The year 2020 was one of many unknowns and as we supposedly sail through the pandemic, the post-vaccine economies will have new hope. While the economic recovery has been sharp, the underlying fragilities can not be ignored. The fiscal temperament in the year of repair and reset will be crucial to watch out for, the cues of which will be very well extended by finance minister Nirmala Sitharaman on February 1, 2021. We expect a fiscal deficit of 7 percent in FY21 but will be on a lookout for a credible glide path ahead.
The decline in tax revenues is on expected lines owing to growth contraction and washout of economic activity. However, more worrisome is the decline in non-tax revenue (lower dividends) and an inability to meet disinvestment targets. While tax revenue should normalise rationally with the return of economic activity in FY22, estimates of non-tax revenue and divestments are the key needle movers, and thus, must be closely watched at. According to the 15th Financial Commission, the share of states in the Centre’s taxes would decrease to 41 percent over 2020-21 (from 42 percent during 2015-20), and we believe this would further boost net revenues.
The cuts in expenditure have always been the key market movers but rationally speaking, we don’t see much scope there. High interest cost, salaries and wages along with a commitment to existing schemes leaves little scope for discretionary revenue spends and capital expenditure, which has a higher fiscal multiplier.
While this vicious circle would continue into FY22, we do prescribe an expenditure growth of at least 13 percent, taking FY22 expenditure to over Rs 34 lakh crore. Thus, India’s expenditure to GDP ratio would rise to 15 percent (from the last three-year average of 13 percent). However, this is largely due to GDP contraction and remains significantly below peers. We foresee continued support for the rural economy through PM Kisan and MGNREGA. At the same time, there is a pressing need to revive the stressed sectors such as hotels, travel and transport and focus on the capex.
FY21 state and central borrowing are expected at 12 percent of GDP. In FY22, we expect this number to still be close to 10 percent of GDP (around 5.3 percent for the Centre and around 4.5 percent for states). Such high government borrowings crowd out private investments and hinder credit offtake in the economy.
At the same time, financing expenditure through borrowings is the need of the hour. Therefore, one needs to look for a credible borrowing plan that looks into tax-free COVID bonds, setting up of an SPV via the RBI and raising money internationally at lower yields.
In FY21, we expect India’s public debt to be over 85 percent of GDP, and for sustainable debt management, interest rates should be kept lower along with expenditure that would help revive nominal growth.
That said, we believe that close monetary and fiscal coordination is required at the frontend. Indian economy’s resilience was demonstrated once again with a vigorous recovery underway, much beyond the expectation of most analysts. The government could do well to support this with a solid policy that will give our economy a fair chance to outshine the peer set.
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