By Anubhuti Sahay
The three most frequently asked questions following Budget FY23 are: (1) how expansionary or growth-supportive the budget is for the economy; (2) is there a possibility that the central government ends with a narrower-than-announced 6.4% of GDP fiscal deficit by end-FY23; and (3) how would it impact inflation, RBI’s monetary policy trajectory and the bond market over the next 12 months.
With respect to the first question, the unequivocal conclusion is that the budget is pro-growth. Relative to market expectations, a fiscal deficit target of 6.4% of GDP is wider and thus more growth-supportive. If we compare it to the pre-pandemic fiscal deficit range of 3.5-4% of GDP, the extent of growth support is more evident. We, however, think a better assessment of government expenditure support to the economy is likely to emerge when the state governments present their budget over the next few months (especially the focus is on a year-on-year comparison). This is because for every rupee of government expenditure (Centre + thestates), 55-60 paisa is spent by the states (factoring out the transfers by the Centre to the states).
The Union government has extended Rs 1 lakh crore of 50-year loans at 0% interest rate to the states in FY23. Ceteris paribus, this should boost the states’ revenue receipts, and thus their spending, without impacting the fiscal deficit. However, as the states would lose revenues on the expiry of the GST compensation cess from July 1, 2022, this loan is likely to offset such losses, instead of boosting revenues at the state level. Hence, unless the states decide to spend more and run a wider deficit than 3% of GDP, the expenditure support at the national level might not be large (and is likely to be smaller than FY22). The Centre has given the states the leeway to run a fiscal deficit of 4% of GSDP in FY23. Such a leeway was also given in FY22, but based on aggregated state finances data until November 2021, the states are likely to keep their fiscal deficit at 3% rather than 4%. We think the combined fiscal deficit in FY23 will be narrower, at 9.4% of GDP relative to 10% in FY22, as pandemic-related expenditure declines.
On the second question, an analysis of the budget maths indicates the possibility of a narrower-than-6.4% of GDP fiscal deficit in FY23. We see potential for FY23 revenue collection to exceed the budget assumption by 0.3-0.5% of GDP, as (1) indirect tax collection via GST, excise and customs may be higher than budgeted, unless there is another round of excise-duty-cuts on retail fuel products, and (2) we see an upside to the modest divestment target if the government divests more than planned, or if divestment plans for FY22 are delayed to FY23. However, given the lack of visibility on this, the risk of another Covid wave, and the potential that the spending target could be higher, we expect the fiscal deficit target of 6.4% of GDP to be met. Subsidy allocations for food and fertiliser could exceed the budgeted amount by 0.25-0.3% of GDP, especially if commodity prices remain elevated, in our view. Such extra spending will likely be covered by expenditure cuts elsewhere or higher-than-expected revenues.
Even if the Centre ends up with higher-than-targeted revenues, the difference is likely to go towards spending rather than put towards fiscal consolidation, in our view. This is evident from the FY22 Budget maths; FY22 revenue receipts are on track to exceed the budget estimate by 0.5% of GDP, as per government estimates. The finance minister has used the extra revenue to cushion growth amid India’s second and third Covid waves, and to clear overdue payments, while allowing modest fiscal slippage (the government estimates the FY22 fiscal deficit at 6.9%, versus the initially budgeted 6.8%). In the absence of future growth shocks, the government may have more flexibility to save rather than spend in FY23. But given the current focus on growth, we see a higher likelihood of any excess being spent instead of being used for consolidation.
On the third question, we do not expect the budget to be inflationary, as the focus has been to improve the composition of expenditure. Capital expenditure is targeted at c.2.5% of the GDP for FY23, unchanged from FY22 and up from the FY15-FY19 average of 1.7% (the headline figure is 2.9%, but we strip out loans to the state governments to focus on capex at the Union government level.) Capex as a share of trend GDP growth (defined as average growth during FY15-FY19) also remains above pre-pandemic levels, at 2.3%. The concern on inflation, in our view, is likely to come from higher commodity prices (especially crude oil) and/or future food price shocks.
Given the upside risks to inflation and muted impact of Omicron on growth, we expect RBI to start its policy normalisation process from the February policy meeting.
We maintain our view that RBI will likely hike the reverse repo rate by 25bps at the February policy meeting and normalise the corridor (gap between the repo and reverse repo rate) back to the pre-pandemic level of 25bps from the current 65bps by the April policy meeting. We also maintain our view that the repo rate will have to be hiked by 75bps during August-December 2022 to 4.75%.
However, liquidity management is the bigger challenge for RBI, in our view. The still-wide fiscal deficit, likely reversal in the monetary policy cycle and lack of measures to pave the way for index inclusion, implies that the bond market will have to deal with a large bond supply overhang (our estimate is Rs 3.8-6.3 lakh crore).
While RBI is likely to provide some support via bond purchases, it will further add to the stock of the existing liquidity surplus; this may not be desirable as the central bank normalises monetary policy.
We therefore expect RBI to be more tolerant of higher government bond yields and to deploy longer-tenor variable rate reverse repos (VRRR) and Operation Twist (OT), among other tools, to manage liquidity in FY23 while it tries to contain sharp spikes in bond yields.
The author is Head (South Asia), economics research, Standard Chartered Bank
