Budget 2021 – Truth & Reconciliation

 (The following article appeared in The Hindu on February 1st. A version of this also appeared in Bloomberg Quint. Both links are appended below:

https://www.thehindu.com/opinion/op-ed/the-finance-minister-has-delivered-but-the-road-ahead-is-long/article33721241.ece

https://www.bloombergquint.com/business/budget-2021truth-and-reconciliation)

Budget 2021 – Truth & Reconciliation 

 

Today’s Union Budget was presented under severe circumstances.

 

The National Statistical Office (NSO) estimates that our Covid-19 impacted economy will contract by -7.7% in the current fiscal year 2020-21 (FY21). While severe, this estimate likely does not incorporate the significantly higher distresses amongst many of our micro, small and medium enterprises. 

 

Thankfully, there are silver linings. We have avoided a second wave of Covid-19, and the worst is hopefully well behind us. Economic activity is rebounding – witness the encouraging GST collections of a record Rs 1.2 lakh crores for January 2021. But our economy – which was structurally weak even before Covid-19 hit us and has since suffered a body blow– needs to be nursed back to full health. 

 

In this backdrop, we evaluate the 2021 budget on three parameters. First, on the credibility of the budget math. Second, on its potential to deliver what India ultimately needs – adequate domestic output and jobs. Third, on how the budget raises resources, and its impact on the economic recovery. 

 

The Credibility of the Math

 

This budget scores very high marks on credibility. For too long now, our budgets have resorted to accounting smokescreens that masked the true extent of our fiscal imbalance. Thus, revised estimates of revenue receipts would invariably be unrealistically high, only to be brought down sharply later when the books were finalized. Likewise, under the cash accounting that our governments follow, expenditures would be brought down by simply not releasing payments. Instead, entities such as the Food Corporation of India would be ‘encouraged’ to borrow from elsewhere, in lieu of dues from the government.  

 

As a result, against the FY20 revised fiscal deficit estimate of 3.8% of GDP presented in last year’s budget, shorn of accounting jugglery, the true deficit is estimated at 5.4% of GDP. Adding borrowings of other central public sector enterprises, the Central Public Sector Borrowing Requirement (CPSBR) stood at 7.2% of GDP – nearly twice the official headline central fiscal deficit.

 

This year, the finance minister has largely come clean on the budget math. She has declared much higher than expected fiscal deficit numbers of 9.5% of GDP and 6.8% of GDP for FY21 and FY22 respectively. In doing so, she has put up realistic estimates of revenue receipts, and recognized “off-balance sheet” expenditures. She has also likely released pending government dues to both the public and private sectors.

 

This truth augurs well on several fronts. First, with realistic revenue budgets, the pressure on tax authorities to engage in tax terrorism should subside. Second, the government can now release its payments and refunds on time, easing a financial bottleneck that has dogged us for a while. Third, a focus on the “real” numbers should allow for a better-informed debate on ways to improve our fiscal balance. 

 

Hopefully, our state governments will also follow this example of providing credible budget math. The “true” center and state combined fiscal deficit is likely around 15% of GDP – far higher than we have ever seen before. 

 

Domestic Output and Jobs

 

There is one path for us to pay down this accumulating public debt, achieve durable growth, keep inflation in check, and ensure stable external balance – and that is by creating adequate domestic output and jobs.

 

The budget scores well on its potential to create domestic output and jobs.

 

While expenditure for FY22 has been maintained at the elevated levels of FY21, there is a shift away from revenue expenditures – the regular payments towards items such as administration, interest, and subsidies, that are arguably less productive – towards productive investments. Capital expenditure in FY22 is budgeted to increase by 26% over FY21, with focus on areas such as infrastructure, roads, and textile parks.

 

Alongside a promise to deliver more on health, education, nutrition and urban infrastructure, these complement ongoing efforts to foster domestic jobs and output, including reform of labor laws, corporate tax rate cuts and Production Linked Incentives.

 

There are also efforts to revive our stressed financial services ecosystem. The finance minister announced the creation of a government ARC, or ‘bad bank’, to warehouse some of the large non-performing assets that permeate the industry. She also announced the creation of a new development financial institution to facilitate and fund infrastructure investments. While in principle, these are welcome ideas, much depends on how the modalities are structured and on their execution. We await clarity on this score.

 

Funding the Deficit

 

The budget focuses on raising funds via disinvestment and asset sales, rather than via additional taxes. Again, I commend this choice – while the wealthy can perhaps pay more to fund our deficit, we should avoid endangering our fragile economic recovery from Covid-19 with any additional tax burdens.

 

The Long Road Ahead

 

While the budget has delivered on truth and held out some potential for the creation of domestic output and jobs, there is still much to be done. 

 

Several sectors of the economy are still reeling under chronic stresses – including pockets of financial services, power, real estate, telecom, airlines and shipping, contact-based services and micro, small and medium enterprises. Any path to a recovery in domestic output and jobs will have to solve for many of these stresses. 

 

Likewise, it would be a mistake to assume that a revival in consumption and government spending would automatically result in durable growth. After the global financial crisis in 2008, we saw a strong revival in consumption, government spending and investments. However, we failed to deliver adequate growth in domestic output and jobs. The result was any central bank’s worst nightmare – high inflation, high imports and external imbalance, inadequate real growth, inequity and fiscal imbalance. All this finally culminated in financial instability, when the Federal Reserve taper tantrum hit us in mid-2013. 

 

The onus is now on the real economy and the government to avoid a repeat of history, to focus on execution, and to deliver on adequate domestic output and jobs. The road ahead will be long and hard, but for today at least, the finance minister has delivered.