The New Deal

LAST YEAR, WHEN Nirmala Sitharaman replaced the Budget in a briefcase—a colonial hangover imitating the ‘Gladstone Box’—with a local bahi khata, she started a tradition. In doing so, the minister’s family, especially her mother, made sure that the bright red cloth pouch with the golden Ashoka emblem was blessed by Lord Ganesh at the Shree Siddhivinayak Ganapati Temple in Mumbai. It was a scramble but the finance minister’s mother managed the auspicious rendezvous.

This year, by carrying the tablet in the ‘sanctified’ cloth pouch she blended tradition with modernity, thereby sending a message. But that is not the only message in the Budget which has been feted for laying out a plan for safely navigating the country’s economy through the global destruction caused by the Covid-19 pandemic.

The Union Budget for 2021-2022 combines the political sensibilities of New Delhi with the economic spirit of Mumbai to achieve a paradigm shift in economic policy—a scale last witnessed in 1991 when the nature of the economic policy regime was changed for good. To align these divergent, often conflicting thinking and expectations, is a bold move to say the very least. To marry an entrepreneurial inclination with a rentier mindset can be the recipe for a Molotov cocktail—especially with political opportunists waiting to strike. Yet, the finance minister seems to have managed the tensions between these two opposing forces with the skill of an accomplished trapeze artist sans the usual safety nets.

THE 1991 MOMENT

PURELY FOR ITS decisive break from the past, the Union Budget for 2021-2022 will rank among the top five ‘disruptive’ Budgets and pitchforks Sitharaman, most unexpectedly, into an elite league of finance ministers. Combining with her boss, Prime Minister Narendra Modi, Sitharaman has carved out a special space for Modinomics in the budgetary history of post-independence India.

The last time a duo combined with such finesse was Prime Minister PV Narasimha Rao and Finance Minister Manmohan Singh in 1991. Exactly why some analysts are referring to this as the ‘1991 moment’; because, once again, a Budget has ignored political rebuke and undertaken a bold and radical paradigm shift. To be sure, Team Sitharaman’s big-stakes gamble was based on the prime minister holding all the political aces. For now, it has paid off with the markets voting, scaling a record high. Sitharaman’s third Budget (the economy did get third-time lucky!) will be remembered for long.

It already has a moniker: A-once-in-100-years Budget. This Budget will not be remembered for the impressive Rs 35 lakh crore expenditure that it promises. It will also not be remembered for the Rs 5.5 lakh crore capital expenditure, almost 3 per cent of the Gross Domestic Product (GDP) or the country’s national income, the highest in recent memory. It will not be remembered even for the massive hike in the expenditure on health; the outlay for ‘health and wellbeing’ was pegged at Rs 2.23 lakh crore in 2021-2022—an increase of 137 per cent over Rs 94,452 crore this year.

Instead, it will be part of Budget history for the change in mindset it boldly articulates; for trying to make ‘Future Proof’ India; for aligning it with the aspirations being articulated by the youth, who account for two-thirds of the population. The unambiguous embrace of economic reforms—already visible in the resolve of the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) to ignore the pushback and stay the course on the new farm laws—is remarkable. Overnight, the iterative approach of ‘reforms by stealth’—a hallmark of the process of economic change pursued for the last 40 years—has been ejected from the policy lexicon.

Also, this Budget is the first policy document of the Union Government which virtually writes the obituary of the Nehruvian legacy of a mixed economy and commanding heights of the public sector so decisively. The Nehruvian development model of the state’s all-pervasive primacy over individual enterprise has been finally turned on its head. As audaciously as Modi did in politics, Sitharaman has done it in economics.

Importantly, this effort should not be seen in isolation. Yes, in terms of scale and intent it is unparalleled. But it is part of a larger transition being undertaken by India—partly by the sheer structural disruption caused by technology and partly owing to deliberate nudges towards a rules-based regime. This transition, which began a decade ago with the introduction of Aadhaar, has seen a phenomenal acceleration in the last six years—an excellent example being JAM (Jan Dhan, Aadhaar and Mobile) which has helped productionise direct benefits transfer; not only has it helped in targeting the beneficiary, but it has also reduced leakages, cumulatively estimated at Rs 1,70,000 crore at the end of March 2020. The rejection of a discretion-based regime—like it happened with the decision to allocate spectrum and coal mines through auctions—is a non-negotiable for any economy looking to provide an equitable opportunity, both for its citizens and foreign investors.

