Budget Highlights: Move towards fiscal profligacy

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The much-awaited budget for FY22 was presented on 1 February 2021. The budget was presented in the midst of the pandemic induced economic crisis. A lot of expectation surrounded the budget as the announcements would have a positive impact on pushing the economy back to the growth track. Discussions were high on whether the Finance Minister would take the path of fiscal prudence or fiscal profligacy. However, the Finance Minister gave importance to increased spending to revive the  economy.

Total expenditure for FY22 is marked at INR 34.8 lakh crores, compared to INR 34.5 lakh crores (RE) in FY21. Finance Minister focused on increasing the spending towards the capital account. Capital expenditure registered a growth rate of 27 percent from INR 4.3 lakh crores (RE) in FY21 to INR 5.5 lakh crores (BE) in FY22. There is a strong infrastructure push in the budget. Increased infrastructure spending would have a multiplier effect on the economy, mainly in reviving  income, employment and demand.

On the total receipts side, tax revenue is projected at INR 22.1 lakh crores, registering a growth rate of 16 percent YoY. And for FY21, Government is expecting a tax revenue shortfall of INR 5 lakh crores. Within tax revenue, government is expecting a shortfall of INR 2.4 lakh crores and INR 1.8 lakh crores in corporate tax and income tax, respectively. This was on expected lines as the economy was in complete lockdown for more than two months.

For FY22, GST revenue is projected at INR 6.3 lakh crore (BE*), compared to INR 5.1 lakh crores (RE#) in FY21. Indirect tax receipts as percent of GDP is projected at 5 percent for FY22 against 5.1 percent (RE) in FY21.  The disinvestment target for FY22 is pegged at INR 1.75 lakh crore. The government aims to capitalise on the current market sentiments, and aims to complete the LIC IPO by 2022. The disinvestment   target for FY21 has been revised downwards from INR 2.1 lakh crores to INR 32000 crores. Government should have a clear roadmap on disinvestment as it can bring relief to the exchequer.

With a greater emphasis on expenditure, fiscal deficit of the central government is projected at INR 15 lakh crores for FY22 compared to INR 18.4 lakh crores in FY21. The nominal GDP growth rate is projected at 14.4 percent, and fiscal deficit  target as percent of GDP is projected at 6.8 percent. For FY21, the consensus was that the fiscal deficit would settle at around 7 percent of the GDP. However, as per the revised estimates, fiscal deficit as percent of GDP is seen at 9.5 percent. The steep decline in tax revenue and difficulty in realising disinvestment target has put pressure on the exchequer.

Though a higher fiscal deficit was expected for FY22, it could also lead to a higher inflationary pressure on the economy. Post the Budget, Monetary Policy Committee Meeting (MPC) took place from 3rd to 5th February 2021. MPC took a cautious approach towards inflation. The inflation rate for H1FY22 has been revised upwards from 5.2 percent to 4.6 percent to 5.2 percent to 5   percent. MPC cautioned about the cost-push pressure and rising petroleum prices that could drive up the inflation rate. RBI governor called for a concerted effort from both the central and state governments to prevent any further escalation on cost build-up.

Similarly, a higher fiscal deficit was a daunting news for the bond market that led to a surge in the bond yields. Market borrowing of the Central government is marked at INR 12 lakh crores for FY22. Increased supply of government bonds in the bond market could lead to demand-supply mismatch putting pressure on the bond yields. As the investors in the government bonds are getting higher yield, the same will be demanded on corporate bonds. This in turn leads to increased borrowing cost for the corporates, negatively impacting private investments in the country. The restoration of Cash Reserve Ratio (CRR) in two phases beginning March 2021 could be seen as the first step towards normalization of monetary policy. It has put even more pressure on bond yields.

To keep the bond yields in check, RBI would have to actively participate in the bond market. In this background, the Central Bank announced the next round of ‘Operation Twist’ to be conducted on 25th February 2021. ‘Operation Twist’ is nothing but the Open Market Operation (OMOs) of the RBI. Here, the Central Bank would be conducting simultaneous purchase and sale of government securities. RBI has decided to conduct OMOs worth INR 10,000 crores on 25th February 2021. Through OMOs, RBI aims to cool off the long-term bond yields. This in turn could support the market borrowing programme of the government.

Considering the present economic scenario, a higher fiscal deficit is justified. Yet, both the government and RBI should act together to minimise the unintended consequences of higher fiscal deficit on the economy.

BE* – Budget Estimate and  RE# -Revised Estimate

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