#105 The 2021 Union Budget 🎧

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- RSJ

The once in a century budget is now behind us. The reaction to it has been positive even among those who tend to be sceptical about the economic management of this government. What we are interested now is to understand if the budget portends a more fundamental shift in the economic policy or the outlook of this government.

Quick Take

As a newsletter, we like to avoid quick takes on events. But this time around a quick take is unavoidable. Here’s our take:

First, after a long time, we have had a budget that is transparent about the finances of the government. The expectations following a year like we have just had were low. The government has used it to present a tough but true picture of its finances. The fiscal deficit for FY21 (the current year) is pegged at 9.5 per cent of GDP. The deficit for FY22 is estimated to be 6.8 per cent and the glide path to a 4.5 per cent target in FY 26 has been laid out. This will mean a deviation from the FRBM Act. The government plans to submit a fiscal deviation statement and introduce an amendment to the Act.

Off-budget chicanery like the FCI borrowings from National Small Savings Funds (NSSF) that were done to keep the fiscal deficit optically low is being junked. There were no new (questionable) welfare schemes introduced and the tax regime was left untouched. These are good signs. Also, the long-drawn glide path suggests the government is being realistic about the recovery while shedding some of its fiscal conservatism. The broad message is it is willing to spend to support the recovery and initiate a capital investment cycle.

Second, the lack of private investment growth was a key problem in the economy over the last decade. There are multiple structural and governance reasons for the same - we have not had real reforms on resolution or liquidation of stressed assets, many key industries have turned oligopolies aided by arbitrary regulatory regimes and there’s an absence of a long-term economic plan that gives entrepreneurs the confidence to make long-term bets.

The budget shows some intent in tackling these issues. There is a significant government investment planned to develop infrastructure. The details of the plan will have to be seen because on the surface the contribution of infrastructure spending to the fiscal deficit (in percentage) doesn’t seem to be moving. But I think we should give the budget the benefit of doubt here. And this spend is required because, given the state of the economy, the government will have to be at the forefront of cranking the investment cycle. The private sector can come in later to buy these projects with good gains for the government and run them efficiently. There are multiplier benefits of investing in infrastructure and the private investor confidence will follow. The announcement about privatisation of two PSU banks and one general insurer is also welcome. It might not mean much in real terms but it signals a bolder approach to reforms. Private investments are the subject matter of confidence.

Third, like many budgets that have come and gone, this one promises divestments and privatisation of public sector units across industries. But there are a few points of difference. There’s no way the fiscal deficit math will work out over the next many years in normal course of events. Not even when you consider the gradual path suggested in the speech. Unless, of course, the government raises capital through strategic stake sale in PSUs. Other ideas like monetisation of government land are attractive but trickier. So, its hands are forced this time and there’s a sense that the Overton Window has shifted on divestment. Also, the speech was more specific in its intent. It named names. This will get done.

Fourth, there are a few areas where the government is either out of ideas or continues to peddle bad ideas. The atmanirbhar and nation-first ideology is now well and truly established as it marks its entry into the budget document. Random custom duty increases make no sense. We should focus on making ourselves competitive and we have written multiple editions of this newsletter arguing why this reversion to the economic thought of the 70s will be counterproductive. But what’s a bad idea worth if it doesn’t grow roots?

The other rehash is the proposals to set up an Asset Reconstruction Company (ARC) to house the bad loans (“bad bank” as it is known) and incubating another Development Finance Institution (DFI). Both these proposals don’t address the root causes of financial sector stress. At best these are band-aid fixes that will take a lot of time and effort to set up and they will go down the same path of irrelevance. The solutions to ‘twin balance’ sheet problem lie in more fundamental reform in regulation, resolution framework and in reducing the arbitrary role of the state in the industry. We will have to wait for that day.

In summary, it is a good budget as much as we find it futile to rate a stock-taking exercise. The problem on hand is two-fold. The government will have to balance a whole host of conflicting objectives.

The liquidity in the system is at an all-time high. RBI narrowed the reverse repo corridor and sucked some liquidity out of the system a couple of weeks back. Yields that were moving up gradually over the last few months accelerated upwards after the budget. The FX operations of RBI continues because it has to constrain Rupee from appreciating too much. We are in danger of being called a currency manipulator. The dollar purchase continues to add to the liquidity. With the express tasks of controlling capital flow and the exchange rate, the impossible trinity comes into play. We start to lose control of the domestic monetary policy. This is evident as the money market rates have become unmoored from the policy and gone below repo levels.

The RBI also has to manage inflation, spur growth and support Rs. 12 trillion of government borrowings next year. This is a non-trivial challenge. Inflation is moderating but there are fears it will go up. The increased cess on petrol and diesel, continuing high liquidity and existing concerns that we still haven’t got all supply chains running to pre-Covid levels mean we can’t be complacent on inflation in the near future. But growth will need an accommodative stance while liquidity will need to be high to support borrowing. It is a conundrum. It will require great sagacity and wisdom to thread this needle.

For macroeconomy watchers, the next few years will be wonderful. We are keeping the popcorn ready.

On the Defence Budget

— Pranay Kotasthane

The first five items of the Union List in the Constitution all deal with defence. As the foremost responsibility of the Union, no budget discussion is complete without understanding the government’s spending plans on defence.

To understand the defence allocations for FY22, we need to understand what happened in FY21.

The revised estimates of FY21 have increased by a marginal 2.3 per cent over what was proposed in the last budget. But there’s been a significant change in the composition of this expenditure. The revised pension expenditure went down by nearly ₹9000 crores while the capital outlay increased by nearly ₹20,000 crores in the same period. This implies that the government has defrayed pension expenses over multiple years while focusing on capital outlay.

Most of this increase in capital outlay is accounted for by committed liabilities for equipment already purchased by the navy and the air force.

The FY22 budget retains the same level of expenditure as the revised expenditure figures of FY21 except on pensions, which are budgeted to go down by a further ₹10,000 crores. 

On the revenue side, with the Fifteenth Finance Commission recommending a non-lapsable fund for funding modernisation, the government can earmark proceeds from the sale of surplus defence land and sale of defence public sector enterprises for modernisation. Over the long-term, this route holds some promise.  

The key lesson is that the government managed to just about maintain defence expenditures at pre-COVID levels in the pandemic year. To confront China’s aggression, India’s military planning needs a change in approach; hopes of a sudden increase in defence allocations should be laid to rest.

HomeWork

Reading and listening recommendations on public policy matters

* On the defence budget, here’s a quick take by Pranay

* Ajay Shah reminds that reversing the dip in private investment should be the parameter for evaluating budget performance.

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