The unshackling of the economic regime proposed in the Budget blends with the emerging ecosystem in which the digital economy is the base. The contours of the digital economy have witnessed an unprecedented expansion in the last nine months when new norms of lockdown and social distancing shifted most transactions to the online space. Already fintechs are stepping into this space to expand the idea of inclusion to include access to working capital credit for MSMEs.

This Budget is therefore an exercise in continuity of change.

BOLD REFORMS

PRIOR TO THE Christmas break, Sitharaman shared a teaser on her upcoming Union Budget. Addressing a summit hosted by the Confederation of Indian Industry, she said, “Send me your inputs so that we can see a Budget which is a Budget like never before in a way. Hundred years of India wouldn’t have seen a Budget being made post-pandemic like this.”

Most interpreted this to mean that the Union Budget to be presented on February 1st would be a game-changer. Only natural for it to then have stirred expectations. Yet, there was one other important subtext to the finance minister’s remarks: the return of the big-bang Budget.

For several reasons, over the last few years, the Union Budget has gradually lost its sheen; it was reduced to just one more date on the annual economic timeline of the country.

For one, the rapid growth of the private sector meant the role of the Union Government as the dominant economic entity gradually decreased. Then the rollout of the Goods and Services Tax (GST) happened. The power to undertake substantive indirect tax changes—the granular detail of every Budget that left everyone, from the middle class to the stock markets, in a tizzy—in the Union Budget was transferred to a new federal entity, the GST Council. And after the big tweak in corporate tax rates in late 2019, the excitement and anticipation about the Union Budget diminished that much more.

Consequently, the Union Budget’s focus was gradually evolving into one about expenditure management. This is because every finance minister had little left over—about a quarter of the total expenditure outlay—for discretionary spending. And that was because the rest of it was mostly pre-empted by annual wages, interest payments on outstanding debt and subsidies.

But then Covid-19 struck. All bets were off. Almost everyone was baying for a course correction and a massive economic stimulus to kick-start an economy which had ground to a halt.

Throughout last year, the finance minister ignored unsolicited advice and calibrated her spending. Despite contracting revenues, the Government did not revisit its expenditure commitments presented in the 2020-2021 Budget—presented just prior to the pandemic. It did announce three stimulus packages staggered over six months. The bulk of the spending, especially in the initial months, was directed towards saving lives—by providing income and food in the hands of the people. It was only when the economy began to exhibit some signs of coming back to life as the spread of the pandemic peaked that livelihood became a policy focus. Net-net, the Union Government spent far beyond its means—exactly why the fiscal deficit witnessed a record slippage to 9.5 per cent of GDP in the current fiscal year.

However, the finance minister had imbibed a very important lesson in this period, which has been incorporated in the ‘Big Bang Budget’ she unveiled on February 1st. It pivoted public policy focus away from leaving money in the hands of consumers and companies to funding big-ticket infrastructure projects with built-in multipliers.

Sitharaman has redefined the role of government and its relationship with the economy in terms of interventions. This is big government with a difference: the commanding heights will now be occupied by the private sector. Indeed, in some ways this Budget resonates with the Bombay Plan of 1944 in which the top industrialists of that time had suggested that government must invest to enable the nascent private sector to grow. This Budget seeks to do the same for a well-established private sector which is currently in a bind because of the pandemic. The idea underlying this Budget is the same: setting the stage for the private sector to perform.

This is very different from the big reforms moment in 1991. Yes, that too was born of a crisis; though unlike now that was caused by a mismanagement of the domestic economy. Further, in 1991, it was the same Congress party, egged on by an unprecedented economic crisis, with India at the risk of defaulting on its global dues, which ended the licence raj—the pernicious practice of capping production through the issue of licences. In fact, the then Congress manifesto had committed to iron out the kinks in licence raj and not junk it. Undoubtedly, the nudge and a wink by the International Monetary Fund (IMF), which was providing a backstop to prevent a sovereign default, influenced the new policy contours.

