Between spending and saving, governments are generally better at the former. High growth comes with the advantage that government revenue expands and gets spent, as is happening this fiscal. But this is also habit-forming. If growth tapers down—as is expected in FY 2024—cutting back government spending will be politically rocky just before a general election. Better then, to get selective on spending early on. Finance Minister Nirmala Sitharaman presented her first budget in July 2019, in the aftermath of the disarray, caused by the extended illness of the late Arun Jaitley, including massive off-budget financing to the public sector in a misguided attempt to stick to the virtuous path of fiscal rectitude pursued since May 2014. Helped by the precipitous decline in international oil prices over the period 2015 to 2018, the fiscal deficit (FD) declined from 4.5 percent of GDP, where the outgoing Congress government had left it in 2013-14, to 3.5 percent in 2016-17. The long sought-after aspirational target of the Union government of FD at 3 percent seemed attainable.

The 1 percentage point reduction in FD was driven by international oil prices (Indian import basket) declining by 20 percent in FY 2015 and a further 45 percent in 2015-16.

Over the half-century preceding FY 2017, FD was below 3 percent of GDP in only three fiscals (FY 1971 at 2.96; FY 1974 at 2.53 and FY 1975 at 2.85 percent)—all under the watch of the Maharashtra social democrat, Finance Minister, Yashwantrao Balwantrao Chavan. Together with the “good practice” fiscal management norms it embodies, achieving this elusive FD target possibly, appealed to the “achievement-oriented” Modi administration. But it was not to be. The 1 percentage point reduction in FD was driven by international oil prices (Indian import basket) declining by 20 percent in FY 2015 and a further 45 percent in 2015-16. This windfall tax revenue gain was used to expand welfare and infrastructure outlays, rather than passed on to retail customers of petroleum products via lower specific tax rates. Oil prices rose from FY 2019 drying up this cache. The options were a mix of cutting back outlays and increasing the FD. Instead, a non-standard option was preferred for retaining the FD around 3.5 percent. Rather than paying off the overdue bills of the Food Corporation of India, which purchases and distributes food for the government, an off-budget loan was arranged against the collateral of publicly held assets of the National Small Savings Organisation. This simply kicked forward the can of government liability. Finance Minister Nirmala Sitharaman took over the hot seat in May 2019. True to character, she resolved to pick up this rolling can by tabling in the FY 2021 budget, an amount of INR 2.64 trillion (1.2 percent of GDP) to pay these overdues. We are, yet again, in an era of high inflation and high oil import prices. It has taken courage and sagacity to reduce the FD from 9.2 percent (FY 2021—the COVID-19 year) to a targeted 6.4 percent this fiscal. Establishing a near-term declining trend back towards an FD of 3.5 percent of GDP (last seen between 2016 to 2018) is beset with three challenges.

The Reserve Bank of India (RBI) expects retail inflation, assessed at 5.78 percent (December 2022) to trend downwards in FY 2024.

The oil slick of global uncertainty and inflation

First, oil price uncertainties, created by the Ukraine standoff, which was partially cushioned via nimble Indian diplomacy resisting the boycott of cheaper Russian oil, has kept imported oil at US$77.7 per barrel in January 2023. But the ongoing opening up of China could firm up oil prices. The Reserve Bank of India (RBI) expects retail inflation, assessed at 5.78 percent (December 2022) to trend downwards in FY 2024. But signals of embedded inflation via core inflation (other than volatile food and fuel) above 6 percent are worrying. A disruption in energy supplies could upset sanguine inflation expectations. Taming the resulting inflation by reducing taxes on the retail supply of petroleum products would increase the fiscal crunch. Excise tax/cess on petroleum products was INR 3.6 trillion, 16 percent of net Union revenue receipts and INR 2.6 trillion, 7.5 percent of “own revenues” of state governments in FY 2022. A deep (1-percentage point) reduction in the fiscal deficit to 5.5 percent could also help reduce inflation. The resulting fiscal stress could be diluted by prioritising outlays with tested, minimum, capital efficiency metrics. Extending drinking water pipe connections sans backup water storage and supply, is one example of inefficient capital allocation. Sadly, evidenced efficiency metrics for alternative budget outlays are not in use.

