Budget with a long-term view

Govt can approach the Budget 2021 with an aim to rebuild the economy to attain the long-term objective of sustained higher growth

Union Finance Minister Nirmala Sitharaman will present perhaps the most significant Budget in recent history on Monday. There are at least two ways to approach the Budget. One, the government can focus mostly on the next financial year. The economy is recovering from the pandemic-induced contraction, and growth is set to rebound sharply. The International Monetary Fund now expects India to grow at 11.5 per cent next year. Revenue collection will also recover with the improvement in economic activity. The government can choose to increase expenditure and push growth during the financial year, as being suggested by many commentators.

The other approach would be to consider it a starting point and rebuild the economy to attain the long-term objective of sustained higher growth. It’s not difficult to argue that the second approach should be followed. This is important because the Indian economy was losing momentum even before the Covid-induced disruption, and it is reasonable to assume that  the pandemic has materially affected potential growth. Further, it is critical to acknowledge that the global economic setting will not be as supportive as it was in recent decades. There are two aspects worth highlighting in this context.

First, the global economy is slowing structurally. As noted in the World Bank’s latest “Global Economic Prospects” report, by 2019, the ten year-ahead global growth forecast fell to 2.4 per cent, compared to 3.3 per cent in 2010. For emerging market and developing economies (EMDEs), growth forecast during the same period declined sharply from 6.1 per cent to 3.9 per cent. Potential output growth was projected to slow by 1 percentage point in EMDEs over the 2020s even before the pandemic. According to the World Bank, the pandemic may steepen the potential growth slowdown in EMDEs by 0.6 percentage point per year over the 2020s. The global economy was slowing before the pandemic due to reasons such as slower working-age population growth and lower investment. The guided slowdown in China over the last few years also affected growth, particularly in the developing world.

Second, global debt has expanded significantly. As the World Bank noted, government debt in EMDEs is estimated to have gone up by 9 percentage points in 2020. The total debt stock in EMDEs in 2019 was at about 176 per cent of gross domestic product (GDP) — largely driven by the private sector. This is worrying because a rapid increase in debt led to financial crises in several countries in the past. Also, the debt stock is rising at a time of slowing global growth.

Such changes in the global economic environment will directly affect India. Essentially, India will need to do a lot more in terms of reforms to attain the desired level of growth in the coming years. It will also need to protect financial stability from potential adverse shocks due to rising global debt stock. Public debt in India too has expanded sharply and is projected to go up to about 90 per cent of GDP in the current year. This will limit the scope of government intervention in supporting growth over the medium term. In fact, one of the top priorities for the government should be to gradually bring it down. This would require prudent fiscal management. The government will, however, need to push capital and infrastructure spending, which can be financed by an aggressive asset sale programme.

Although regaining growth momentum would require wider policy intervention, the Budget can start this process. For instance, the government needs to decide how it intends to deal with public sector banks (PSBs). Continuous capital infusion is an unsustainable proposition. Issuing recapitalisation bonds also has limits. The disruptions in the economy will make things more difficult for PSBs. Their gross non-performing asset ratio, according to the Reserve Bank of India, can go up to 16.2 per cent by September 2021. Poor asset quality in the banking system will be a drag on growth.

Another sector that needs immediate attention is power, though it may not directly affect central government finances. The dues to power generators are mounting. This is again an untenable situation. The sector needs deeper reforms, and the Centre will have to take the lead. Excessive cross-subsidisation and lack of transparency in pricing are affecting the competitiveness of Indian businesses. While it’s important that the government initiates action on pending problems in different sectors, it’s equally vital to avoid certain things — there is no margin for policy errors. For instance, the government should not raise import tariffs. In fact, the focus should be on increasing exports, and protectionist policies will not allow that to happen.

Further, it should avoid cutting taxes and adding new recurring expenditure at this stage. Such moves could make fiscal management even more difficult. It’s being reported that the government intends to set up institutions like a bank investment company, bad bank, and a development finance institution. At best, these institutions would give a sense of accomplishment in the near term, but will not solve the underlying problems. India’s medium-term potential growth is said to have slipped to around 5 per cent. Broader policy decisions, therefore, should be driven by the goal of attaining sustainable 7 per cent-plus growth in the medium term. The Budget will be a good starting point in this direction.