“When it came to the Congress party, Rao was able to defend reforms with trickery—using Jawaharlal Nehru as a shield and Manmohan (Singh) as a mask,” wrote Vinay Sitapati in his seminal book Half-Lion: How PV Narasimha Rao Transformed India, by far the most authoritative tome on the 1991 phase of economic reforms.

Thirty years later, yet another crisis served up a fresh opportunity to hit the reset. But with a difference. Unlike earlier, this crisis was on account of the Covid-19 pandemic which had ravaged every economy in the world. Further, at the helm was BJP, the new political pole, which enjoyed a comfortable majority in Parliament. It had no legacy or baggage. If anything, it drew from the previous NDA regime led by Atal Bihari Vajpayee which, among other things, had hit the accelerator on disinvestment—demonstrating political courage to go ahead with the outright sale of some units. No regime thereafter dared to even come close.

That was till Budget 2021-2022.

THE FACILITATOR

THE UNION BUDGET has no doubt, in the aftermath of the pandemic, reclaimed its primacy. But primarily as a facilitator. Even though the Centre has bumped up its own capital expenditure, its composition is such that it catalyses capital formation in the private sector. The purpose of the increased capital allocations is more to generate outcomes rather than output, reflecting a major shift in the mindset of the Government. The outcomes that are not budgeted but factored in as expected, is the private investment.

It has ordained a fundamental ideological reset wherein the Union Government no longer sees itself as the investor of the last resort and first call. Not only is there a clear focus on strategic investing but also the political will in monetising assets that have been created over the last 70 years to free up scarce capital. This is the real essence of the latest Budget offering.

This is the key difference between a Budget for an open market economy and that for a liberalised regulated economy. Ideologically, this is an out-and-out open economy Budget. Not surprisingly, in its analytical moorings, even though it is a pure pump priming Budget, it is more Schumpeterian than Keynesian. Unlike John Maynard Keynes (whose ideas fundamentally transformed macroeconomics and the economic policies of governments) who advocated plain government intervention to prop up the economy and failed businesses of all types, Joseph Schumpeter (the Austrian political economist who popularised the term ‘creative destruction’) believed that the economy will be driven by the animal spirits of entrepreneurs—inspiring a culture of perform and perish—which is what the Government is hoping will be unleashed such that India Inc shakes out of its stupor and kickstarts the investment cycle.

THE FISC KARMA

THE OTHER STRUCTURAL change undertaken by the finance minister is the exorcising of the ghost of the fiscal dharma. It has been in the making for 40 years and till this Budget was an untouchable. The idea was first introduced when India negotiated a structural adjustment loan with the IMF in 1980 to bail it out of an external sector crisis. India exited the programme in 1982 and managed to evade implementing the reforms it had committed itself to for availing the loan. But it hung on to the idea of fiscal conservatism—nothing wrong in conforming to the mantra of spend within your means.

In fact, in the 1980s, the Government set up a committee under the chairmanship of Bimal Jalan to draw up a blueprint for a ‘Long Term Fiscal Policy’. Elements of this began to be progressively incorporated into the Budget arithmetic. It gained fresh impetus after the largesse of the 1980s, wherein the Government borrowed abroad to fund the Budget deficit, ended badly and landed India in an external debt crisis. Soon, the fiscal deficit became the metric to measure a Budget’s success or failure.

Thereafter, every finance minister used it as a given; got into the habit of fixing an annual target and measuring their success in Budget management by sticking as close as possible to this number. This became both the means and the end. It was almost impossible to achieve these targets, encouraging finance ministers to take items off the balance sheet and, in some instances, just cook the books. On paper, governments were spending within their means, but in practice, they were not. The outcome has been a massive debt overhang. Worse, finance ministers obsessing with the balancing of books often took their eyes off the quality of spending—using the borrowings to fund wages and rising debt service obligations instead of capital expenditure to create assets. This year, for instance, the finance minister has had to budget nearly Rs 80,000 crore towards debt service; a sum which is sufficient to fund the rural employment guarantee scheme outlay in a normal year.

