Building resilience for the long game

The Budget should focus on keeping the domestic house in order. If it manages to do so, then India could attract large capital inflows once the global shocks fade

India’s coming Budget will be presented against a crucial macro-political backdrop. This will be the last full Budget ahead of the 2024 general elections, but the economic backdrop is equally important.

The economic backdrop

2023 is likely to be a year of global economic slowdown, with the impact of one of the most synchronised and aggressive monetary policy tightening cycles still to be felt. Our baseline view is a mild recession in both the US and Europe, with global gross domestic product (GDP) growth slowing below trend to 1.8 per cent year-on-year in 2023, from 3.2 per cent in 2022. This will affect India’s growth via weak exports, and, more importantly, by delaying private investment. India’s exports and investment cycles have historically moved in sync, as falling global demand and elevated uncertainty tend to delay capex decisions. We expect India’s real GDP growth to slow sharply to 5.1 per cent y-o-y in FY24, lower than consensus expectations of around 6 per cent.

Nominal GDP growth is likely to slow more materially from 15.4 per cent y-o-y in FY23 to 8.5-9.0 per cent in FY24, as the moderation in commodity price lowers wholesale price index inflation more sharply than the expected easing in consumer price index inflation. Thus, the arithmetic fiscal boost received in FY23 from higher nominal GDP growth — the denominator effect — is unlikely to be repeated in FY24. Tax buoyancy is highly sensitive to both nominal GDP growth and the state of the business cycle, meaning a moderation in tax buoyancy is also likely in FY24.

Finally, 2023 is a year where high uncertainty prevails: Whether it is about China’s reopening effects or the soft versus hard landing debate in the US. The only thing that’s certain is that many of the assumptions made on February 1 are prone to change, and hence, the Budget should build in adequate buffers.

Prerogative of a good Budget

The first imperative of the Budget is to assess whether it needs to play a counter-cyclical role, and, in what form; and second, laying the groundwork to achieve the medium-term goals.

If indeed FY24 is a year of economic slowdown and subdued private capex, then should the Budget aim to boost growth or pursue fiscal consolidation? We think it is important to consolidate because of India’s weak starting point. The central government’s fiscal deficit of around 6.5 per cent of GDP is nearly twice its pre-pandemic average of 3.5 per cent during FY17 to FY19, and offers limited scope to respond.

Since the pandemic, the government has rightfully raised capital expenditure. In FY23, we estimate central government capex will rise to 2.7 per cent of GDP, up from its pre-pandemic average of 1.7 per cent during FY17-FY19. We think public infrastructure spending should be stepped up further in FY24, but without compromising on consolidation, by using some of the space created by the reduction in food and fertiliser subsidy bills, and through other revenue-raising mechanisms such as asset monetisation. Fears that public capex will crowd out private capex are unlikely to hold ground in the coming year.

Ideas for boosting consumption such as through a reduction in personal income taxes for middle-income households will be a wasted bullet, in our view. Rationalising personal income taxes so that more individuals opt for the new regime of lower taxes and fewer exemptions is a sound idea, but a broader reduction in the effective tax rate will only add to the government’s fiscal burden, without boosting consumption, because individuals are more likely to save than consume in a period of uncertainty. A more targeted support for lower income households, as and when needed, may be more worthwhile.   

From a medium-term perspective, India’s policymaking is on the right track. The aim to create more jobs via a boost to the manufacturing sector should continue, while steering away from protectionist measures such as Custom duty hikes. A step-up on skill development to empower the youth, increased agriculture investments to boost farm productivity, and using digital infrastructure to find and connect new markets are important.

In the long term, India’s growth will entail high energy demand, and it is essential that this increased energy comes with minimum environmental impact. India needs to be green first, rather than transition to green later. This requires investments in renewables, green technology and large-scale afforestation. Agriculture and food security depend on access to a consistent supply of fresh water. Investments are required to ensure water availability across the country, including in desalination plants and water networks.

Finally, we need to create stronger counter-cyclical fiscal buffers. The forthcoming Budget may not be the right time for this, but compulsorily setting aside a small percentage of revenues every year when growth is in an upturn, will enable us to smooth out the fiscal deficit over the economic cycles. 

An eye to the future

A number of shocks that the Indian economy will face in the coming year are likely to be on account of global spillovers. On its own, India remains on the right track. A key role of the Budget will be to counter the slowdown effectively, work in sync with monetary policy, and ensure economic resilience on the other side of the economic cycle. If the domestic house remains in order, then India could attract large capital inflows once the global shocks fade, as investors look for countries with strong fundamentals and medium-term growth prospects, setting the stage for a V-shaped growth recovery. It’s time to play the long game.

The writer is the chief economist (India and Asia ex-Japan) at Nomura