Budget should maximise capex, set stage for MPC to control inflation

Budget 2022: ICRA expects a satus quo on the stance of the monetary policy as well as the reverse repo rate in the upcoming meeting of the Monetary Policy Committee.

The Union Budget 2022 is being finalised amidst the third wave of Covid-19 in India. In our view, it should focus on maximising capital spending to inject durability into the economic growth outlook, with the rebound in global commodity prices portending that the Monetary Policy Committee (MPC) will have to prioritise inflation management in FY23. 

Encouragingly, the quarterly data suggests a modest broad-basing of the economic recovery in Q3 FY22, with a larger number of high frequency indicators bettering their respective pre-Covid volumes. However, the onset of the third wave of Covid-19 has subsequently triggered state-wise restrictions. These have expectedly interrupted the momentum in the ongoing month, underscoring that the recovery is yet to attain durability.

Until November 2021, the government's fiscal deficit was limited to Rs 7 trillion, amidst spending of Rs 20.4 trillion. We expect its gross tax receipts to exceed the budgeted amount by a robust Rs 2.5 trillion in FY22. Adding the higher-than-budgeted surplus transfer by the RBI to the anticipated extra net tax revenues, we expect the revenue receipts (net of devolution to states) to surpass the FY22 Budget Estimates (BE) by a considerable Rs. 2.3 trillion.

However, we expect the government's spending to be fairly back-ended in FY22, especially on those items that were included in the Second Supplementary Demand for Grants, such as food and fertiliser subsidies, export incentives/remissions under various export promotion schemes (such as MEIS and RoSCTL), equity infusion into Air India Assets Holding Limited, etc. Such back-ended spending is likely to drain much of the substantial cash balances that the government has built up.

If the flows from LIC’s much-awaited IPO get delayed to FY23, which is our base case, the fiscal deficit is expected to print at Rs. 16.6 trillion in FY22, higher than the budgeted Rs. 15.1 trillion.

Looking ahead to FY23, the Union Budget should focus spending on the areas that have the maximum potential of spurring a durable growth recovery. In our view, this is best achieved by enhancing capital expenditure and infrastructure spending, as well as pushing PLI schemes in sectors with the highest employment generation potential. Funding of such outlays can partly be achieved through a further rationalisation of Centrally-sponsored schemes and Central sector schemes.

If there is another moderate to severe wave of Covid next year, additional funds may be warranted for items such as free foodgrains and an enhanced allocation for MGNREGA. Such schemes are a crucial input into bolstering confidence in urban and rural areas in uncertain times. However, the level of funding required in a fourth wave scenario need not be built into the budget itself, to allow greater space for capex, and can always be provided via a supplementary in the middle of the year.

In the base case, we foresee the government's fiscal deficit declining to 15.2 trillion or 5.8 per cent of GDP in FY23, with net G-sec issuance of Rs. 9.1 trillion. ICRA expects that the planned ceasing of GST compensation will cause the state governments’ fiscal deficit to rise to the cap of 3.5 per cent of GSDP set by the 15th Finance Commission, suggesting a net state development loan (SDL) issuance of Rs. 7.3 trillion in FY23.

Following the restrictions triggered by the third wave, we expect a status quo on the stance of the monetary policy as well as the reverse repo rate in the upcoming meeting of the Monetary Policy Committee (MPC), in spite of the rise in retail inflation in December 2021. This meeting is scheduled to be held in February 2022, shortly after the presentation of the Union Budget. 

Nevertheless, the recent rebound in commodity prices suggests another round of price hikes by Indian producers may be on the anvil after the third wave ebbs. As a result, we expect the CPI inflation to average at least 5 per cent in FY23, which means the MPC will likely prioritise inflation management once the current uncertainty subsides.

Clearly, 50 bps of repo rate hikes are on the cards in FY23, even as the US Fed may go in for three-four hikes of 25 bps each starting as early as March 2022. With net and gross market borrowings of the centre and the states expected at Rs. 16.4 trillion and Rs. 22.6 trillion, respectively, in FY23, domestic bond yields are certain to harden further.

Disclaimer: Aditi Nayar is chief economist at ICRA. Views expressed here are her own.