Sitharaman has, despite the threat of a rebuke from the international rating agencies which still use the fiscal deficit as a primary metric in their risk assessment of a country, decided to ditch this practice. Instead, she has given primacy to public expenditure policy over fiscal policy. By going against the precedent, tradition and wisdom of meeting or reducing the fiscal deficit number, the ghost of fiscal deficit has been exorcised; at least till 2026. From a high of 9.5 per cent of GDP in 2020-2021 it is estimated to be 4.5 per cent of GDP by 2025-2026.

Normally, a high level of fiscal deficit endangers the macroeconomic stability when it is disproportionately used to finance current and not capital spending as it ‘crowds out’ private investment and puts upward pressure on interest rates. A closer look at the deficit numbers reveals that the finance minister has done better in this fiscally profligate Budget than in the ‘fiscally prudent’ Budget last year when 80 per cent of the fiscal deficit was used to finance the revenue deficit; a longstanding fiscal concern. As against this, in the current Budget, the share of borrowings going to finance capital expenditure has increased from 20 to 25 per cent; certainly still very low, but better than in previous years—at the very least, a new beginning.

The idea, it seems, has been to restore and recalibrate the expenditure balance that has got skewed since 2010. The finance minister has, at the appropriate time, pulled back from a transfer payment, revenue expenditure-led Budget to a capacity-creating, capital expenditure-led Budget.

It is in this framework that the level and, more importantly, the structure and composition of public expenditure need to be analysed. Having secured a high level of spending, the real challenge will be to make it consistent with macroeconomic stability. This has been attempted by making the public expenditure policy part of a systemic reform package aimed at raising the sustainable growth rate by promoting domestic saving and productive investment.

In the budgetary arithmetic, this means a reduction in revenue deficit as a percentage of the fiscal deficit, and allowing for an increase in the proportion of capital expenditure to overall fiscal deficit. Even if the fiscal deficit is a bit higher, its quality will be much better for both growth as well as inflation. Exactly the sentiment influencing the stock markets; they are clearly making a distinction in the quality of spending—alternatively, in the normal course of things, they would have baulked at the prospect of a government going in for such a big borrowing.

The new structure of public expenditure, biased as it is in favour of infrastructure, rightly recognises the severity and seriousness of supply-side constraints that are holding back growth and in some instances contributing to price pressures.

A focus on public expenditure policy will go a long way in addressing another structural constraint: the decline in the savings and investment rate. If these are restored through changes in public expenditure policy, growth will revive on its own.

THE NEW COMMANDING HEIGHTS

THE REJIG OF the key principles underlying the Budget arithmetic has been accompanied by one of the most audacious moves with respect to the future role of the public sector. After testing waters with the move to offload Air India, the Union Government is proposing to go the full distance. In the Budget, the finance minister made clear that the presence of the public sector will be restricted to a few strategic sectors—identified as: Atomic Energy, Space and Defence; Transport and Telecommunications; Power, Petroleum, Coal and Other Minerals; and Banking, Insurance and Financial Services.

The policy statement annexed to the finance minister’s speech adds, and very bluntly at that: ‘In non-strategic sectors, CPSEs will be privatised, otherwise shall be closed.’

Explaining the logic of the new policy, the statement says: ‘[The idea is] Minimising presence of Central Government Public Sector Enterprises including financial institutions and creating new investment space for private sector.’

Ergo, the Government is walking its talk and saying it is no longer in the business of running enterprises that can be undertaken by the private sector. It is the explicit political acceptance of what was known to academicians and policymakers for long — that public sector investment/expenditure provides less efficient outcomes compared to the private sector. A remarkable reset of the 60-year notion of the public sector as the commanding heights of the economy. Indeed, a remarkable makeover. The first time probably an official document has so openly turned up in the corner of Indian business. Presumably, BJP-ruled states will deploy the same template and provide proof of concept for this reform to be made universal.

Alongside, the finance minister has given fresh wind to an existing proposal to monetise public infrastructure. The resources thus freed are to be used as a key financing option for new infrastructure construction. “A ‘National Monetization Pipeline’ of potential brownfield infrastructure assets will be launched. An asset monetisation dashboard will also be created for tracking the progress and to provide visibility to investors,” she said.

The proposal is to link the proceeds from this monetisation of assets to the projects awaiting funding in the National Infrastructure Pipeline (NIP), the body created in 2019. The NIP launched with 6,835 projects has now expanded its pipeline to 7,400 projects. About 217 projects worth Rs 1.10 lakh crore have been completed.

