Reform within status quo

If you cut to the chase, little has changed in the Budget per se, as will be seen in a moment. What has changed is the government’s fiscal conservatism and therefore spending strategy, plus a positive willingness to push the reform button on several fronts. These include a sharp turn in the approach to the role of the public sector, opening up to more foreign ownership of insurance companies, churning the ownership of government-created assets, selling public sector banks, and trying out earlier-discarded ideas on financial sector reform like a fresh asset reconstruction company (in effect a “bad bank”) and a development finance institution. Other than the last two, which have history against them, the rest are to be wholeheartedly welcomed. The stock market is inordinately excited, both because of the reform measures proposed and also the absence of a one-time cess which had been feared. Stable tax policy is a benefit in and of itself. But a more sober assessment of what the Budget has actually done, separate from what has been promised, may cool sentiment somewhat.

Shorn of the associated drama that has become almost de rigueur, the Budget is in simple terms the government’s annual financial statement. Focusing on that, total expenditure next year will be virtually the same as this year, the increase being less than 1 per cent. Gross tax receipts go down and up; but in relation to GDP, they will be virtually the same next year as this year and the last year. Within that framework, what is notable is the shift in the direction of spending, favouring capital expenditure in line with what was argued in the Economic Survey on Friday, that such expenditure is a bigger fiscal multiplier.

Other than this, the outlay numbers are unremarkable. There is more for health, rural development, and the financial sector, but most segment-wise outlays show only modest changes if compared with the pre-Covid year of 2019-20: Like the education mission, the Pradhan Mantri Awas Yojana, the Gram Sadak Yojana, city metros, defence, etc. Some even show declines, like the direct benefit transfer for LPG supply, the employment guarantee scheme, and the “umbrella” integrated child development scheme. The continuing neglect of defence in the face of a clearly worsening security scenario is inexplicable.

What stands out amidst this broad status quo picture is the willingness to make up for the lack of revenue by borrowing much more, on a scale not seen until now. This is understandable in a crisis year like the present one. Even though the fiscal deficit this year is exaggerated by the finance minister doing more transparent accounting, as she had promised, a figure of 9.5 per cent has shock value, and it is interesting that Nirmala Sitharaman paused for a fractional moment before disclosing it. What is more notable is the deficit of 6.8 per cent of GDP during next year’s recovery, as it takes one back by a decade to the excesses of 2011-12.

The risks of excessive borrowing were played down in the Survey’s strong advocacy of just such a strategy, but show up in interest payments, which have grown from Rs 6.12 trillion in pre-Covid 2019-20 to Rs 6.93 trillion this year and further to Rs 8.10 trillion next year — up 32 per cent over two years. There is the additional risk here of a revenue shortfall on disinvestment proceeds, which have repeatedly belied ambitious targets. Next year’s target is more than five times this year’s likely realisation. It would be wise to keep fingers crossed. Also notable is the fact that much of the deficit until now has been on account of interest payments against past debt. Adjusting for this, what is called the primary deficit has hovered around 0.5 per cent of GDP in recent years. This figure shoots up understandably in the current year, but stays higher than normal at 3.1 per cent for next year.

Such trends reduce space for the counter-cyclical fiscal stance that the Survey correctly has argued for. One wishes there was less reluctance to explore taxation avenues, including a higher average rate for the goods and services tax (correcting for reductions in the run-up to the 2019 elections). This is especially so since the tax-GDP ratio has fallen by 1.3 percentage points since the last year of high growth, 2017-18, from 11.2 per cent of GDP to 9.9 per cent. For the Centre’s share, this drop is equivalent to about Rs 1.6 trillion on next year’s anticipated GDP of Rs 223 trillion, no small number in the overall matrix.

The only additional increase one has seen is in customs duties (which is protectionist but in line with the Atmanirbhar strategy) and in excise duty on petroleum goods. This is clearly not enough. The result is that borrowings in the Budget (at Rs 15.1 trillion) will be almost equal to the government’s net tax revenue (Rs 15.5 trillion). The government has sensibly limited the impact of such high borrowing on the money market and on market interest rates by drawing much more on small savings, but this is high-cost debt and will not help to keep down the interest burden. Despite that, bond yields have climbed.

Still, the context matters when passing judgment. Faced with a virtually impossible fiscal situation, the finance minister has worked hard to present a Budget that has boosted sentiment. But if the Budget is a bet on growth, Ms Sitharaman should be aware of the risk of it falling short, since various commentators have argued that the economy’s medium-term growth potential has been affected. The only way to deal with that is through sustained reform measures that boost productivity. That is an additional reason to welcome what has been announced. It will be particularly important to reach the disinvestment target and to get the financial sector sorted out, so that the economy can put the “twin balance-sheet” problem behind it. Finally, the measures to make life easier for different categories of tax-payers will be widely welcomed.