The budget for 2022-23 has been discussed from several angles. In this article, we want to raise three important questions, which have an impact not only on the current year but also on the years to come. First, is increased capital spending the best way to stimulate an economy in the current situation? Second, can the government operate with a high budget deficit for several consecutive years? And third, what should be the mechanism for determining the level of state borrowing?
What stands out prominently in the budget is the focus on capital spending, which is expected to rise 24.5% from revised estimates for 2021-22. This is a welcome change in direction that continues the trend of the previous year. In 2022-23, 45.2% of the budget deficit will be used to finance capital expenditure. In the UK, they endorsed the golden rule of fiscal prudence under which there would be no limit to the budget deficit as long as it was fully used to fund capital spending. Of course, the budgetary definition of investment expenditure does not entirely correspond to the conception that economists have of it. Even loans are treated as part of capital expenditure.
Increased capital spending not only creates immediate additional demand, but also lays the foundation for future growth. In the age of planning, all our plans were aimed at increasing the rate of investment. Therefore, in principle, increasing capital expenditure seems to be the right approach. Capital expenditures have a higher multiplier, but take longer to calculate. Revenue spending has a lower multiplier, but its impact is almost immediate. In the context of the situation created by Covid-19 in terms of loss of employment and income, the question arises whether tax expenditures, such as income support for vulnerable groups, should also benefit from a high priority.
In the budget, the allocation for MGNREGA has been reduced. It is possible that as overall production increases, the need for it decreases. If this happens naturally, all is well. Otherwise, the government should not skimp on the expense in this regard.
On subsidies, the drop in oil subsidies is well taken. But on food subsidies, we have to rethink. Thus, there is concern about the reduction of certain revenue expenditures. As we have explained elsewhere, there is some fiscal space to increase spending, and as revenue grows beyond targeted levels, revenue spending to provide social safety nets should be increased. . Even with regard to capital expenditure, the government should produce a separate document listing the major projects in which investments will be made not only by the government directly but also by public sector companies.
The next problem is the level of the budget deficit. The question is how long can we continue with a very high level of budget deficit. The budget deficits are well beyond what was considered appropriate under the FRBM law. The Centre’s budget deficit in 2020-21 was 9.2% of GDP. Some of it was, of course, due to some cleaning operations, which is desirable. Even then, it is extremely high. In 2021-22, it represents 6.9% of GDP and is expected to be 6.4% in 2022-23. The standard we had set was 3% of GDP. As a result, the Centre’s debt-to-GDP ratio is projected at 60.2% of GDP in 2022-23, compared to the desired level of 40% of GDP. For the Center and the states combined, this would affect 90% of GDP. One can understand the compulsions; the impact of Covid-19 had crippled the economy. In 2021-2022, the economy should reach the level where we were in 2020. Extraordinary measures had to be taken to revive the economy. Public spending was to increase. But we should not minimize the situation we face.
It is sometimes claimed that our debt to GDP ratio is low compared to other countries like Japan. But that’s not an appropriate comparison because tax revenue relative to GDP is high and interest rates are low in Japan — interest payments on debt account for only 4.7% of tax revenue. The corresponding figure for India, taking into account the Center and the States combined, was 25.8% in 2019-2020. In the case of the Center alone, interest payments will represent 42.7% of revenues in 2022-23. This is a big preemption, leaving less for other productive expenses. Such a large public loan poses a problem. In 2022-23, the Center and the States will borrow an amount equivalent to 10.4% of GDP. Savings of the household sector (which is the only surplus sector) in financial assets does not exceed 7.5 per cent of GDP. Thus, the borrowing program can only be completed with the support (albeit indirect) of the RBI. This is what we were doing in the 1980s. Such RBI support will have an impact on inflation, if not immediately then at least with a lag. Of course, we must take into account its favorable impact on production. Currently, the goal appears to be to reduce the Centre’s deficit to 4.5% by 2025-26. Even that may or may not be achieved. But will it be enough? A medium-term fiscal consolidation plan is urgently needed, indicating the period during which a sustainable level of fiscal deficit will be reached. The “crowding out” of private investment may not happen now. But it will eventually become a problem if we have high and prolonged budget deficits.
The final question concerns state government borrowing and the role of the Center in this regard. The government has agreed to raise the state borrowing limit to 4% of the GSDP for 2022-23. But he imposed the condition that 0.5% of this sum will depend on the implementation by the States of the reforms of the electricity sector. This condition is unnecessary. Power sector reforms are needed and incentives can be provided in other ways. The limit for 2022-23 should have been raised without imposing any conditions. Article 293 of the Constitution stipulates that the States must obtain the Center’s authorization to borrow as long as they are indebted to it. Prior to the 12th Finance Committee, the Center used to borrow for the purpose of lending to the States. The 12th FC recommended that this system be stopped and that at least all major states be allowed to acquire all of their borrowing directly from the market. We hoped that as this new system took root, a stage would be reached where states were no longer indebted to the Center and would then borrow according to their own assessment.
In this context, the proposal in the Centre’s budget to provide an interest-free loan for a period of 50 years should be reconsidered. If the Indian government believes that states should spend more on infrastructure, they should just be allowed to borrow more. Of course, under the current proposal, there are no interest charges for the states. It’s a sweetener. It is also worth recalling here a recommendation from the 12th FC which was to set up a lending council consisting of the Union Government, the States and the RBI which could take the decision on how much the States should be allowed to to borrow. This recommendation has not been acted upon before. It needs to be revamped.
Rangarajan is the former Chairman of the Prime Minister’s Economic Advisory Council and the former Governor of the RBI. Srivastava is Chief Policy Advisor, EY India and former Director, Madras School of Economics. Views are personal