A Change of Strategy

Context: Budget 2021-22 has turned to fiscal activism with a focus on medium-term fiscal finances.

Indications of a turn towards Fiscal Activism: from Union Budget 2021-22

• High fiscal deficit: It also reflects the government’s move towards greater transparency, as higher loans of the Food Corporation of India are now counted above-the-line.
• Increase in Government spending: It will rise by 55-60 %, year-on-year, in the final quarter.
  • Increase in Revenue Expenditure (RE): To 12.5 % of Gross Domestic Product (GDP) in FY 2022.
  • Increase in Capital Expenditure (Capex): To 2.5 % of GDP in FY 2022.

Factors resulting in the change of the strategy:

• High multiplier effects: With the economy now normalizing, government spending is likely to have a greater bang for the buck. (since the composition of spending is skewed towards higher capex)
  • According to the Reserve Bank of India, the short-term multiplier of capex is around 0.47 and longer-term is 2.41.
  • Higher capex could boost GDP growth by 0.7-1. Percentage points (pp) over the medium term.
• The government has likely shed its sovereign rating-related caution: by focusing on growth over debt sustainability.
  • According to the Economic Survey, higher growth is a pre-condition for debt sustainability. (The real GDP growth will rise by 13.5 %, year-on-year, in FY2022) 
  • The idea behind this strategy is that higher public investment will crowd in private investment, boost consumption leading to a durable growth recovery over the medium term.
  • In turn, this will increase nominal GDP growth and tax revenues, and enable fiscal consolidation and debt sustainability over time — a pet peeve of rating agencies.

 Way Forward: To realize the benefits of Fiscal Activism

• Corporate sector should pursue growth instead of focusing on debt deleveraging.
• Easing monetary policy: A more proactive role by fiscal policy in driving growth will allow monetary policy to nurture the nascent green shoots of growth and ensure smooth government borrowing.