When Budget 2021 was announced by the Finance Minister, the markets expected a major departure from the original FRBM (Fiscal Responsibility and Budget Management Act) Act. The FRBM Act had gradually guided the Indian economy towards the fiscal deficit target of 3.5% with the possibility of tapering to 3%. However, COVID changed the contours of fiscal management completely. Here is how fiscal deficit panned out over the years.
COVID and the need for fiscal expansion
When it came to fiscal expansion over last 2 years, India was not alone. Every country in the world including developed and emerging economies gave heavy fiscal support to tide over the tough times. The result was a huge fiscal bill. With total of $400 billion in the form of various support measures, of which $200 billion was by way of fiscal incentives and doles, the fiscal situation had gone for a total toss.
Budget 2021, announced on 01-Feb 2021 set the tone for fiscal expansion in a big way. The fiscal deficit target for FY21 was revised from 3.5% to 9.5% in one stroke. At the same time, the fiscal deficit target for FY22 was raised in one sweep from 3.1% to 6.9%. Eventually, the rising GDP number led to the fiscal deficit target being revised to 6.8% for FY22. The actual numbers for FY21 show that India closed the year with 9.4% fiscal deficit as against the budget estimate of 9.5%. For FY22, it will be closer to 6.6% as per early estimates.
How will fiscal deficit estimates look like for FY23?
For FY23, the big question is what will be the approach? In Budget 2021, the finance minister had indicated that the fiscal deficit would be reduced gradually and in a calibrated manner to 4.5% by 2026. That is still a long time away. Government has enough time to reach that target. The primary focus will be to ensure that the green shoots of growth that are visible on the GDP, IIP and core sector front are not dissipated.
There is another consideration that will drive fiscal deficit in Budget 2022. Year 2022 is expected to be a hawkish year, at least that is what it looks like now. The RBI may not have the monetary tools at its disposal to spur growth if required. That means, the only tools that the government can rely on will be fiscal tools. The government would, therefore, prefer to keep their fiscal taps open and target the fiscal deficit in Budget 2022 at around 6.5% of GDP with a leeway of 20 bps on both sides.
What will drive the fiscal deficit decision in Budget 2022?
Several factors will influence the fiscal deficit decision when the FM rises to present the Budget on 01-Feb 2022.
a) The theme of the budget will be the key. There are two possibilities at this point. The government may opt for a grand reformist theme or it may opt for a conservative budget after the fiscal excesses of last 2 years. If it is a growth budget, then one can expect fiscal deficit target for FY23 at around 6.5% or higher.
b) Debt market liquidity will be a key issue. The Indian government securities are expected to be included in the global bond indices in Mar-22. That will give the government more space and global liquidity to borrow. With generous support of foreign investors, the government would be willing to live with a higher fiscal deficit. After all, fiscal deficit has to be bridged with borrowings.
c) Budget 2022 will try and sync fiscal deficit with RBI policy. If the RBI is planning just 1 rate hike, then higher fiscal deficit will not be a problem. However, if there are likely to be more rate hikes then it would be unviable for the government to borrow. It may then prefer a relatively lower level of fiscal deficit.
d) Lastly, crude prices will play a critical role. High crude prices are not only inflationary but also hit fiscal deficit. For example, a rise of $10/bbl in crude results in a 49 bps spike in inflation and 43 bps higher fiscal deficit as percentage of GDP. If crude prices don’t taper, the government will pencil in a lower in a fiscal deficit to factor in the risk of crude spiking the fiscal deficit.
More than FY22 fiscal deficit, markets will look for time table
Broadly, the expectation from the budget will be on two fronts. Firstly, if you looks at other countries with similar sovereign ratings as India, India’s fiscal deficit ratio and its total borrowings ratio are sharply higher. That makes the economy more vulnerable. India is unlikely to get any sovereign upgrade unless this fiscal deficit is brought on FRBM lines. Budget 2022 may not be the right time to talk about cutting fiscal deficit, but government should try and give a 3-4 year time table of fiscal deficit reduction.
Secondly, India’s revenue deficit is more than 70% of fiscal deficit, which basically means we are borrowing for our morning breakfast. That is not an encouraging signal. The Budget must talk about time-bound targets to get revenue deficit below 50% of fiscal deficit. That should be music to the ears of markets, foreign investors and even rating agencies.