLI sectors (particularly mobile phone manufacturing) has gone up, it's not clear the extent to which this objective has been achieved.
Similarly, the pharmaceuticals and mobile phone manufacturing sectors have met only a fraction of their employment objectives. Given MSMEs' critical role in employment generation, one would like to see MSME units better integrated into the PLI. To ensure PLI industries do not become pure import and assemble units, incentives must be linked to concrete research and development outcomes; this is the only way they will be sustainable in the long run.
Expenditure on rural infrastructure will be a priority, given its effectiveness in generating employment and income in rural India. For instance, Aggarwal (2018) finds that the Pradhan Mantri Gram Sadak Yojana (PMGSY), with the objective to bring the habitations of at least 500 people within reach of the nearest market through the construction of an all-weather road, resulted in lower prices of goods, greater use of technology, higher enrolments in schools, and expansion in labour market activities.
There is also a case to be made for expanding programmes such as the Pradhan Mantri Kisan Samman Nidhi. This is a universal basic programme that gives a guaranteed, unconditional and perpetual cash transfer of Rs. 6,000 per year to all landowning farmers in India. Ghosh and Vats (2023) show that such a programme, by providing a permanent increase in income and protecting against downside risk, raises demand for credit and investment in capital-intensive technology. They find that $1 of guaranteed income each year increases credit by $15.7 and income by $1.7. The programme, therefore, has the potential to increase both investment and consumption spending in rural India.
Health care is expected to be a priority for the government. The economic consequence of health shocks on households, particularly when insurance and access to credit are limited, can be severe. Programs such as Ayushman Bharat - Pradhan Mantri Jan Arogya Yojana (AB-PMJAY) have been welcome initiatives on the road to achieving universal health coverage. However, as a NITI Aayog report points out, about 30% of the population does not have health insurance access (Kumar and Sarwal 2021). The report terms this section of the population as the “missing middle.” These people are not poor enough to be eligible for government-subsidised insurance, but are priced out of private insurance markets. The budget must find creative ways to work with the private sector to bring this segment into the insurance pool.
Finally, fiscal consolidation is likely to remain a priority for the government. The revised food subsidy program could result in a saving of 0.6-0.7% of the GDP. This would ensure that the fiscal deficit stays around 5.8% of GDP, which would also be consistent with the glide path promised by the government to bring the deficit to 4.5% in three years. Overall, we can expect the budget to focus on continuity, with not too many surprises.
The author would like to thank his colleague Venky Panchapagesan for his input on the subject of environmental sustainability of buildings on the path to achieving net-zero targets.
- Agarwal, Shilpa (2018), “Do Rural Roads Create Pathways out of Poverty? Evidence from India”, Journal of Development Economics, 133: 375-395. Available here.
- Ghosh, P and N Vats (2023), ‘Safety Nets, Credit, and Investment: Evidence from a Guaranteed Income Program’, Job Market Paper.
- Kumar, A and R Sarwal (2021), ‘Health Insurance for India’s Missing Middle’, NITI Aayog Report.