Where the budget gets India’s economy wrong
What is the basic economic philosophy of the 2021-22 Union Budget? Two sets of numbers can answer this question. Let us look at the tax projections first. The 2021-22 Budget Estimate (BE) for Gross Tax Revenue is ₹22.17 lakh crore, which is lower than 2020-21 BE figures of ₹24.23 lakh crore. The shortfall would have been higher if collections from Union excise duties (basically taxes on petrol-diesel) had not increased by ₹68,000 crore between 2020-21 and 2021-22 BE figures. Tax rates have not been changed in this budget. Taxes are a fraction of income. This means the budget itself assumes that personal and business incomes in 2021-22 will not reach levels which should have been achieved in 2020-21. Lower incomes will also mean lower demand.
Take government spending figures now. The BE for total central government spending for 2021-22 is ₹34.83 lakh crore. The Revised Estimate (RE) for total central spending in 2020-21 is ₹34.5 lakh crore. The Gross Domestic Product (GDP) deflator — if one takes 14.4% nominal GDP growth projection for 2021-22 given in the budget and 11% real GDP forecast given in the latest Economic Survey — comes to 3.4%. This means that central spending should have increased to at least ₹35.7 lakh crore to keep it unchanged in real terms. The fact that it has not happened implies that the 2021-22 budget entails a negative fiscal stimulus to the economy.
If one reads both sets of numbers together, the macroeconomic takeaway is clear. The budget has pinned its hopes on supply-side economics, while the economy is facing a demand-side crisis.
To be sure, one could argue that 2020-21 was an abnormal year — and, therefore, the government is justified in rolling back its welfare spending push, as the economy gets unlocked and vaccination gains momentum. This is in keeping with the government’s view that the economy is already on the rising side of a V-shaped recovery curve. But this argument is overoptimistic. If the economy were indeed on a V-shaped recovery path, why are the government’s tax projections for 2021-22 lower than what they were a year ago?
There is an additional problem with what is a premature withdrawal of the fiscal boost. A lot of the sequential recovery, especially in rural areas, was contingent on the government’s support. This has been withdrawn in a big way. For example, spending on the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS) is down from ₹1.15 lakh crore in 2020-21 RE to ₹73,000 crore in 2021-22 BE. Similarly, allocation for Pradhan Mantri Awaas Yojna is down from ₹40,500 crore in 2020-21 RE to ₹27,500 crore in 2021-22 BE. PM-KISAN allocation was ₹75,000 crore in 2020-21 BE; it came down to ₹65,000 crore in 2020-21 RE and has been maintained at that level in 2021-22 BE.
Once the resource flow to such schemes reduces from April 2021, rural incomes and demand will take a hit. When read with the fact that even the better-looking high-frequency economic indicators, such as Purchasing Managers’ Indices, have been highlighting the fact that labour markets have not recovered even though production has picked up, this has an ominous possibility. While India was spared a second wave of Covid-19 infections, it could end up with a second round of distress in labour markets, especially for those who are at the bottom of the pyramid and have the highest propensity to consume.
What explains a negative fiscal stimulus in the wake of a contraction? Given the government’s economic philosophy even during the pre-pandemic slowdown, this is not surprising. It believed that the slowdown was not because of a demand-side problem, and that the solution was to be found in supply-side measures and a formalisation push in the economy. But this approach may have worsened the economic situation.
The budget has only carried forward the supply-side focus of the government. After having announced critical factor market reforms in agriculture and labour, the government has gone ahead with liberalising foreign direct investment limits in critical sectors such as insurance, announced privatisation of government-owned banks, and has taken up large-scale monetisation of government assets beyond public sector companies. This is what explains the exuberance in equity markets.
While these policies might play a role in keeping the fiscal deficit under control despite a bleak revenue scenario, there will be little impact in terms of fresh economic activity and, hence, boosting aggregate demand. In fact, the net economic impact of these policies need not be benign for two reasons. One, large-scale monetisation of infrastructure assets such as roads and railways can lead to a hike in user charges and hence higher inflation in the long-term. Two, continued exuberance in equity markets will continue to encourage divergence of household savings towards speculative activities and will also make their assets more vulnerable to a sudden windfall loss as and when interest rates are hiked in advanced countries, and foreign investors pull out.
The possible clash between the government’s assumptions and the reality of the economy will determine India’s trajectory in the next year.