“The EU budget should focus on quality growth rather than consolidation”
Although the government has always shown its intention and political focus on infrastructure development, financing it has remained a challenge.
By Upasna Bhardwaj
Ahead of the 2022 Union budget, uncertainty remains over whether the government will focus on fiscal prudence or profligacy. While government finances remain precarious (especially relative to emerging peers), it faces a significant challenge in coping with the uneven recovery, in which the rural/informal sector has yet to emerge from the scars inflicted since the pandemic. This decision becomes even more crucial given the elections to the seven state legislatures in 2022.
We believe that to put the economy back on a sustainably stronger growth path, the two main pillars of the EU budget will be infrastructure and rural/agricultural demand. Although fiscal space remains limited, we expect the government to prioritize the quality of spending on health, roads, railways, highways and the expansion of the LIP for other sectors. In addition, we foresee a possible extension of existing incentives and income support measures to small units and the bottom of the pyramid (in the form of easier access to credit, higher allocations to farmers and to NREGA, an extension of subsidies and likely support for urban employment programs among others).
Although the government has always shown its intention and political focus on infrastructure development, financing it has remained a challenge. We expect more clarity on credible execution of previously announced National Infrastructure Pipeline (NIP) plans, asset monetization pipeline and scale of divestment, as well as progress on index inclusion global bond, which could provide a new source of funding for additional spending.
With a looser medium-term fiscal consolidation roadmap (fiscal deficit expected to reach less than 4.5 percent of GDP by FY2026), the government may prefer to undertake more gradual fiscal consolidation in the short term to cope with the nascent and unbalanced recovery. But this would require a political need and a desire for aggressive consolidation in the years to come. Although we estimate that the government’s policy priority provides an element of uncertainty and could lead to a budget deficit anywhere in the range of 6-6.5% of GDP, balancing all aspects, we expect a budget deficit for the 2023 financial year to 6.3% of GDP compared to 6.8% during the 2022 financial year. The final result for the 2022 financial year remains dependent on the proceeds from the sale of LIC. We do not entirely rule out the possibility of additional borrowings in the market in the event of an impact on the expected timelines of LIC’s IPO.
For fiscal year 2023, we expect nominal GDP growth of 14%, but tax growth is expected to return to normal after a strong recovery seen in fiscal year 2022 amid improved tax compliance, post-Covid normalization and a faster growing formal sector. Fiscal momentum is expected to be weaker in FY2023 (0.6 vs. 1.3 in FY2022), largely due to lower excise duties on petroleum products. We expect the tax-to-GDP ratio to decline from 10.8% to 10.2% in FY2022. Overall, we expect gross tax revenue to increase by 8% (with growth direct taxes to 13% and indirect tax growth to 3% due to excise tax cuts) from 23% in FY2022. Non-tax revenue and divestment proceeds will be critical in defining the scale of spending expansion and the pace of fiscal rectitude. We forecast overall spending growth of 7%, with a further push in capital spending expected at 19%. Among the major categories of revenue spending, we also expect a higher allocation for agriculture, health and rural development and a lower subsidy bill.
Given the government’s likely growth priority, we expect G-Sec’s net supply for FY2023 to be higher at around Rs 10.1 trillion (FY 2022 Rs 9.24 trillion). ) and that the gross borrowing in the market will be even higher at around 13.6 trillion rupees against 12.1 trillion rupees. billion in fiscal 2022 given the large redemptions. Short-term borrowing is expected to be around Rs 500 billion, with other sources of funding amounting to Rs 6.1 trillion. In addition, net state supply is also expected to increase (6.4 trillion rupees from 5.3 trillion rupees in FY 2022) as the cushion related to the GST compensation fund ends by June 2022.
Fears of ample supply, an unfavorable global backdrop and an expected acceleration in the pace of monetary policy normalization have already weighed on bond market sentiment. The frequent decentralization of the auctions as well as the additional sales of OMO on the secondary market (`200 billion since November 2021) have further aggravated the woes. Bond supply and demand dynamics remain heavily skewed, especially given the RBI’s inability to support bond markets as they accelerate the policy retreat. Much of the bond pressure is likely to be seen at 1HFY23 given the significant net supply, upstream policy tightening and likely inflows of IFPs linked to the global bond index that will not occur. than at 2HFY23. We therefore expect rates to rise significantly and peak at 1HFY23, before stabilizing once REIT debt flows begin. The 10-year yield could peak around 7-7.15% before moderating towards a range of 6.50-6.75% in 2HFY23E.
The author is an economist at Kotak Mahindra Bank. The opinions expressed are personal.
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