Enduring states are quick to create fiscal space for future shocks, uncertain events or a rainy day. The fiscal space used up in the 2008 global financial crisis was never sufficiently recouped in the last decade. Thus, when Covid-19 struck in March 2020, India’s debt-to-GDP ratio had reached 74%; it has been pushed up to 90%. Ever since private investment weakened from 2011-12, the clamour for more and more public capex has grown with every budget; recourse to revenue expenditure has grown with populist social sector programmes, subsidies, and cash dole-outs becoming the foundation of electoral successes. The fallout has been a conspicuous slowdown in fiscal consolidation and repeated toying with publicly pronounced roadmaps. The chickens have now come home to roost.

When the government has needed more resources to support distressed citizenry from a lengthy pandemic atop a prolonged economic slowdown, the headroom to manoeuvre barely existed. Months before the budget, international conditions turned adverse—it was clear the budget would have to weigh macroeconomic stability concerns even as it had to focus on growth support with a fragile recovery and a large negative output gap. The apprehension was that fiscal consolidation could have adverse short- and long-run impacts. This had considerable merit.

Therefore, the budget favours gradual consolidation—a 50-basis points reduction in the fiscal deficit to 6.4% of GDP in FY23 from an overshot 6.9% this year—with a capex push. Yet the growth push is tepid. One, the effective Rs 10.7 lakh crore capital spending—Rs 7.5 lakh crore budgetary and Rs 3.2 lakh crore as grants in aid for capital asset creation includes MGNREGS allocations, budgeted at Rs 73,000 crore in FY23 against Rs 98,000 crore in FY22RE. Two, combined public capex—budgetary and resources of public enterprises—actually moderates to 4.7% of GDP in FY23 from 4.8% of GDP in FY22RE; at Rs 12.2 lakh crore total in FY23, this increases just 10.4% from Rs 11.1 lakh crore (FY22RE), which grew 22.3% over -7.5% in FY21. The truth is PSEs’ capex is falling—in FY23, this is 27% below FY20 level. Fiscal resources are insufficient to offset the slack.

Herein lies the bind. Central government debt-GDP ratio will nonetheless rise to 60.2% of GDP in March 2023 from 59.9% this year. The medium-term fiscal policy-cum strategy statement does not provide a consolidation path given pandemic uncertainties, alluding to slowing global growth in 2022 and retention of flexibility for contingency response. But like last year, it reiterates fiscal consolidation will continue to reach deficit-GDP level below 4.5% by FY26 through a fairly steady decline over this period. A more stringent fiscal consolidation path beginning FY24 may have to be spelled out. From a medium-term growth perspective, this hardly makes sense! It closes any space for response to any further shocks or failure of private demand to revive ahead.

It was easy to push up deficit financing and debt over the last decade, as many other countries did, when inflation was benign and well-anchored. Financing large borrowings did not encounter much push back from the bond market or crowd-out private sector credit demand that remained weak. Rating agencies also remained fairly considerate under the assumption public capex would both shield and bolster medium-term growth prospects.  But conditions have changed. Globally, inflation has resurged. As long as inflation in advanced economies remained below the 2% target, it was alright to float as much bonds they wanted and print as much money as markets needed. Post-Covid, the risk of inflation catching fire in these economies is real. The US Federal Reserve, for instance, has grudgingly admitted to its lapses as inflation galloped to a 40-year high, running the risk of de-anchoring; it is now preparing to raise interest rates like many other advanced economy central banks are.

This may sound alarmist, but bond markets are going to be risk-averse and yield-sensitive, especially in the EMEs. India’s bond market responded yesterday with a 17-basis-points jump in the benchmark 10-year yield to 6.85%. Rising cost of debt—market borrowings increase 32% this year in reorientation from small savings that decline 28%—are a pointer to future difficulties. Higher interest rates will have to be reckoned with, more so if inflation does not subside. Notably, the IMF projects global growth slowing considerably in the medium-term, especially in advanced economies. This could impact global trade and thereby India’s exports, the only bright spot in 2021. If private demand does not revive, then growth could face headwinds from medium-term fiscal contraction.

The author is a New Delhi-based economist. Views are personal.