The shove to push the economy

Good morning! In the last full Union Budget ahead of the 2024 elections, finance minister Nirmala Sitharaman laid out the government's roadmap for economic reforms (and with it, introduced a host of catchphrases and acronyms). The government is pushing for growth by raising capital expenditure at a time when the world is staring at a possible recession. Will these bets pay off? In today's edition of The Intersection, Srijonee Bhattacharjee dissects the nuances. Bonus: we’ve included a list of long reads for the weekend.

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It is in plain sight that there is an acknowledgment of growth slowing in the coming year, as is the strive to support it responsibly. For the second year in a row now, finance minister Nirmala Sitharaman has attempted to underwrite economic growth with capital expenditure.

According to the finance minister, she did not want India “to miss the bus”. Sitharaman said prime minister Narendra Modi also instructed her that “Growth ka momentum rakhna chahiye” (keep the momentum going).

India is trying to position itself as a choice destination for global companies to set up supply chains. It is showcasing iPhone maker Apple’s India foray as the success story that multinationals can emulate. However, there is no certainty it will happen. There is no certainty that even local industries will begin capital investments. And without that, job creation could be in peril, which, in turn, would hit private consumption. Global headwinds and likely inflation could add to the woes.

That is where government spending on roads, ports, and other infrastructure projects could help. If private investments, consumption, and exports kick in, the economy could hit the much-vaunted 8% mark. Else, it could still hold growth at the baseline, as chief economic advisor V Anantha Nageswaran projected in the Economic Survey 2022-23. The budget also doesn’t veer away from the “glide path” to arrive at a fiscal deficit of 4.5% at the end of 2025-26. Sitharaman will keep her fingers crossed that rating agencies would be reassured that higher capital expenditure would not mean more borrowings and a weakening balance sheet.

If the country’s rating gets affected, it will increase the borrowing cost at a time when a fifth of the budget goes to paying interest on debt. That bet has other costs though. Revenue expenditure will get crimped.The minister has frozen or slashed allocations for major central schemes such as the National Health Mission and the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA); initiatives that have historically bolstered rural incomes and demand.

The revenue expenditure, or the routine costs such as running welfare schemes, paying salaries, pensions and interest, proposed by the Budget stood at 11.6% of the GDP, lower from 12.7% in FY23 and 13.5% in FY22 while the capital expenditure allocation rose to 3.3% of the GDP from 2.7% and 2.5% in the ongoing and previous financial years respectively. During this entire period though, the share of gross tax revenue in the GDP remained nearly unchanged.

But a cut as large as ₹29,400 crore ($3.6 billion) in schemes such as MGNREGA, or no revisions in allocations towards Gram Sadak Yojana and the National Rural Livelihood Mission doesn’t bode well for a country already grappling with employment generation.

“...The entire policy system is, at its peril, turning a blind eye to the stark fact that the central government is severely fiscally constrained and, therefore, only able to secure consolidation through expenditure compression,” Rathin Roy, managing director of the Overseas Development Institute, London, argued in his analysis of the Budget in the Business Standard.

“This is why invoking the so-called fiscal multiplier is fallacious and analytically lazy. Shrinking public spending cannot possibly activate any multiplier or compensate for deceleration in either private investment or consumption.”

Picking battles

The thrust on capital expenditure, especially in infrastructure such as railways, telecom, and roads is significant. At ₹10 lakh crore, a 33% jump on year and the third hike in a row, the government is ready to do the heavy lifting at a time when private investment is not seen stepping up considerably. While the Economic Survey pointed at an uptick in private investment, it also acknowledged that at a time of global uncertainty, the private sector tends to be hesitant in making such big ticket commitments.

That the Budget is extending ₹1.3 lakh crore as 50-year interest-free loans to the states even as the finance ministry accepted that states are likely to utilize only 76% of the current fiscal year’s capital expenditure outlay of ₹1 lakh crore, points to the conviction that it has in the idea and its multiplier effect playing out. The government also announced an Urban Infrastructure Development Fund via banks’ unutilised Priority Sector Lending targets meant for Tier 2 and Tier 3 cities.

The Budget for FY24 has taken conservative estimates for tax revenue and nominal GDP: they have assumed a tax buoyancy of one, the nominal GDP being estimated at 10.5%. Tax buoyancy is a measure of the rate at which tax revenue rises when GDP grows. This is key to improving the government’s finances.

