Growth slowdown, fiscal dilemma complicate India's Budget preparation

Last week, the Union Ministry of Finance released its “Mid-Year Review of Trends in Government Receipts and Expenditure”. On the surface, this document made for unremarkable reading. The Ministry pointed out that revenue receipts in the first half of the year, at almost 52 per cent of Budget Estimates, were above the five-year rolling average; and the fiscal deficit, as a percentage of gross domestic product or GDP, was below the norm for the first half of the year. This might give the sense that India’s macroeconomic position is quite comfortable as the season for preparing the Union Budget gets underway. Indeed, the document recommits the government to the glide path of fiscal consolidation and does not express any particular concerns.

 

It would not be entirely true to get a sense of comfort from the Mid-Year Review, however. Counterintuitively, this document reveals areas of considerable weakness, which will worry North Block. Most of these areas are connected to the unexpected underperformance in growth exhibited by the Indian economy last quarter. Together with low spending, partly because of the elections in the first quarter this financial year, this has meant that real growth has come in at only 6 per cent in the first half. Given that nominal growth, as provided for in the Union Budget, was supposed to be 10.5 per cent and instead has come in more than a percentage point lower at 8.9 per cent in the first half, the Budget mathematics for next year has developed complications.

 

This is revealed in the data in the Mid-Year Report. The fact that revenue receipts were above the five-year rolling average does not reveal everything, given that the past five years include the extraordinary years of the pandemic. The government’s capital expenditure, which supports growth, has been lower in the first half than in comparable years. This may flatter the overall deficit numbers — but it also reveals the dilemma facing the government. If it is to push growth up, it can take the risk of spending more. But the lower numbers for the fiscal deficit in the first half of the year, based on the Budget Estimates for the current year, might not fully reflect the actual nominal GDP against which the final fiscal deficit for the year is calculated. Thus, there is a real risk that even returning to earlier predicted paths for spending will, in fact, wind up causing the government to burn through the deficit targets.

 

There are thus no easy choices facing the government. There will be a very real temptation to try and develop optimistic assumptions about growth in the last quarter of the year in order to make the Budget mathematics a bit easier. But that would be a mistake. The current administration has made a point of using only rational and defensible extrapolations for growth and revenue, and has been rewarded by the markets for this restraint. The macroeconomic stability provided by this hard-earned reputation must not be put at risk by overoptimistic projections. In the end, the government will have to choose between accepting slightly lower growth (and revenue and spending) and delaying fiscal targets. If, in the end, the year surprises on the upside in terms of growth, that will be all to the good. But, based on the data so far, the government will have to make some hard choices in the Budget.