This prioritised infrastructure spending on roads, affordable housing, railways, power, etcetera, will address various infrastructure bottlenecks, boost the core sectors, and create a multiplier effect on the economy. The associated job creation would eventually translate into higher consumption as well.

GROWTH, GROWTH, GROWTH

THE OUTCOME OF all these building blocks coming together is growth. In this year’s Budget, the expenditure balance that had got skewed since 2010 has been pulled back from a transfer payment, revenue expenditure-led Budget to a capacity-creating, capital expenditure-led Budget. In this, Sitharaman has also tweaked the expenditure strategy of her mentor and predecessor Arun Jaitley.

Apart from securing a level of spending consistent with macroeconomic stability, the composition will engender a sustainable growth rate by promoting domestic savings and productive investment.

The new structure of public expenditure has recognised the severity and seriousness of supply-side constraints that are holding back growth. So even with a lower level in real terms, the structure and composition of the budgetary expenditure will generate growth.

Be it through encouraging infrastructure debt funds done earlier or credit enhancement mechanism for infrastructure financing institutions or the setting up of a new Development Finance Institution (DFI) with more suitable maturity and quality of funds, it will go a long way in not only propelling autonomous investment demand through a change in the composition of public expenditure but also providing liquidity for financing infrastructure and thereby reducing the capacity constraints.

While the economy is still in a comatose consumption mode because of the pandemic, the autonomous investment demand will, over the next three years, see a restoration of the earlier level of savings. This is important from the point of view of keeping the current account deficit in check and insulating the external account and, in turn, will keep the currency risk at bay.

A PANDEMIC BUDGET

IN THE RUN-UP to this year’s Budget, one issue was apparent. The health sector desperately needed a reset. Seven decades of neglect of public policy has left both lives and livelihood at risk. The Covid-19 pandemic demonstrated that geography is no defence against the growing trend of vector-borne diseases. Worse, it is neither the first nor is it going to be the last.

Sitharaman’s Budget has explicitly accepted that unmanaged health risks have the potential to cause unprecedented economic disruption. It has also tacitly acknowledged that the current level of spending on healthcare, a little over 1 per cent of GDP, is inadequate.
“Taking a holistic approach to Health, we focus on strengthening three areas: Preventive, Curative, and Wellbeing,” Sitharaman said.

Besides developing capacities in primary, secondary and tertiary care health systems—funded by a new programme with a budget of Rs 64,180 crore to be spent over six years—the strategy commits to providing drinking water universally, a holistic plan to rewire urban India under an Urban Swachh Bharat Mission 2.0 with a total financial allocation of Rs 1.41 lakh crore to be spent over the next five years.

Including the cost of funding the Covid-19 vaccine programme with an initial budget of Rs 35,000 crore, the total outlay under ‘health and wellbeing’ has been bumped up to a staggering Rs 2.23 lakh crore—compared to Rs 94,452 crore in 2020-2021.

The underlying idea is very simple: prevention is better than cure. So, by ensuring basic hygiene and drinking water, a range of illnesses like diarrhoea, responsible for significant fatalities, can be contained.

Yes, even now it is not enough to fund the health needs of India. But it is a beginning as well as a signal of a mindset reset in the approach to healthcare. Since health is a state subject, the collective success of this programme depends on a coordinated effort. Easier said than done, especially given that states are even more resource-strapped than the Union Government.

Even though this Budget is decisively pro-business, it is also a social Budget that proposes to use market instrumentalities to reset the economy. Implemented together, it should trigger a recovery; the former will address the demand-side issues while the latter will ease the supply-side constraints. It is consistent with the ideology of this Government which prefers empowerment over entitlement—the idea that people are happier if they are taught how to fish rather than simply being handed the fish.

OVER TO RBI

WITH SUCH AN expansionary fiscal policy, attention will inevitably shift from Raisina Hill in New Delhi to Mint Street in Mumbai. Whether or not the economy will revive, will now depend on how the Reserve Bank of India (RBI), India Inc and the banking sector respond to the challenge.

