By Upasna Bhardwaj
Ahead of Union Budget 2022, uncertainty remains on whether the government will focus on fiscal prudence or profligacy. While the finances of the government remain precarious (especially compared to the EM peers) it is faced with a significant challenge to address the uneven recovery, wherein, the rural/informal sector is yet to emerge from the scars inflicted since the pandemic. This decision becomes even more crucial given the elections to state legislative assemblies of seven states in 2022.
We believe that to bring the economy back on a sustainably stronger growth path, the two key pillars of the Union Budget will be infrastructure and rural/ agricultural demand. While the fiscal headroom remains limited, we expect the government to prioritise on the quality of the expenditure towards health, roads, railways, highways and PLI expansion for additional sectors. Further, we expect possible extension of existing measures of the incentives and income support to the small-scale units and bottom of the pyramid (in the form of ease of credit, higher allocations to farmers and NREGA, extension of subsidy along with probable support for urban job schemes amongst others).
While the government has always shown its intent and policy focus towards infrastructure development, financing the same has remained a challenge. We expect further clarity on credible execution of the earlier announced plans of the National Infrastructure Pipeline (NIP), asset monetisation pipeline and disinvestment magnitude along with progress on the global bond index inclusion, which could provide a newer source of financing the extra spending.
With a medium-term fiscal consolidation roadmap being more relaxed (fiscal deficit to reach sub-4.5% of GDP by FY2026), the government may prefer to undertake a more gradual fiscal consolidation in the near term to tackle the nascent and lopsided recovery. But that would necessitate a political need and will to aggressively consolidate in the later years. While we reckon that policy priority of the government provides an element of uncertainty and could result in the fiscal deficit anywhere in the range of 6-6.5% of GDP, balancing all aspects we expect the FY2023 fiscal deficit at 6.3% of GDP compared to 6.8% in FY2022. The final outcome for FY2022 remains contingent on the LIC divestment proceeds. We do not entirely rule out a possibility of additional market borrowings in case of spillovers on the expected timelines of the LIC IPO.
For FY2023, we expect nominal GDP growth at 14%, but the tax growth is expected to revert to normalcy after a sharp pick-up witnessed in FY2022 amidst better tax compliance, normalisation post-Covid and a faster growing formal sector. Tax buoyancy is expected to be lower in FY2023 (0.6 compared to 1.3 in FY2022), largely due to the fall in excise duty on petroleum products. We expect the tax-GDP ratio to ease to 10.2% from 10.8% in FY2022. Overall, we expect the gross tax collections to grow at 8% (with direct tax growth at 13% and indirect tax growth at 3% due to excise duty cuts) compared to 23% in FY2022. The non-tax revenue and divestment proceeds will be key in defining the magnitude of expenditure expansion and the pace of fiscal rectitude. We expect overall expenditure growth at 7%, with greater push from capex expected at 19%. Amongst key revenue expenditure categories, we also pencil in higher allocation for agriculture, health and rural development and a lower subsidy bill.
Given the likely growth priority of the government, we expect the FY2023 net G-Sec supply to be higher at around Rs 10.1 trillion (Rs 9.24 trillion in FY2022) and the gross market borrowing to be even higher at around Rs 13.6 trillion against Rs 12.1 trillion in FY2022 given the heavy redemptions. The short-term borrowing is expected around Rs 500 billion, with other sources of financing amounting to Rs 6.1 trillion. Further, the states’ net supply, too, is expected to increase (Rs 6.4 trillion compared to Rs 5.3 trillion in FY2022) as the GST compensation fund related cushion ends by June 2022.
The fears of heavy supply, adverse global backdrop and expected pick-up in pace of monetary policy normalisation has already been weighing on the bond market sentiments. The frequent devolvement of auctions along with incremental OMO sales in the secondary market (`200 billion since November 2021) have further added to the woes. The bond supply-demand dynamics remain heavily skewed, especially given the inability of the RBI to support the bond markets as they step up policy withdrawal. Much of the pressure on bonds is likely to be witnessed in 1HFY23 given heavy net supply, front running of policy tightness and likely global bond index related FPI inflows happening only in 2HFY23. We, thus, expect rates to inch significantly higher and peak out in 1HFY23, before stabilising once the FPI flows in debt begin. The 10-year yield could peak around 7-7.15% before moderating towards 6.50-6.75% range in 2HFY23E.
The author is an economist at Kotak Mahindra Bank. Views expressed are personal.