Budget will have to find a balance between capital spending and borrowing

The Indian government will present the Union Budget 2022-23 on February 1, 2022. Besides giving the national accounts, the government will communicate its long-term agenda to several observers through Budgets. The big question facing policymakers is how to equitably distribute expenditure — given that Covid-19 has disproportionately affected the medium and small enterprises and the lower strata of society, while the economy is just starting to recover and needs fiscal impulse. Meanwhile, the government must try and sound fiscally conservative as well. Until that unfolds, let us look at how various countries have operated on this policy spectrum, and what India can do.

On one end of the spectrum is China. In what it calls a “common prosperity drive”, Beijing clipped the wings of many high-flying giants, including the likes of internet conglomerates such as Tencent and Alibaba, food delivery app Meituan and ride-hailing app Didi. All told, over $1 trillion in shareholder value was lost in the crackdown.

In a rare international defence of the government action, China’s President Xi Jinping spoke at the online World Economic Forum’s meeting that “the common prosperity we desire is not egalitarianism. We will first make the pie bigger and then divide it properly through reasonable institutional arrangements. As the rising tide lifts all boats, everyone will get a fair share from development, and development gains will benefit all our people in a more sustainable and equitable way”.

This is a form of pseudo-budget but is problematic. It allows China to pander to its gallery (a society that has no voting rights), while the cost is borne by a select few investors and companies. (Besides the ones mentioned above, international companies such as Microsoft, Apple, and now Tesla, fearing action, have agreed to store data gathered in China in that country itself).

Now, compare that to the other end of the spectrum, when Ronald Reagan, the US president in the eighties, aggressively cut income tax rates for the rich. The understanding was this: the cuts would give the rich a greater incentive to invest and create wealth, thereby allowing them to spend more, create jobs and increase income for everyone else. This came to be known as “trickle-down economics”, i.e., if there is more income at the top, more of it will eventually trickle down to the rest of the economy, making everyone richer than before.

The inherent assumption is that given a bigger slice of national output, the rich will equitably distribute it across all factors of production — land, labour, capital and risk. Sadly, history does not bear witness to that happening even remotely.

India is operating somewhere in the middle of this spectrum. It had slashed corporate taxes in August 2019 hoping to spur investments. Since the onset of the pandemic, however, the government has had to provide for the economically weaker sections, while ensuring that the systematic transfer of wealth from the unorganised sector to the organised one is contained (as evidenced by record high tax to nominal GDP ratio). Lastly, in the absence of corporate capital spending, it falls upon the government to provide the fiscal impulse for growth as well.

Let us talk numbers then. For the first time in decades, tax collection will surpass Budget estimates (by over 20 per cent or Rs 3 trillion). However, divestments will likely fall short, leaving an investible surplus of only half that amount.

Second, non-negotiable revenue expenditure (interest, subsidies, and defence) forms close to 70 per cent of receipts, leaving the government with a discretionary surplus of only Rs 8 trillion. The social spending bills (education, health, water supply, housing and labour and rural employment), totalling over Rs 2 trillion, will likely rise by 20 per cent this year. Besides, we have additional revenue expenditures of Rs 16 trillion. In total, we are staring at a revenue deficit of Rs 10 trillion.

This is before all the capital spending of Rs 5-6 trillion. The fiscal deficit, then, climbs to Rs 15-16 trillion, of which we fund a third (Rs 5 trillion) from small savings and the rest from the borrowings.

A bleak scenario, one might think; the government has no room to manoeuvre. Well, that’s true, but over Rs 180 trillion of projects are pending execution, and the time to act is now. Strong economic growth follows large capital spending and given that private companies are still capex-shy, we shall likely see budgeted capital expenditure rising over 20 per cent this year (on top of 30 per cent last year). This is not even accounting for some populist moves given that it is a heavy state election year.

Well, can’t you borrow more? Well yes, but that comes with costs (crowding out private investments, higher interest rates, risk of rating downgrade, and such), but that is what it might end up being. Finding alternative routes to fund capex could be one way to go (like REITs, InvITs, IDFs or private equity), but given the numbers it appears that the government is unlikely to target an ambitious fiscal consolidation (and instead choose a steeper glide path in the run-up to FY26, as promised last year).

Given the constraints, it is going to be an interesting Budget. Having read this, however, if you are wondering if I came here just to know whether the STT (securities transaction tax) and LTCG (long-term capital gains) tax are going to be cut, let me redirect your attention to China’s example at the start of the column and say that “in a Budget, number matters, but perception matters more”.


(The author, Jigar Mistry, is co-founder of Buoyant Capital. Views are his own)