The planned revival and recovery of the economy will require a complete coordination between the fiscal policymakers and the mandarins of monetary policy.

There cannot be an RBI prescription for reviving growth that is at variance with the finance ministry policy for it. The same is true for inflation. The perspective of the central bank and that of the finance ministry, to the extent that these are at variance, only change the nuances and the emphasis of the policy.

To close the loop, the new public expenditure policy has to be complemented by fiscal and monetary policies to provide greater liquidity to the infrastructure sector that has become a binding constraint for growth. Maybe the current team can take a leaf out of the 1991 episode. In July of 1991, when the ‘hop, skip and jump’ strategy of devaluation was implemented, the political class got cold feet after the hop—the first round of devaluation—and an effort was made to stall the second round of devaluation. It was pulled off because Manmohan Singh and RBI’s then deputy governor, C Rangarajan, colluded in making the latter go incommunicado till the second round of devaluation was carried out. Such behind-the-scenes moments will crop up even now but they will have to be handled with conviction and courage.

If the last one year is any indication, the country’s central bank is very likely to step up to the plate. In the aftermath of the Covid-induced economic mayhem, the RBI aligned its vision with that of the finance ministry to focus on growth. Throughout most of last year, the RBI ensured ample supply of liquidity to ensure, in turn, that the additional borrowing undertaken by the Union Government to fund the stimulus did not crowd out private sector demand or disrupt the bond market. This newfound bonhomie is unlikely to be revisited soon.

THE OMISSION

WHILE IT IS a fact that the Budget is not the panacea for all of the country’s economic challenges, it is also true that the finance minister missed a trick. The most critical deficit facing the Indian economy—the natural resource deficit—is conspicuous by its absence.

Besides importing two-thirds of its oil requirement, India is slated to overtake China as the world’s largest coal importer over the next decade, even though China’s coal consumption is over six times India’s. Even in the case of iron ore, India has slipped from being the third-largest iron ore exporter globally and is now at risk of becoming a net importer soon.

While it is a fact that the Budget is not the panacea for all of the country’s economic challenges, it is also true that the Finance Minister missed a trick. The most critical deficit facing the Indian economy—the natural resource deficit—is conspicuous by its absence

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It is also important to realise that this natural resource deficit is the primary source of the macroeconomic vulnerabilities the country is facing.

First, the main driver of the current account deficit on the balance of payments has been oil and gold imports. Second, a large element of India’s persistently high inflation has been driven by energy and commodity prices. Third, the fiscal deficit has bloated over the years primarily because of energy subsidies overshooting conservatively budgeted projections. Thus, there is clearly a need for an innovative structure that can appropriately channel India’s financial savings to physical assets and can use the same to mitigate the macroeconomic issues facing the country.

Like the innovative proposal in monetising public infrastructure assets, the Government could have proposed a natural resource investment trust. Such a trust would own a portfolio of natural resource assets across the world, focusing on those of critical importance to India.
A well designed natural resource investment trust would not only help address India’s natural resource deficit but also provide a channel for domestic Indian savings into physical assets, address the balance of payments challenge in a structural fashion and also provide Indians with a naturally inflation-hedged investment avenue.

To sum up, the impact of Sitharaman’s Budget will reverberate across the economy; the euphoria has already seized the markets with the Sensex scaling Mt 50K. At the same time, it has given BJP ownership of a distinct economic ideology. Till the presentation of this Budget, barring the trimmings and wrapping, BJP’s economic policy was similar to that designed by Congress in the 1990s. The highlight of this differentiation being the emphasis on the internal institutional reforms, as distinct from external liberalisation.

As the late Arun Jaitley, also the mentor of Sitharaman, once pointed out, proof of concept is key to winning public confidence—citing public services like electricity as an example, he had said that one can only charge the cost price for it after one delivers reliable and 24×7 power. What the Modi regime has done in the last six years by targeting leakages is restore primacy and faith in the public delivery system. Sitharaman’s Budget takes it to another level.

About The Author

Haseeb Drabu and Anil Padmanabhan

Haseeb Drabu is an economist and the former finance minister of Jammu and Kashmir. Anil Padmanabhan is a Delhi-based journalist who writes on the intersection of politics and economics in his weekly column ‘Capital Calculus’