Think Tank

Budget 2022-23: Will it Provide a Booster Dose to the Economy?

The 2022 Union Budget will be pivotal in defining the way forward for the Indian economy amidst a continuing pandemic. Before the recent surge in Covid cases, the economy was getting back on track: GDP growth in the September quarter was 8.4% and most high-frequency indicators were at or above pre-pandemic levels. However, economic activity and business sentiment may have taken a short-term hit due to Omicron, and there could be future waves to contend with. Given these circumstances, what were the government’s priorities in this Budget? Where will it get the resources to spend? To decode these issues and take stock of India’s economic trajectory, we invited Ananth Narayan, Associate Professor of Finance at SP Jain Institute of Management and Research, to share his views at a recent joint session of the India CEO and India CFO Forums.

US money supply has surged since Covid hit, making available trillions for consumption and investment

The Global Context…

The outlook for the world economy currently hinges on US money supply. M2 – the sum of currency in circulation, current and savings accounts, retail deposits and money-market mutual funds – reflects the amount of money in the system that is available for consumption or investment. In February 2020, just before Covid hit, this number stood at USD 15 trillion – which itself was more than 3x its level of USD 4-5 trillion at the turn of the century. In response to the pandemic, the US Federal Reserve deployed an additional USD 6 trillion – which correlates almost exactly to America’s entire fiscal deficit for the last two years – taking the total up to USD 21 trillion.

Vast sums are available to be deployed. This is fuelling higher asset prices and rising inflation.

Today, irrespective of fundamentals such as economic growth and unemployment, there are vast sums of money in people’s hands waiting to be deployed. This has caused asset prices to soar: the Nasdaq is 40% above its pre-Covid level. Concurrently, with vaccination rates rising, consumption – particularly of services and luxury goods – has risen sharply, especially among those at the top of the income pyramid. All of this has fuelled inflation: US CPI inflation was 7% last year as against a target of 2%, while in the EU it stood at 5.1%. With inflation soaring and interest rates being low, the real (inflation-adjusted) returns on FDs and other fixed-income instruments have turned negative. Effectively, this means that wealth stored in such instruments is being destroyed.

Rate hikes in the US and Europe are likely to be more frequent and come sooner than previously thought

The political class and central bankers are in unison about the need to tame inflation. Particularly in the US, there is a clear intent both to bring down inflationary expectations to ‘normal’ levels, and to control the volume of money in the system. Two months ago, expectations were that the Fed would hike rates twice this calendar year but currently, it is expected to hike rates as much as 5 times. Similarly, from an expected 2 hikes of 10 bps each, the European Central Bank is now expected to effect 4-5 rate increases in 2022. China is the only exception to the trend of global monetary tightening. It continues with its monetary easing, mainly to offset the crisis in its real-estate sector.

A K-shaped recovery is at work in India

…and India’s

In India, there are marked differences in the performance of the formal and informal sectors. The formal economy has been doing extremely well, with large, listed companies recording a ~150% increase in profits relative to pre-Covid levels in the first half of FY22. The gross value added for the top 4,000 companies was up by 50% and salaries by an average of 15%. Starting salaries are about 25% higher than they were pre-Covid.

Formal payments have surged, replacing informal (or cash) payments

Most of these gains can be attributed to the growing formalisation of the economy. From about 150% of GDP, formal payments currently stand at over 220%. Although it is difficult to measure the value of informal payments, it can be imputed from the formal-payments data. Given that India’s GDP is barely higher than it was pre-Covid but formal payments have surged, it is safe to assume that one mode of payment is being swapped for the other. This has also resulted in a large increase in tax revenues.

The informal sector still accounts for the bulk of production, and employments there are not promising

According to estimates by CMIE (Centre for Monitoring Indian Economy), the formal sector accounts for just 15% of employment – about 60 million people out of a total workforce of 400 million. The remaining 85% includes farmers, who make up the bulk of employment. The ILO (International Labour Organisation) estimates that India’s employment-to-population ratio declined from 55% in 2005 to 43% in 2020. In comparison, Bangladesh, Vietnam and China had ratios of 53-55%, 75% and 65%, respectively. Worryingly, female participation in the workforce was under 20%, and has been decreasing since 2005.

More and more people are leaving the workforce – particularly rural women

It is necessary to distinguish people actively looking for a job from those who are not. Regular surveys by CMIE and the NSSO (which runs a Periodic Labour Force Survey, or PLFS) measure both the labour-force participation rate and how many people have stopped looking for work. CMIE estimates suggest that, since 2016, India has lost roughly 20 million manufacturing jobs – though the rise of gig employment compensates for some of these losses. However, over the years, there has been a steady rise in the number of people not looking for a job, indicating that more people are dropping out of the workforce. This is particularly true of rural women, who, thanks to the safety net provided by schemes such as MGNREGA, no longer feel compelled to seek regular wage employment. Conversely, there is no such net protecting informal workers in urban areas.

Tax revenues have surged

Deciphering Budget 2022

The FY23 Budget is a mix of good and bad news. The sterling performance of the formal sector has ensured robust tax collections. Total revenues through December 2021 exceeded Rs 17.3 trillion – almost as much as the Rs 17.8 trillion budgeted for the full year. Thanks to growing formalisation, Central tax revenues are now ~35% higher than 2 years ago. (State-level tax collections, though, are flat.) Consequently, the government has revised its tax-revenue estimates upwards by Rs 3 trillion, or about 1.5% of GDP, allowing it a considerable degree of freedom in terms of fiscal policy.

The government is being extremely conservative with its budgeting

Another positive is that the government continues to take a very conservative approach to budgeting. It is attempting to push up capital expenditure to the extent possible, and to control revenue expenditure, such as on salaries, pensions, subsidies etc. The share of the budget allocated to capex rose to 16% last year and is expected to touch 19% in the coming fiscal year.

However, government debt has jumped

On the other hand, government debt now stands at ~90% of GDP, a ratio last seen in 2004-05. Moreover, despite rising tax revenues, the fiscal deficit will be mildly higher than budgeted (Rs 15.9 trillion, compared to an estimate of Rs 15.1 trillion). This is largely on account of increased outlays in FY22 towards food and fertiliser subsidies, higher allocations towards the MGNREGA and a jump in export subsidies – though some of these expenses are slated to fall in FY23.

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