Budget 2023: The FM’s inflation-growth dilemma 

Walking the Tight Rope
Last Updated 20 January 2023, 06:19 IST

It is Union budget time again, and speculation is rife and expectations high. Though the economy is in a recovery phase, the global headwinds of slowdown and inflation, along with continued risks of the virus in China, pose serious policy challenges. The Union government is faced with the dilemma of having to loosen the purse strings to fast-track growth recovery through enhanced infrastructure-spending while facing the constraint to return to the path of fiscal consolidation. This is the last full-year budget of this government. Hopefully, it will not be overtaken by electoral considerations.

Finance Minister Nirmala Sitharaman has the difficult task of preparing the budget at a time when both the global and domestic economic environments are far from being congenial. The IMF projects the world economy to grow at just 2.7 per cent in 2023, as compared to 3.2 per cent in 2022 and 6 per cent in 2021. One-third of the world, and half of Europe, is expected to slip into recession; and the US is on the cusp of it. With major production centres in China in the grip of the pandemic, the country is also expected to face a phenomenal slowdown. The sharp rise in interest rates in the West to tame inflation has only added fuel to the fire.

India’s growth in FY23, estimated at 7 per cent, looks impressive compared to other large countries, but this is mainly due to economic recovery from the low base of the first two quarters of FY22. The RBI projects that in the second half of FY23, GDP growth will be just 4.3 per cent, and next year, it will be 6 per cent. The crucial element to accelerate growth is to increase investment, and the public sector will have to take the lead role in this. Although indicators like PMI for services as well as manufacturing at 57.8 in December were the highest in 27 months, and on services at 58.3 was an improvement over the previous month (56.4), and bank credit to commercial sectors has been impressive, it is too early to take these as a trend.

Thus, growth acceleration will need a significant increase in infrastructure spending by the government, but that will be constrained by the need to comply with the fiscal consolidation path. The framework of consolidation recommended by the Finance Commission is to compress the fiscal deficit to 4.5 per cent of GDP by 2025-26, if the recovery is lower than expected by the Commission, 4 per cent if the recovery is as per expectation, and 3.5 per cent if it is faster.

The Finance Minister had, in her 2021-22 budget speech, committed that the fiscal deficit will be compressed to 4.5 per cent by 2025-26. Assuming that the government will contain the deficit at the budgeted 6.4 per cent in 2022-23, there will have to be a reduction of 1.9 percentage points in the next three years, and quite a considerable part of that has to be done in the forthcoming budget as the compulsions of electoral politics could constrain such effort next year. To keep pace with the required compression, the budget would have to reduce the fiscal deficit to 5.8 per cent next year.

The nominal estimate of GDP put out by the first advanced estimate provides some cushion. The budget had assumed a nominal GDP of Rs 258 lakh crore, and the advance estimate puts it at Rs 273.08 lakh crore. If the nominal value of the fiscal deficit is limited to the budget estimate of Rs 16.6 lakh crore, the fiscal deficit will work out to 6.08 per cent. In other words, the new GDP estimate provides a cushion of Rs 86,500 crore. However, there has been overshooting of expenditures from the budget by an estimated Rs 3.36 lakh crore. This includes increased allocation to food and fertilizer subsidies, additional dearness allowance payments, and additional allocation to MGNREGS as those seeking work under it have swelled from 50 million before the pandemic to 70 million now.

The swelling of food subsidy was due to the additional allocation of foodgrains under Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) and the increase in fertilizer subsidy was on account of inputs. However, increased tax collections over the budget estimate on account of higher buoyancy in both income taxes and GST should be enough to meet these additional expenditure requirements. Thus, actually, there may not be much increase in the fiscal deficit in nominal terms and, as a percentage of GDP, there could actually be a marginal decline.

The Finance Minister would be hoping that the buoyancy in tax revenue seen this year will continue into the next year and, in addition, the government would garner more through monetisation of assets and disinvestment. In particular, GST has shown higher revenue productivity and with better technology and administration, compliance should increase. With crude oil hovering around $80 a barrel, the fertilizer and transport bill too could settle at a lower level. The rationalisation of subsidies is important, and this is the time to do that.

The discontinuation of additional allocation of foodgrains under PMGKAY would save at least Rs 5000 crore. The introduction of a single national agency in the administration of Centrally-Sponsored Schemes (CSS) seems to have helped the government to effect significant savings, and the benefit of that will accrue in the coming years as well. There is a much larger issue of consolidation and design reform in the CSS, but it is unlikely to be initiated this year. With a pickup in employment opportunities in urban areas, migration of labour from rural areas will increase and the requirement for MGNREGS allocation would be less.

On the reform front, some important measures are expected in this budget. The last couple of years have seen greater transparency as off-budget liabilities have been phased out. The 15th Finance Commission has made a number of recommendations under the rubric, “Fiscal architecture for 21st Century”: (i) to have credible fiscal rules; (ii) initiate a public finance management system to provide comprehensive, consistent, reliable and timely reporting of fiscal indicators as a part of the fiscal rule-based policy and; (iii) Creation of an independent fiscal assessment mechanism to provide assistance and advice on the working of fiscal rules and public finance management system.

Also, it is hoped that the attempts to make the tax system simple and transparent by phasing out deductions and concessions and reducing the rates will continue. In doing this, it is not necessary to increase the number of brackets. Importantly, keeping the long-term perspective on competitiveness and growth, the protectionist policy followed since 2017 must be reversed.

(The writer is Chief Economist, Brickwork Analytics)

(Published 19 January 2023, 17:16 IST)

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