View: This budget, Sitharaman must walk a tightrope – balancing demand stimulation and fiscal consolidation


Nirmala Sitharaman has a tough job ahead on Tuesday. With Omicron raging and America eager to move forward in the form of the Federal Reserve’s aggressive monetary policy tightening, the budget will have to strike a balance between boosting rural demand and l infrastructure investment in the budget, while continuing on the path of modest fiscal consolidation.

Revenues for the 2022 financial year will exceed the budget forecast (BE). Increased tax revenue will likely make up for any shortfall from asset sales. With the rebound of the economy and greater formalization of the post-Covid economy, direct and indirect tax collections showed strong growth compared to last year. Gross tax collections in April-November 2021 stand at 70% of BE, the highest in the last 10 years. Overall, gross tax revenue is expected to exceed BE in fiscal year 2022. Even after assuming a shortfall in divestment revenue, total revenue is likely to be higher relative to BE in fiscal year 2022.

This trend of strong tax revenue collection is expected to continue in fiscal 2023. But the rate of tax revenue growth will likely be lower. Growth-sensitive taxes – corporate, income and GST – are expected to continue their healthy growth in fiscal 2023 as the rebound in growth is expected to continue. In addition, deferred asset sales next year – any insufficient divestment this year will likely be realized in FY23 – should keep non-debt inflows strong.

Capital spending is expected to be the focus of the budget as grant payments decline. In the current financial year, the Indian government has focused on infrastructure spending as Covid-related spending has declined. Assuming there are no further significant disruptions due to the pandemic, grant spending should be further reduced next year. Capital expenditure as a percentage of GDP has increased in recent years and the trend is expected to continue.

The Indian government is expected to target fiscal deficit consolidation of 0.5% of GDP in fiscal year 2023. A key pillar of India’s macroeconomic stability in recent years before the pandemic has been the gradual reduction of fiscal deficits, which also had positive externalities of reducing the current account deficit (CAD), helping the process of disinflation and keeping the currency relatively stable.

Changing this trajectory could potentially reverse hard-won gains since late 2013. However, a sharp consolidation of the fiscal deficit could stifle the nascent recovery and make it more difficult to reduce public debt as a percentage of GDP over the medium term. Therefore, gradual fiscal consolidation is likely to be the preferred route to fostering a sustained recovery in growth.

Announcement of India’s inclusion in global bond indices is likely by the end of this year. Investors will be watching the budget closely for any announcements that could lead to further progress on this front. If Sitharaman announces the removal of capital gains tax and withholding tax on foreign bond investments in India in the budget, this would likely lead to an announcement in the fourth quarter of 2022 of the inclusion of the India in Government Bond Index – Emerging Markets (GBI-EM) Global Diversified bond index, with actual inclusion likely in early 2023.

RBI is unlikely to be a net seller in the bond market in fiscal 2023. Government borrowing is expected to remain elevated next year, and there should be an oversupply of government bonds even after assumed some foreign portfolio inflows in anticipation of inclusion in the bond index. Domestic banks are likely to buy fewer and fewer bonds next year as credit growth picks up as the economy recovers.

This oversupply will likely force RBI to continue buying on the open market (on a net basis) next year, despite domestic liquidity constraints. Without this, excess supply should put upward pressure on government bond yields in a rising rate environment.

The author is an Indian economist,

Goldman Sachs

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