Notwithstanding the Omicron stumble, a recovery of sorts—uneven and incomplete—is underway that is likely to deliver 8.5%GDP growth this fiscal year. Given the significant slack in labour and capital markets, there is also sufficient momentum to push growth closer to 9% in FY23 as long as there aren’t more significant pandemic disruptions and the global economy remains strong. So, what stance should this year’s budget take?
The answer might be counter-intuitive and against the grain of the dominant budget narrative in India at present. To see why this is the case consider what the growth numbers are telling us about the underlying state of the economy. Let’s take the government at its face value that India’s potential growth is 7%. So in FY21, when growth declined 7.3%, India’s level of GDP fell 14.3% from where it should have been. This year, at an 8.5% growth rate, the economy will claw back some of the losses. Yet, by the end of this fiscal year (March 2022) , the level of GDP will still be 5% below its potential level. Assuming that India’s GDP is about $3 trillion, the loss of income is roughly $150 billion! By all accounts, corporate profitability has soared in the last two years. Consequently, the hit to households and SMEs is likely to be significantly larger.
With this kind of income loss, it is incredulous to believe that household and SME balance-sheets have not been seriously damaged. The clearest evidence of balance-sheet impairment is a rise in bank NPLs. This hasn’t happened as yet because of the extended forbearance provided by RBI. But regulatory forbearance has a finite shelf-life. Sooner or later, RBI will remove the accommodation and when that happens India will likely see NPLs climb. This is not something new in India. But NPLs involving a handful of corporates is one thing and taking millions of middle-income households and SMEs through bankruptcy proceedings is very different and much more intractable. Setting aside the potential rise in NPLs, there is ample evidence of such damage: Just look at the languishing consumption of middle-income durable goods, such as two-wheelers and the increase in MNREGA recipients.
It is this damage that we fear will be the single biggest headwind to medium-term growth. Accordingly, we believe that India’s medium term growth from 2023 onwards is likely to settle well below the government’s aspirational 7% rate. It is also for this reason that we have been exhorting since the start of the pandemic that large income support is crucial to ensuring that the economy does not incur permanent scarring. The income support was not intended to boost short-term demand as many have mistakenly interpreted. With the pandemic raging and extensive lockdowns, there was little chance that demand would be boosted. It was to preserve the households’ and SMEs’ balance-sheets such that when the pandemic receded, they would not be hamstrung and there would be sufficient domestic consumption and investment to complete the recovery.
This brings us to the question of whether there is fiscal space to provide such support. Arithmetically, the government’s borrowing needs are funded by the sum of the domestic private sector’s net savings and foreign borrowing. The arithmetic for this fiscal year is something like this: The Centre and state governments’ fiscal deficit of around 11% of GDP will be financed by 9.5% of private net savings (corporate and household savings less private investment) and 1.5% of GDP of foreign borrowing (the current account deficit).
So, if growth in 2022-23 is to be driven by the private sector and, say, it needs another 2 percentage points (ppts) of GDP of higher consumption or investment and if the government only consolidates the budget by 0.5 ppts of GDP—as many analysts have been exhorting given the still fragile recovery—then foreign borrowing or the current account deficit will have to rise to close to 3% of GDP. Even in normal times, India has struggled to fund such a large current account deficit without facing serious currency depreciation pressures. Doing so in a year when global financial conditions are poised to tighten sharply as the US Fed embarks on raising interest rates and removing quantitative easing will be much more challenging. India, thus, needs to substantially consolidate its fiscal deficit if the private sector is to lead and sustain the recovery without jeopardizing external financial stability. Otherwise, and as has been the case for the last two years, growth will remain driven by public spending, thereby increasingly raising doubts about its sustainability.
Under these circumstances, the only way more income support can be provided is by cutting infrastructure spending and subsidies. But replacing subsidies with income support doesn’t really help much except perhaps in some efficiency gains. Admittedly, it is a hard choice but all this could have been easily avoided if the government provided the income support back in the pandemic year. It did not. Instead, India had so much excess savings in FY21 that it funded other countries’ deficits (the current account was in a surplus of 0.9% of GDP).
Be that as it may and at the cost of sounding like a broken record, next year’s budget needs to cut the fiscal deficit sharply, while increasing income support even if it comes at the cost of lowering infrastructure spending. Otherwise, India will have shiny new highways and airports without many to use them. As they say, a stitch in time saves nine. There is still time.
The author is Chief emerging markets economist, JP Morgan
Views are personal