Fiscal consolidation started too early
The finance minister, in her budget speech, highlighted India’s strong resilience during the pandemic as the economy rebounded to pre-pandemic GDP levels. India has lost two years of GDP due to the pandemic. Meanwhile, the conflict in Ukraine added to the prevailing uncertainties.
The ONS, in its latest estimate of national income for 2021-22, cut growth from 9.2% to 8.9%, from a contraction of 6.6% in 2020-21.
The recovery from the pandemic has been uneven as a large number of small and micro businesses struggle to recover. Although aggregate unemployment rates returned to pre-pandemic levels in September 2020, a disaggregated analysis of CMIE Consumer Pyramids Households Survey (CPHS) data shows a disproportionate impact of the pandemic on women’s employment and earnings, young people and people from marginalized communities. The government’s fiscal strategy is crucial in guiding the post-Covid inclusive recovery process.
Medium term growth strategy
From a medium-term growth strategy perspective, attempts to boost investment spending are commendable as they should attract private investment and create significant multiplier effects. And that should create jobs and boost aggregate demand.
However, given the capital-intensive nature of large-scale infrastructure projects, massive job creation is unlikely. In addition, there is a huge gestation period. Thus, the actual multiplier effects may be lower than those assumed by the budget.
The government has increased investment spending at the expense of revenue. Compared to the FY22RE allocation, total expenditure and revenue expenditure declined in real terms after adjusting for inflationary expectations in FY23. As the economy recovers from Covid 19, an increase in revenue spending was expected because it has a higher multiplier effect in the short term and helps the economy recover faster than investment spending. It will also have an enhancement effect.
No increase in demand
The latest estimates for 2021-22 published by the NSO show that private final consumption expenditure – representing around 60% of GDP – has returned to pre-pandemic levels. However, some studies show that the poorest 40% of the population have experienced a greater decline in income and the recovery has been weak, leading to increased inequality. Analysis of CPHS data shows that not only is the consumption of marginalized groups and lower sections declining faster, but their recovery has been slow while the consumption of the non-wealthy has returned to pre-pandemic levels after the pandemic. initial lock.
Therefore, social sector expenditures are essential for households pushed below the poverty line. When total revenue is deducted from incurred expenditure (interest payments increased by 15.6% and pensions by 4.1%), nominal social sector expenditure is significantly reduced. The programs that have borne the brunt of fiscal consolidation the most are food subsidies and MGNREGA.
Expenditure on food subsidies decreased by 17.8% from ₹2,86,469 crore in FY22RE to ₹2,06,831 crore in FY23BE. MGNREGA’s budget was reduced by 25.5% from ₹98,000 crore in FY22RE to ₹73,000 crore in FY23BE. PM-Kisan (farmer income support) and rural development spending remained essentially flat.
On the other hand, allocations for urban development, transport, IT and telecommunications have increased considerably, which could aggravate the divide between rural and urban areas. As urban areas have lost more jobs during the pandemic, an urban job guarantee program would provide income to the unemployed and help stimulate consumer demand.
Premature fiscal consolidation
The Union government’s misplaced emphasis on fiscal consolidation is largely responsible for the reduction in tax expenditures. While the revised revenue expenditure estimates exceed budget estimates, the revenue shortfall fell from 5.1% (FY22BE) to 4.7% of GDP (FY22RE).
The increase in the collection of direct taxes and GST could have been used in social sector projects. Instead, the finance minister preferred to stick to the path of fiscal consolidation and reduce the budget deficit from 6.9% (FY22RE) to 6.4% (FY23BE). This fiscal consolidation in times of crisis is delaying the process of inclusive recovery.
Despite the increase in tax revenue and the marginal reduction in total expenditure, the Union’s public debt, both internal and external, is expected to fall from 52.7% in the financial year 22RE to 59% of GDP (financial year 23BE). Normally, this would be considered important and concerning. However, due to counter-cyclical fiscal policy measures, governments around the world resorted to debt financing fiscal stimulus, resulting in record global debt of $226 trillion, bringing the debt-to- GDP at its highest after World War II. War.
The IMF’s Global Debt Database shows that the public debt-to-GDP ratio hit a new high of 99% in 2020, driven mainly by advanced countries where public debt to GDP rose to 122.69% in 2020. India’s debt to GDP ratio increased from 74% to 90% during the pandemic.
More importantly, the weight of available empirical research suggests that higher debt does not necessarily lead to lower growth. A higher debt-to-GDP ratio can boost aggregate demand and output in the short term. And that’s what the Indian economy needs now. International experience suggests that countries that borrowed to fund fiscal spending were able to recover from the pandemic faster.
Furthermore, recent research shows that borrowing does not have a negative impact on the economy as long as the government follows a credible fiscal policy plan that brings the debt burden down to sustainable levels. Therefore, it is important that the government invests substantially not only in building infrastructure for growth, but also focuses on targeted short-term measures that stimulate consumer demand from those most affected by the pandemic.
The government’s fiscal consolidation path may be driven by fears of a sovereign rating downgrade by global credit rating agencies (CRAs). However, last year’s Economic Survey demonstrated that economic fundamentals do not justify or determine sovereign credit ratings. Research suggests that rating agencies give higher ratings to developed countries, regardless of their fundamentals.
The budget began prematurely scaling back expansionary fiscal policy and focused on fiscal compliance amid fears of a sovereign rating downgrade by global rating agencies.
The ongoing war between Russia and Ukraine has disrupted supply chains and driven up energy and commodity prices. As costs rise and interest rates rise, capital spending will slow. A larger allocation to revenue spending, especially to flagship social sector programs, would have supported the economic recovery. One can only hope that the government’s strategy does not cost the Indian household dearly.
The authors are with Gulati Institute of Finance and Taxation, Thiruvananthapuram. Opinions expressed are personal
March 15, 2022