Budget: Continuity & coherence

With some tweaking and good implementation, we can find a safe passage despite global turbulence

Initial perceptions often become entrenched. But it is important to look at new data. We were told the Indian economy was the worst performer under Covid-19 shocks; that the growth recovery is only because of the dip. But the IMF’s recent growth figures for 2020 and 2021 show India to be out-performing (India -6.6 and 9; Mexico -8.2 and 5.3; Spain -10.8 and 4.9; and France -8 and 6.7). Most major countries had a worse dip and a lower recovery despite more government spend.

The macroeconomic strategy that helped us achieve this is hazily visible in the Budget. Drawing out the major strands shows that each is necessary and one complements the other.

Government debt ratios have risen uncomfortably and interest payments eat up almost half of revenue — unlike the Japanese and US governments, which can borrow at low rates despite much higher debt. Yet both private consumption and investment need support.

The Budget prioritises investment while continuing essential support for the vulnerable and taking only a small step on the path of fiscal consolidation. The six points below show why.

First, past periods of higher growth saw a substantial jump in investment — public pre-reform and private after — but macroeconomic volatility hurt growth. If the current double-digit growth in public investment crowds in private investment, it can reach the required critical mass. Some low-level construction will create jobs fast. The absence of space restrains more consumption stimulus. Moreover, our own 2008 experience and current US inflation tell us prioritising consumption raises inflation and aborts growth as supply-bottlenecks begin to bite.

Second, a better composition of government expenditure and other supply-side action will help keep inflation within bounds. Gati Shakti plans smart green coordinated infrastructure, which would decrease logistics costs. Buoyant revenues allow excise to be moderated, if necessary, to contain commodity inflation. Oil taxes can be used counter-cyclically. Domestic policy affects the consumer price index (CPI) more while international inflation affects the wholesale price index (WPI). The CPI impacts household welfare and is the inflation target. The government itself puts a large weight on containing inflation. Excellent fiscal-monetary coordination on these issues will allow real interest rates to be smoothly maintained below growth rates; prevent jumps in risk premium; and sustain growth and fiscal consolidation, while giving savers positive real returns.

Third, there is concern on state capacity for implementation. States have to participate for public investment to rise and for outcomes on health and education to improve. The Central Budget avoided populist sops, but freebies are being freely promised in state elections. Arbitrary pricing (free electricity) is especially harmful. Moreover, our higher per capita income makes support through prices incompatible with World Trade Organization rules — India is facing multiple cases. Subsidies have to shift to income transfers, which do not distort. But with one billion-plus population and a narrow tax base, these have to be well-targeted. Limits on borrowing restrain states. To meet these, however, they tend to cut investment. Punjab is a prime example of the harm this causes.

Illustration: Binay Sinha

Therefore, carrots and sticks are required to induce states to invest more. The Budget protects investment by providing them finance but with conditions — loans are to be used to pay state shares in infrastructure projects.

If a fiscal council were set up to implement such schemes, with democratic state participation, the Centre could avoid the flak it gets for attempts to discipline. The council could be mandated to help states converge to best practices in expenditure quality; accounting; transparency; prompt payment; rationalising multiple schemes; and overseeing essential delegation to the third tier, which states have not done.

Fourth, the Budget continues use of the financial sector to deliver stimulus. The BIS credit data shows Indian firms and household leverage is about half the emerging market average, while government debt is about double. This strategy will help government debt fall and private debt rise as required.

It avoids risks because of big differences from such past use. Warranties, which reduce bank risk aversion and use liquidity created, are government liabilities, not banks’. Public borrowing does not rise today and debt may not in the future if the recovery is good. In line with reforms, corporate governance and regulation have tightened, regulatory relief was time-barred, capital buffers are large, and banks are doing risk-based lending. Collection efficiencies are good. Financial stability has surprised on the upside.

The rising share of non-bank credit points to healthy diversity, to which the Budget contributes further. Bank credit shows steady growth even with large industry deleveraging — that to medium industries and consumer durables grew at above 40 per cent. Even in these uncertain times, investment is already rising in some sectors.

Fifth, conditional performance-linked incentives, corporate tax cuts, and limited tariff realignments are leveraging diversification of supply chains to finally give India a chance at job-intensive exports. This, therefore, is not the right time to raise taxes for redistributive purposes. What is new is incentives are transient until scale is reached, focused on creating international competitiveness, based on careful listening to industry to avoid capture and to identify national interest. Support for technology and innovation continues to sustain services export, in which India has a comparative advantage. Multiple strategies are required to cater to India’s varying levels of skill.

Sixth, US inflation and Fed tightening create risks. But following the Fed in 2013 and 2018 contributed to India’s decade-long growth slowdown. Indian inflation has a very different structure; caps on interest-sensitive flows ensure outflows will only be a minuscule share of reserves; reduction of durable liquidity from outflows will allow the RBI to support government borrowing more. There is room, therefore, to align policy rates to the domestic cycle. Postponing index fund inclusion is sensible in this volatile period.   

The Budget has continuity as well as coherence and with some tweaking as well as good implementation we can find a safe passage despite continuing global turbulence. We are doing some things right.

The views here are personal