Prioritising stability over growth

The backdrop of the Budget augurs well for the government, but a closer look calls for a cautious approach

Amidst the uncertain global environment and gloomy economic outlook, many credible international institutions have repeatedly projected India as a sweet spot and, so to say, a safe harbour for investments.

The signs of peak inflation ebbing, the National Statistical Office  (NSO) forecast of a rather respectable 7 per cent gross domestic product growth for 2022-23, and relatively mild new Covid variant augur well as the backdrop for the finance minister to present the Budget on February 1. This feel-good factor helps given that it would be the last full-year Budget before the 2024 Lok Sabha elections. So far so good.

A closer look at the macroeconomic scenario, however, throws up a different picture and calls for following a cautious approach while firming up Budget proposals.

On the domestic front, even an optimist would find the combined fiscal deficit of around 10 per cent, the current account deficit projected at over 3.5 per cent, and core inflation sticking to 6 per cent as ominous signs. Also, note that the NSO’s forecast figures for the current year, based on extrapolation of the first eight months data, are subject to revision.
 

Illustration: Binay Sinha

On the international front, no one has any clue as to how the Russia-Ukraine conflict will play out in the coming year. Many economists of repute are predicting an imminent global recession. There are already some signs of it especially in the major economies of the EU, UK and China. Even the US may face a mild recession.

Naturally, these external factors will pose formidable challenges to the Indian macroeconomic stability, and its growth story. In the interconnected world in which we live, there are limitations to projecting the narrative of “decoupling” of India’s economy from the world or of India remaining “an island of calm” amidst the global turmoil.

One of the reasons why India’s inflation numbers have remained lower than those of the developed economies of the West is the comparative moderate fiscal stimulus provided by the government during the pandemic.

The Reserve Bank of India (RBI) started its interest rate raising cycle in May 2022, with the present repo rate being 6.25 per cent. The central banks of the developed countries, especially the US Fed, have been much more aggressive in increasing the interest rates. The current Fed funds rate is 4.25-4.5 per cent; no one knows what would be the terminal rate, though a few are predicting it to go up to 5 to 5.5 per cent. In such a situation, the RBI may have little option but to keep the interest rate high. Any fiscal indiscipline by the government at this stage may only push the RBI to further tighten the monetary policy.

In the present unfavourable overall macro scenario, it would be wise to have policies which, in near term, favour financial and economic stability over growth aspirations. The temptation to loosen fiscal policy should be resisted at this stage; though it might prove to be “easier said than done” considering the likely pre-election populist demand pressures.

Without getting into the “freebie” debate, the government would do well to contain its revenue expenditure. The Union Budget on February 1 will be followed by state governments’ budgets. Apart from the parliamentary election in 2024, nine states will go to the polls in 2023. The Government of India (GoI) needs to set the right example by not giving in to populist demands.

As for the capital expenditure, the increased government spending in the last few years hasn’t resulted in the desired “crowding-in” of private sector investment. It is ironic that various industry federations, while themselves shying away from making fresh investments, keep on demanding higher government capital expenditure allocation in the Budget. At the same time, they also preach the virtues of fiscal prudence!

In fact, higher government borrowings to meet its spending requirements, coupled with high interest rate regime, is likely to result in “crowding out” of the private sector borrowings. It may thus be prudent to not increase the government capital expenditure allocations for 2023-24 beyond the current year’s level. 

The GoI is likely to meet its current year’s fiscal deficit target of 6.4 per cent essentially on account of higher nominal growth and tax collection buoyancy. According to the glide path, the fiscal deficit for the next year is to be 5.5 per cent before it gradually reduces to 4.5 per cent by 2025-26. Predicting actual numbers for 2025-26 at this stage would be nothing more than kite-flying.

As for 2023-24, the writing on the wall is that both the real and nominal GDP numbers would be much lower than the current year’s figures. Add to that the expediency of meeting the pre-election year demands. It would be an achievement for the government, if it could contain the fiscal deficit at even around 6 per cent for 2023-24.

Budget making is an art wherein various competing demands on limited resources are considered by the government and appropriate views taken. Without being prescriptive, here are a few suggestions concerning the financial and economic sectors for the forthcoming Budget.

The government would do well to refrain from setting an unrealistic target for divestment revenue receipts. In the last few years, such receipts haven’t been significant and the target pressure may in fact result in sub-optimal outcomes. This is not to say that the government should go slow on getting out of business activities, but only that it shouldn’t depend on divestment proceeds to meet its revenue requirements. The government needs to prioritise corporate governance improvements in the public sector enterprises.

The government should eschew providing tariff duty protection to the various sectors of domestic industry without solid reasoning. Relying solely on this approach to become part of the global supply chain network wouldn’t work. Sincere efforts are needed to bring to fruition various crucial free trade agreements, which have been under negotiations for several years.

The capital gains tax regime needs an overhaul. During the last few years, the capital gains tax rates for different asset classes have been frequently tinkered with in rather an ad hoc manner. Consider the securities market. For direct investment in the listed debt securities, the holding period to become eligible for long-term capital gains tax is 12 months; it is 36 months, if the investment is made through debt-oriented mutual funds or debt ETFs. There is also a lack of clarity for investments made in business trusts. There is a crying need to simplify and rationalise the existing capital gains tax framework.

Many meaningful suggestions have been doing the rounds for quite some time for amending the Insolvency and Bankruptcy Code (IBC) — an extremely important piece of legislation. The Budget should announce the government’s plan to improve the IBC’s efficacy.

The writer is a retired IAS officer and former Sebi chairman