Why the budget is still key to policymaking
Despite its slightly waning importance in recent years, the Union Budget is the only policy statement in a year when the Centre has to present its objective assessment of the economy and evaluate the efficacy of its prognosis a year later
In three days, finance minister (FM) Nirmala Sitharaman will present her fifth consecutive Union Budget, and the last full exercise of this term. Newsrooms will adhere to the annual budget news cycle, though reactions will be on expected lines. The government and its supporters will hail this as a game-changer, and the Opposition will criticise it.
The budget continues to be seen as the centrepiece of the State’s annual economic planning, even though its importance has been dipping in recent years. The share of the central government’s spending, which is what the budget decides, has been shrinking. As a share of India’s nominal Gross Domestic Product (GDP), the total central spending peaked at around 20% in the late 1980s. It has settled around the 15% mark in the last few years. After the Goods and Services Tax (GST) rollout, the bulk of indirect tax decisions has moved to the GST Council. This means that the budget has a limited role in deciding the prices of most goods and services. To be sure, the customs and special excise duty on petrol and diesel still matter.
Why, then, does it still capture so much attention? There are four prisms through which this question can be answered.
The politician’s budget
In some ways, the Indian State is still considered the proverbial mai-baap (benefactor of the last resort). A parliamentary form of government with an almost never-ending election cycle (at the state level) often translates to multiple claims and aspirations for central funding for projects from the voters, who also look to the government for relief and help, especially during trying times.
The government, too, looks for opportunities to send a political message to bolster its narrative. Even a mention of a micro project aimed at doing something specific in a small region in the budget speech is a way for a party to say that it cares about a particular political constituency, or area.
While the macroeconomic effect of such allocations — often a few crore rupees or, at best, a few hundred crores — is negligible, they have an important role in political messaging. To be sure, not all political decisions in the budget are fiscally insignificant. For example, the additional food subsidy after the coronavirus pandemic or the announcement of a scheme such as PM-KISAN are some such examples. However, others, such as increasing the income tax exemption limit by a few thousand rupees, can create a feel-good environment without making a major impact on either government finances or disposable incomes.
The development economist’s budget
Even though the private sector has gradually increased its share in the economy, government spending in the social sector still matters a lot. In sectors such as health and education, India spends less than it aspires to. While all governments make lofty promises about the social sector, the budget is one occasion when one can objectively evaluate these claims. Unlike politically driven considerations that require immediate attention and allocation, social sector spending often requires long-term focus on financial commitment and actual delivery at the grassroots level. This is why big-ticket announcements with concomitant funding are less frequent.
The market (economist’s) budget
It is not without reason that commentators track capital markets obsessively even as the budget speech is being read out in Parliament. Because it is a large borrower, the government can move money markets by changes (or lack thereof) in its fiscal targets and priorities. Decisions on taxes on profits or capital gains can have a significant impact on the finances of companies and high-net-worth individuals. Moreover, given the size of the Indian economy, the budget’s decisions on these things impact domestic and global financial players.
For example, the government announced a couple of years ago that it is willing to consider the route of sovereign borrowing from international markets. The decision, to be sure, was not implemented fully, but it could have provided a hugely lucrative market for international borrowers. Relaxation of foreign direct investment cap in critical sectors is another such example.
Governments are, theoretically speaking, sovereign bodies, and, so, not accountable to the markets. However, financial market considerations cannot be ignored completely while undertaking the most significant fiscal exercise for a government that runs a large fiscal and current account deficit. This is especially true when global money markets are in churn. Simply speaking, markets are the binding constraint in the budget’s attempts to fulfil its political and developmental roles. Managing this constraint is, for all practical purposes, the budget’s central contradiction.
The macroeconomist’s budget
The binding constraints — markets, constitutional provisions guiding fiscal federalism (the Centre has to transfer a certain part of its taxes to states), and pre-existing financial commitments on accounts of salaries and interest payments — mean that the larger macroeconomic framework of the budget is primarily pre-decided, ruling out any significant disruption between budgets. An example of such a disruption would be the government announcing a departure from the Fiscal Responsibility and Budgetary Management (FRBM) Act framework or announcing a radical change in the taxation policy. To be sure, such disruptions are possible. For example, in September 2019, the government announced a significant reduction in corporate tax rates.
Before the dissolution of the Planning Commission, five-year plans (FYPS) offered a bigpicture macroeconomic blueprint of the government’s larger economic strategy. Budgets within a given FYP period were expected to adhere to the priorities and allocations decided in the plan documents. While the current government has done away with the Planning Commission and FYPS, its economic policy narrative of targeting the centenary of Indian Independence in 2047 has adopted an even bigger time horizon. This narrative is largely driven by a supply-side economic philosophy of boosting long-term growth by an infrastructure revolution, which we are told will attract capital in both manufacturing and services. However, a lot of such spending in pursuit of these objectives is supposed to be off-budget.
Despite its slightly waning importance in recent years, the budget is still very important. Simply speaking, it is the only policy statement in a year when the government has to present its objective assessment of the state of the economy and evaluate the efficacy of its prognosis a year later. It also presents a critical opportunity to assess whether a gap is opening up between the ex-ante and ex-post evaluation of the economy and revenues, a key yardstick in determining the effectiveness of policymaking.