Math of the economy: How to understand the Budget
NEW DELHI: The budget, because it is essentially a set of assumptions about the government’s finances over the next fiscal year is based on a mathematical calculation. Here are four elements which are key to understanding this.
Growth assumption
Union Budget 2022-23 assumes a nominal GDP growth of 11.1% . This is a significant dip from the 17.6% nominal GDP growth for 2021-22 as per the first revised estimates. There are two ways to look at this drastic reduction in nominal growth. One, either the government is assuming that inflation will come down significantly or it expects real growth to be significantly lower than the 9.2% value this year. Two, the government is being extremely conservative about the economy’s prospects going forward and things could turn out to be better next year.
Tax buoyancy
The government can project different levels of tax receipts over the next year for any given nominal GDP growth rate. This is a function of tax buoyancy which is defined as the change in tax collections per unit increase in GDP. Tax buoyancy can increase or decrease depending on tax rates, extent of tax evasion and the distribution of income among different classes. This year’s budget expects a tax buoyancy of 0.86, significantly lower than the 1.4 figure for the revised estimates for 2021-22. Simply speaking, the budget assumes that taxes will grow at a lower rate than the GDP in the next fiscal year. Again, this could be a very conservative assumption.
Petroleum prices
India imports at least 80% of its energy requirements. This makes the macroeconomic situation extremely sensitive to crude oil prices. While the Budget has not made any explicit assumptions about petroleum prices, the Economic Survey has made its 8%-8.5% real growth projection assuming that crude prices will be in the range of $70-$75 per barrel. If oil prices end up being significantly higher (as they are now, although it is important to remember that the survey’s assumption is an average for the entire year), the budgetary math can go for a toss.
A January 2019 Mint Street memo published by RBI summarized the effect of a rise in crude oil prices for India.
“We find that if a crude price shock hits the Indian economy, the CAD (current account deficit) to GDP ratio will rise sharply irrespective of a higher GDP growth; and a $10/barrel increase in oil price will raise inflation by roughly 49 basis points (bps) or increase the fiscal deficit by 43 bps (as a percentage of GDP) if the government decides to absorb the entire oil price shock rather than passing it to the end users”, the authors said in the memo. One basis point is a hundredth of a percentage point.
Economic distress
While there is no quantitative indicator of economic distress, allocations for various pro-poor schemes suggest that the budget expects an improvement in the fortunes of the poor in the next fiscal year.
This can be seen from the fact that allocations for key pro-poor programmes such as the rural employment guarantee scheme and food subsidy have seen a significant reduction over the revised estimates for 2021-22. This is a key assumption in the budgetary math as any red flags on the distress front will make it politically necessary for the government to increase such spending which will either entail an increase in fiscal deficit or squeeze on other spending heads.
To be sure, there is another element which is key to understanding the budget’s mathematical basis. This is the bond yield on long-term government securities which determine the borrowing cost of the government over the course of year. Bond yields did see a 17 basis point increase over the course of the day on February 1, largely a reaction to the government’s announcement of higher market borrowings. If bond markets continue this trend, there is bound to be fiscal stress. Perhaps this is why the budget has made multiple references to innovative ways to financing many of the projects it has talked about.
Whether or not and at what cost these plans materialise remains to be seen.