Budget Needs To Consolidate Debt By Bringing Fiscal Deficit Down

Policymaking is a continuous process done through the year. The problem with the hoopla that surrounds Indian budgets is that it implicitly assumes that all policy announcements need to be made in a longish speech on the first day of February every year. This often diverts attention from other policy measures announced at other times. It also skews the criteria defined to gauge how “good” a budget is. Budgets that are solid and credible from an economist’s perspective are routinely dismissed as workman like or run-of-the-mill for their lack of the cliched “big bang announcements”.

But first one needs to recognize a universal truth. Governments across the world, be it in developed, emerging or poor economies face financial constraints. Thus, economists' measure the goodness of a budget on three counts. First the credibility of its projections on taxes and expenditures given the underlying economic conditions. Second, the solidity of public finances – whether the quantum of debt created by running a fiscal deficit is within acceptable limits. Third, given the various financial constraint, the cohesiveness of its strategy to either fight a slowdown or cool down an overheated inflationary economy.

What does this mean for the assessment of budget 2023-24? For one thing, India faces strong global headwinds in the form of a sharp slowdown or even recession in the developed economies. The first question to ask after the FM finishes her speech is whether the invariable impact on the Indian economy is baked into its assumptions about taxes and other revenue collections. Is it too optimistic about growth in projecting taxes and other revenues or is it conservative. Most economists are projecting a 5.5 to 6 per cent growth for 2023-24, a good percentage point down from this fiscal year’s levels. Will the budget recognize this and reflect it in its forecasts or will it err on the side of exuberance?

Global inflation has been a challenge for most governments and central banks world over have responded by tightening monetary conditions. Thus, there is less cash sloshing around in the global system. This would affect things like disinvestment as there will be fewer dollars and rupees chasing public asset sales. If budget 2023-24 premises its calculations on large asset sales, that should raise a red flag.

The unavoidable fiscal support provided to alleviate the pain of the pandemic has left the economy with a huge debt burden. At 85 per cent of GDP, India’s consolidated government debt is way higher than our emerging market peers and threatens to leave behind a vicious cycle of high-interest charges, more borrowings to service it, a further increase in the interest tab and so the hamster wheel turns. The February budget needs to consolidate the debt by bringing the fiscal deficit down. While the current year’s deficit is likely to be 6.4 per cent of GDP, anything materially higher than 5.8 per cent for 2023-24 could raise concerns around the bloating debt burden, especially in a year when growth is slowing but interest costs continue to remain elevated. Moreover, the government’s medium-term consolidation objective of bringing the fiscal deficit down to 4.5% by 2025-26 could become that much harder.   

The past two budgets laid out a strategy focussed on capital spending – spending on roads, railways etc. -- as an engine for growth, raising its capex target to an all-time high Rs 7.5 lakh crore in 2022-23. The capital spending to GDP ratio has risen to 2.9% in 2022-23 from 1.7% in 2019-20. At a time where the pandemic has perhaps made a more permanent dent to India’s potential GDP growth, a spending mix tilted towards capital spending bodes well for the economy – creating multiplier effects by generating employment and attracting private investments along the way. A standard measure economists use to measure the total impact on economic activity for every rupee increase in government spending – called the fiscal multiplier – is almost double for capital spending compared to revenue spending. To recall, revenue expenditures are those that do not lead to the creation of fixed assets and usually include spending on interest payments, subsidies, income transfers, salaries and pensions, and spending on certain welfare schemes. Therefore, a case can be made for the government to raise its capital spending outlays even in 2023-24. 

However, the unevenness of the consumption recovery and with the rural economy, especially those at the lower rung of the income pyramid, being hit hard by the pandemic, adequate focus on increasing allocations for rural schemes (like the rural job guarantee scheme) and providing a stronger safety net also becomes essential. How the budget walks this fine line between capex and revenue spending would therefore become essential, especially in a year when the government could face financial constraints and the pressures of fiscal consolidation.

Bottom line is that Budget 2023-24 faces a tall task of being fiscally responsible, realistic in its assumptions but also supportive for growth. Time will tell which boxes it finally manages to tick.

Abheek Barua

Guest Author Chief Economist, HDFC Bank