Tax revenue increases when people earn more and spend more. If incomes do not rise, spending will not improve and tax revenue will remain stagnant. The rise in tax collections seen in the past few months is largely due to the rise in inflation. If the budget proposals were certain to generate more jobs and thereby income, there was no need to rationalize taxes. The cuts are designed to make room for private consumption in the existing personal balance sheets.

Global headwinds could, however, change even conservative assumptions.

A Nomura Research report sees FY24 nominal growth at around 8.5%-9% owing to its expectation of recession in some developed markets and a lagged impact of tighter monetary policy. The report also sees a “political pressure for countercyclical spending” in the second half of the year given the frugal outlay on revenue expenditure.

“The expenditure side of the math expects largely flat growth in revenue spends, which might be at risk if a renewed commodity upturn pushes up subsidies. The projected ~0.7% of GDP worth savings in subsidies has been channeled towards a sharp increase in capital outlays,” Radhika Rao, senior economist at the DBS BANK Group, said in a research note.

In such a situation, the government may be faced with a choice between a cut in capital expenditure and fiscal slippage. Growth may seem like a greater priority for the government. However, the government acknowledges that the optics of fiscal prudence is important at a time when global investors are becoming risk-averse.

“There is a risk that despite growth, especially with China re-emerging, India could move out of the radar screen (of global investors) if you don’t tick the right boxes,” Abheek Barua, chief economist at HDFC Bank, tells The Intersection. Barua points out that India’s consolidated debt, which is over 80%, is much higher than our emerging market peers. ”So if you didn’t suggest or make this kind of consolidation an imperative, then you are going to get stuck in this spiral of high-interest rates, high cost for the government, and a fiscal riot because of that.”

Taxation (Many birds with one stone)

The rebates and rationalization announced on the personal taxes front could serve at least three purposes. One, a structural change to an easier, cleaner, and more compliant tax regime. Second, some fillip to consumer demand in a year where Indian exports may shrink further. Third, some sweetener for the middle class ahead of the 2024 general elections.

Experts are of the opinion that the new regime in time may result in significant ups in the collection of direct taxes. In a press conference after the Budget speech, Sitharaman said the intention was to make the new regime more attractive for the taxpayer. It would improve compliance, net more people, and make filing easier.

“...If rates are so low (as announced in the new tax scheme), you are going to benefit net-net by paying less tax. Even the exemptions that you would have otherwise gained from (the old tax scheme) would have resulted in probably the net amount being the same,” she said.

By keeping all changes exclusive to the new regime, the government is hinting at a sunset clause on the old one.

Oiling the machine

Micro, small, and medium enterprises (MSMEs), which account for the vast majority of employment in the country after farming, found a few items checked off their wishlist. The budget addressed their biggest grievance—customers delaying payments. Usual deductions on payments to MSMEs would only be provided to buyers once payments were fulfilled. It could help end or shorten long supplier credit cycles. A credit guarantee scheme that would make collateral-free credit of around ₹2 lakh crore available to the sector is expected to cut interest rates on loans by one percentage point.

In agriculture, the thrust on digital public infrastructure is expected to address information asymmetry and bring about transparency, lowering the cost of doing business by making data accessible and cheaper.

“Information asymmetry is one of the main reasons for market failures along with farmers not being able to access the right credit, the right inputs at the right time,” Amit Vatsyayan, Leader– Agriculture, Social and Skills Sector at EY India said.

“One of the key steps in building a new ecosystem is to invest in digital public goods, for which the government is now showing intent. Already buoyed by the benefits it has received out of the work on Aadhar and UPI, there’s a clear and significant focus on building the agri stack, which has been reinforced in the current budget.”

Where the Budget falters is in addressing social welfare. As former Secretary to the Ministry of Rural Development, Amarjeet Sinha said in a debate in reference to the cuts in revenue spending. Schemes such as MGNREGA have not only created rural employment but have made meaningful contributions in transforming rural infrastructure, which is accessible and relevant to communities. To lose sight of the importance of such programmes in capacity building for longer term gains of capital expenditure isn’t judicious.

A study (pdf) showed that when the fiscal deficit is controlled, every rupee of capital expenditure at the cost of revenue expenditure generates ₹1.99 in the economy. The government is hoping the theory will hold good on the ground too.

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