Fiscal consolidation path must be gradual and credible

January 29, 2021 6:45 AM

The government must aim to provide a credible fiscal consolidation path along with relatively acceptable budget numbers. The consistently widening gap between budget estimates and actuals has led to volatility in the bond market.

Market sentiment already is jittery amidst fears of excess supply and early monetary policy normalisation that will restrict RBI’s intervention in the bond market going ahead.

By Upasna Bhardwaj

To bring the economy back on a sustainable, strong growth path, the government will look to the Atmanirbhar Bharat route in the Budget. The expected focus-areas will be both soft (health and education) and hard infrastructure (roads, railways, highways, real estate, etc), manufacturing (PLI scheme being a good start), financial sector (recapitalisation and privatisation/consolidation policy of PSBs) and possible income support to the bottom of the pyramid (laying out a plan for an urban job guarantee scheme/UBI).

While the government has always had a policy focus on infrastructure development, financing the same has remained a challenge. This Budget must make clear the direction on the financing of overall infrastructure over the medium term, especially at a time when the PSBs may not be willing to go in for such long gestation projects given their stretched balance sheets. It could be through various channels like the establishment of Development Finance Institutions (DFIs) and/or merging these with IIFCL; redefining the role of the Centre-State and private sector in financing; channelising proceeds from divestment/privatisation of PSEs to a corpus for financing long-term projects; and through increasing dependence on external financing.

Given the government’s limited resources, expenditure prioritisation will continue to be key, with a higher allocation to capital expenditure in FY22, which has been quite low historically. In this context, the government could provide clarity on the path ahead in terms of progress on global bond index inclusion, a new source of financing the extra spending. Notably, the foreign ownership of the Centre’s debt remains very low at ~1.6% as compared to 9.5% in China and 30% in Indonesia.

The recommendations of the Fifteenth Finance Commission are awaited, which will likely provide guidance on the medium-term fiscal roadmap, fiscal anchor (point-based, range-based or debt/GDP), and revisions to revenue-sharing between the Centre and the states. The fiscal space will accordingly be defined. Given that the recovery remains nascent, a gradual consolidation, with the fiscal deficit for FY22 at 5.5% of GDP, down from 7.1% in FY21, is likely.

While the nominal GDP growth will likely be ~14%, the tax buoyancy should be significantly higher, led largely by expected jump in corporate earnings amidst normalisation (towards pre-Covid levels). The Tax-GDP ratio should also pick up to 10.2%, from 9.7% in FY21, although significantly lower than the pre-Covid average of ~11%. Additionally, the non-tax revenue and divestment proceeds will be key in defining the magnitude of expenditure expansion and the pace of fiscal rectitude. Overall expenditure growth will likely be 7%, with a greater push from capex (expected at 12%).

The fiscal maths suggests FY22 gross market borrowing to be marginally lower, around Rs 10.7 lakh crore against Rs 12 lakh crore (for financing deficit) in FY21, and net supply at around Rs 8 lakh crore (Rs 9.7 lakh crore in FY21). The short-term borrowing is expected to be ~Rs 50,000 crore, with other sources amounting to Rs 3.7 lakh crore.

Finally, the government must aim to provide a credible fiscal consolidation path along with relatively acceptable budget numbers. The consistently widening gap between budget estimates and actuals has led to volatility in the bond market. Market sentiment already is jittery amidst fears of excess supply and early monetary policy normalisation that will restrict RBI’s intervention in the bond market going ahead.

Senior economist, Kotak Mahindra Bank
Views are personal

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