Union Budget 2021: A recipe for sustainable growth
February 3, 2021 6:15 AM
Fixing the plumbing, Budget announced the upping of FDI limit to 74% in insurance sector, and the more awaited ‘Bad bank’ a.k.a ARCL and AMC to consolidate and takeover existing stressed debt of PSBs and dispose of assets to AIFs.
The Budget was bold in some sense to create fresh yet durable avenues of infrastructure funding.
The French phrase ‘Tour de Force’, in our mind, brilliantly captures the essence of FY22 Union Budget. The departure from the anticipated fiscal path for both FY21 and FY22 notwithstanding, the demonstration of greater transparency, higher capital spending along with creation of new plumbing institutions for finance, should serve the economy well as it emerges from its deepest growth contraction on record.
While an expansion in FY21 fiscal deficit was anticipated amidst the revenue shortfall, the 9.5% of GDP print was significantly above market expectations of 7.5-8.5%. For FY22, the Budget presents a record correction in fiscal deficit by 270 bps to 6.8%. Given the global backdrop of expansionary fiscal policy, India’s own higher deficits do not look glaringly out of place, perhaps a tad more acceptable now than ever.
A large part of upside in fiscal deficit has been led by funding transparency with food subsidy coming “on-budget”. The Centre’s decision to cease FCI borrowing for food subsidy via the NSSF route has meant that this amount has come directly on its books. As such, food subsidy bill for FY21 stands adjusted upwards to `4.2 bn compared to `1.2 trn in FY20. For FY22, it is pegged at `2.1 trn — a more realistic number in the aftermath of one-time readjustment and end of free foodgrains distributed to migrants under the PM Garib Kalyan Ann Yojana in FY21. To put this in perspective, in the absence of this adjustment, FY21 fiscal deficit would have stood at 7.9% of GDP (closer to our expectation of 7.5%).
The countercyclical push to growth recovery however remained unbroken. Capital spending is budgeted to grow by 31% YoY in FY21 (overshooting BE of 23%) to 2.3% of GDP and still higher to 2.5% — a 17 year high in FY22. This we believe will permit the frenzy in government spending seen over Nov-Dec to continue well into Q4 FY21.
If the revised FY21 capex target is to be achieved, Q4 spending will need to get ramped up by 60% on an annualised basis. This, we believe will impart a strong impetus to growth and we accordingly expect FY21 GDP contraction to be shallower at 7.3% (vs. our earlier estimate of -8.3%); given that capital spending multiplier is 7x of revenue spending on economic output. Thereby, via an improvement in quality of spending to a level last seen over a decade ago, the Budget attempts to reify the neoclassical Say’s Law of ‘Supply creating its own demand’ — by emphasising investments over consumption.
Though trivial, the Budget arithmetic is pleasingly realistic on the revenue assumptions, imparting an element of credibility.
In fact, we believe that the Budget has been conservative by assuming a nominal GDP growth of 14.4% vs. our expectation of 15.5%. The recent strong momentum seen in tax collections (ex-excise duties) accompanied by a faster recovery in growth could impart an upside risk to tax revenues as Tax/GDP ratio has been assumed to remain unchanged at 8.0% in FY21 RE and FY22 BE calculations. We believe the investor community and rating agencies would welcome the focus on both – Transparency and Conservatism.
The Budget was bold in some sense to create fresh yet durable avenues of infrastructure funding. The contours of the capex push reveal its spread across sectors of roads, railways, ports, urbanisation etc., in line with Government’s National Infrastructure Pipeline. The announced setting up of – 1) A new DFI (Development Finance Institution) and 2) National Asset Monetization Pipeline, will accomplish the aim to surgically steer funds to this capital starved sector over the coming years.
Fixing the plumbing, Budget announced the upping of FDI limit to 74% in insurance sector, and the more awaited ‘Bad bank’ a.k.a ARCL and AMC to consolidate and takeover existing stressed debt of PSBs and dispose of assets to AIFs. This coupled with committed recapitalization of Rs 200 bn and envisaged privatization of 2 PSBs, will relieve some burden off the banking sector (along with the new DFI) and reinvigorate credit appetite to support growth recovery.
The FM also picked up the gauntlet to prioritize health spending. While the 137% increase in total health and well-being outlay in FY22 vis-à-vis FY21 (BE) has made adequate headlines, two facets remain underappreciated. One, Rs 350 bn spending on vaccine Budgeted for FY22 is over and above Rs 120 bn already slated to be spent in FY21 on Emergency response and health system preparedness program and vaccination for healthcare and frontline workers. Second, nearly 40% of the spending is in the form of grants i.e., by definition intended towards states, keeping in mind the last mile executor in this case.
Amidst these dulcet tones of the Budget, market reaction however was asymmetric. The pro-growth spending spiel lifted equity markets, but debt markets gave the Budget a clear thumbs down. This was not surprising, as amidst the substantial fiscal slippage in FY21, market borrowing is now slated at 2.2x of initial budget estimates, with long term and short-term borrowing increasing by 1.9x and 9.0x respectively. Further, investors had to digest the news of an additional borrowing of INR 800 bn over the course of next two months. For FY22 though gross borrowing is expected to moderate (for both g-sec and T-bills), it will remain elevated compared to the pre COVID levels in FY20 thereby warranting RBI support in the form of OMO purchases. (We continue to expect g-sec yield in the 5.75-6.25% range in FY22 and expect INR at 71.50 levels by end FY22). As such, RBI’s role will remain active and complimentary to fiscal policy to ensure that costs to funding growth remain in check in FY22 yet again.