India’s high-debt burden compromises fiscal resilience

Second, prune the public debt. The Finance Minister noted in the FY2020-21 budget speech “The Central Government debt that has been the bane of our economy got reduced, in March 2019, to 48.7 percent of GDP from a level of 52.2 percent in March 2014”. Just two years later, Union government debt increased to 59 percent of GDP(FY2022) and the combined debt of the Union and state governments to 84 percent of GDP. Not surprisingly, interest payments in FY 2023 (budgeted) at INR 9.4 trillion, are the largest expense outlay bucket, accounting for 43 percent of budgeted Union net revenue receipts, up from 41.7 percent in FY 2021. Defence and domestic security services at 15 percent come next, followed by subsidies (food, fertilizers, and fuel) at 14 percent and inflation-indexed government pensions at 9 percent.

Union government debt increased to 59 percent of GDP(FY2022) and the combined debt of the Union and state governments to 84 percent of GDP.

These four outlays account for 81 percent of the total net revenue receipts, leaving just 19 percent for other “revenue” outlays. The budgeted Effective Revenue Deficit is 1.8 percent of GDP in FY 2022, illustrating that around INR 4 trillion or 43 percent of the interest payment is being funded by additional borrowing. Not very sustainable. High-growth economies can afford to do this, as can “start-ups,” which borrow against their future growth prospects. For a large, lower middle-income economy like India, with historically moderate long-term growth rates (4 to 6 percent), it compromises reserve fiscal capacity to respond, through counter-cyclical measures, to economic downturns induced by economic shocks—a risk-laden strategy.

Infrastructure lags

Third, infrastructure remains a drag on growth although intercity highways have improved. Better telecom connectivity is possible by increasing the use of the Bharat Net broadband network to include those outside the metros in the Fourth Industrial Revolution (4IR). The electricity grid has reached most consumers, but reliability and quality of supply remain question marks, evidenced by the ubiquity of decentralized storage batteries or backup diesel generators amongst the top 40 percent of homes, which can afford them. Multimodal transport solutions remain underdeveloped as do train stations and bus terminals in most towns and rural areas. The competitiveness of major Indian ports in 2018 was ranked 42nd well below China, Malaysia and Thailand- pulled down by low outcomes in infrastructure and turn-around time. The gas grid remains nascent with just 10.1 million connections versus 309 million users for LPG canisters – a more volatile substitute for cooking fuel, than piped natural gas.

The competitiveness of major Indian ports in 2018 was ranked 42nd well below China, Malaysia and Thailand- pulled down by low outcomes in infrastructure and turn-around time.

A notional outlay of INR 103 trillion over five years was provided in the FY 2020 budget for a National Infrastructure Pipeline with 6500 projects (now enhanced to 8968 projects) with 2,100 projects under development presently. Union government capital expenditure more than doubled from Rs 3.4 trillion in FY 2020 to Rs 7.5 trillion (budgeted) in FY 2022-23. But the economic impact of enhanced capital outlays is muted. Per the advance estimates of national income accounts, “gross fixed capital formation” increased by just 10 percent from a share in GDP of 26.6 percent in FY 2021 to 29.2 percent in FY 2023. This indicates that sufficient private investment has not been “pulled in”. Some of this is because public investment substituted for dampened private investments during the COVID-19 pandemic. How private investments respond going forward, will test whether public sector investments are judiciously targeted to “pull-in” or meet the gaps in private investment. The fact that mining and manufacturing, proxies for private investment sentiment, are estimated to grow at a paltry 2.5 percent and 1.6 percent respectively, in the current fiscal, is disquieting.

Loosen the reins

The economy is in a phase where government intervention is least well placed to determine the direction of growth. This is in contrast to the COVID-19 years when the government, with its deep pockets and administrative reach, was best placed to keep the economy afloat and provide income support to people- a job it did remarkably well. For a new phase of growth, government disintermediation, rather than enhanced control over the economy, is appropriate. The global response to an economic downturn has been to enhance government controls over the economy. India should buck that trend by fast-forwarding the incomplete economic liberalisation that started in 1991. First, resume the much-delayed privatisation and disinvestment of public sector enterprises and government-owned financial sector entities. Second, make Indian Railway an autonomously regulated, commercially run entity, providing a surplus to the government rather than looking for budgetary support. Third, maximise the economic impact by encouraging public finance outlays to be driven by competitive metrics of allocative efficiency across investment options and program/project implementation models. India has momentum. What it needs is for the reins to be lightly held.

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