Economic outlook: Budget likely to be balanced

The Union Budget will try to strike a balance between growth and consolidation goals, while the pandemic will dictate India's near-term outlook. The economy is in a transition phase, as demand shifting from goods to services and need for restoring jobs, as a fall in the national unemployment rate masks a lower labour participation rate and an unemployment rate that is still to return to pre-pandemic levels.

The stage is set for an investment revival, with the central and state government at the driver s seat, given a host of catalysts in the pipeline, including strengthening the infra institutional architecture, increasing the presence of new age companies, and increasing high-value manufacturing exports, amongst others. After two years of extraordinary stimulus and a bloated central bank balance sheet, global policy conditions are tighter. For India, monetary and fiscal policy are likely to complement each other this year, dialling back on the sluggishness shown in the past two years.

Despite the higher spending demands in FY 22, we expect the Rs 2 -- 2.5 lakh crore overshoot in revenues to help absorb the shortfall, apart from the government surplus cash position with the central bank and the unspent balances with ministries. An additional cushion is from the higher nominal GDP of 0.3% of GDP, which is likely to keep the deficit within the budgeted - 6.8% of GDP. The revenue deficit compared to the gross fiscal deficit ratio is a reflection of the quality of the spend.

We expect a 60 bps consolidation in the fiscal deficit for FY 23. The Budget speech is likely to point out a higher allocation towards capital expenditure, which has a higher multiplier for growth compared to revenue spends. An increase in capex spending by a third is expected to be seen as a rebound to 2.4 per cent of GDP compared to 1.7 per cent in FY 12 -- 20. Market observers will be watching for a path towards the inclusion of government bonds into global indices, changes in the taxation framework, and clearing the way for Euroclear eligibility of government bonds.

Thirdly, moves to backstop the manufacturing push by higher PLI allocations, while also building in the green goals with an emphasis on sectors such as solar cell and solar module manufacturing. On the taxation front, the equity markets lower the scope of changes in the capital gains tax or STT. Tax rates and structure for individuals were undertaken within the last two years, so we don't expect further changes in this space, but relief may be expressed via an increase in standard reduction or moves to lower mortgage costs.

Market participants will look for medium-term macroeconomic projections, including the revised Fiscal Responsibility and Budget Management Act FRBM, at the FY 22 budget, the government projected the fiscal glide path to lower the deficit to 4.5 per cent of GDP by FY 26, implying an average of 60 bps reduction in the deficit annually. We expect the target to be maintained, which indicates that the authorities are keen to preserve ongoing fiscal consolidation, but without any adverse cutbacks that will negatively affect growth.

The absolute deficit will remain wide despite a narrower fiscal deficit than GDP, causing gross market borrowings of around Rs 12.5 -- 13 lakh crore, at multi-year record highs and setting the stage for an unfavourable start for bond markets next year. Domestic bonds are affected by a rise in US Treasury yields, domestic sticky inflation, high crude prices and gradual policy normalisation by the central bank, as well as the impending demand-supply mismatch from high issuances. Borrowing costs are bound to go up if there is a resumption of operation twists or purchases under the market stabilisation bonds.

The author is Senior Economist, SVP at DBS Bank, Singapore.