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Ragini: Welcome to the EY podcast series on the Union Budget 2023. In this session, we are going to discuss the key messages from the Economic Survey and the FY24 Union Budget. From a macroeconomic perspective, Finance Minister Nirmala Sitharaman indicated in her budget speech that in spite of the massive global slowdown caused by the pandemic, followed by the geopolitical disruption, India would remain the fastest growing economy among major economies of the world.

In this context, it is important to discuss the extent to which the Union Budget has supported growth. I am Ragini Trehan, and I am very pleased to have with me Dr. D.K. Srivastava, Chief Policy Advisor, EY India. He is a noted economist and a well-known academician with more than 50 years of experience in public finance and fiscal policy. Dr. Srivastava has held many prominent positions.

He was Economic Advisor to the 10th Finance Commission, Principle Consult to the 11th Finance Commission, member of the 12th Finance Commission and a member of the Advisory Council to the 15th Finance Commission. Dr. Srivastava has also been associated with a number of committees set up by the central and state governments as well as by the RBI. Thank you for sparing time today, Dr Srivastava.

Srivastava: Thank you for having me, Ragini.

Ragini: Let me start with India's growth outlook. The Economic Survey had pegged the real growth at 6.5% for the next fiscal. But the budget papers used a nominal growth assumption of 10.5% for calculations. We would like to hear your thoughts on this.

Srivastava: Well, the Budget does not state the assumptions regarding the GDP growth, but we can derive the underlying real growth by using the available information regarding inflation. So, nominal growth consists of two components: real GDP growth and deflator-based inflation. The RBI had indicated that the CPI and the WPI are likely to fall next year, and it may take both of these may be close to 5%. This is also close to the professional forecast survey that RBI brings out. 

If we allow for an inflation component of 5%, the implied real GDP growth in the budget is 5.2%, which is well below what was indicated by the Economic Survey at 6.5%. The paradox is that while the budget indicates that it is going to stimulate growth and that India is a global growth leader in FY23 and in the future also, the growth rate is reduced from last year (FY23), which is 7%.  So, from 7% to 5%, there is a reduction of 1.8 percentage points in the underlying growth. This has an implication for most of the budget numbers because they actually indicate the tax revenue buoyancy, and the revenue receipts are estimated accordingly. So, if those are underestimated, then all other expenditure demands are also underestimated.

Incidentally, the FY23 nominal growth assumption was 11.1%, but the realization came out to be 15.4%. So, only one year prior to FY24, the government showed that it had underestimated the nominal GDP growth in FY23. It is quite possible that the nominal growth is being underestimated at 10.5%, although the margin may not be as large as last year.

Ragini: Those are very valid points, Dr. Srivastava. This brings me to the next question. The FM has taken a target of fiscal deficit of 5.9% of GDP for the next year but expects the deficit to come below 4.5% in 2025-26. If that is the glide path, how long is it going to take to bring the fiscal deficit below 3%, which was the original target of the FRBM Act (Fiscal Responsibility and Budget Management Act)?

Srivastava: This year, the adjustment is from 6.4% to 5.9%. That is half a percentage point. And if we continue with half a percentage point, then from 5.9% to go all the way to 3% would require six years, or at least five years. But the FM had indicated that the next two years would be used to bring the fiscal deficit down to 4.5%.

This means the average reduction in the FY25 and FY26 would be 0.7 percentage points. After reaching 4.5%, if we reduce by 0.5 percentage points, we will still need three more years. So, I would say that it would take two plus three, which is five years, to reach a level of 3% of GDP.

But of course, the FM has not indicated whether they intend to reach that level of 3% or whether, as recommended by the 15th Finance Commission, they would set up a high-powered committee to re-examine the FRBM target, which had given this rate target of 3% of GDP. We will have to see how this goes about, but right now we are significantly away from the FRBM target. 

Incidentally, this has a significant implication for interest rates because when the government borrows relatively large amounts from the available investable resources, there is less available for the private sector and the non-government public sector. And that is why there is pressure on the interest rate.

Ragini: The Economic Survey has also pointed out that the government has done the heavy lifting in terms of capex in the past few years and the private sector investments now need to start playing a bigger role. But with capacity utilization in the manufacturing sector having fallen to 72.4% in the fourth quarter of FY23, how realistic is the expectation of a much higher private sector investment this year?

Srivastava: The government’s own investment expenditure is meant to crowd in private investment expenditure. But the relative importance of government capital expenditure, even if we combine central and state capex, is only 5% of the overall gross fixed capital formation. So, the relative role of private investment expenditure is much larger than that of government capital expenditure. The crowding in effect would depend on the demand that gets created both through investment stimulus and through any upward lift of consumption expenditure.

Both are important components, but even more important is the determination of private investment expenditure as a function of interest rate. Right now, because of high inflation rates and because of the US Fed increasing the Fed rate, there is pressure for the nominal interest rates or the policy rate in India to be uplifted. And as long as we have a relatively high interest rate, it will be difficult to bring in additional private investment.

Unless demand increases and cost of investment goes down, capacity utilization may not pick up. So, I would say that new investments would start once capacity utilization crosses the threshold of 75%. We were close to that a little earlier and I think we might reach there provided a situation is created when the interest rate in the system starts to go down and private investment expenditure would then be able to pick up.

Ragini: Those are very pertinent insights, Dr. Srivastava. My last question to you in this regard is that the budget anticipates much lower subsidy expenditures this year. Where do you think are cuts possible?

Srivastava: The reduction in subsidy expenditure has cut across both food subsidies and fertilizer subsidies and other petroleum price-linked subsidies. These reduction amounts are largely sensitive to global crude prices because once the subsidy amount is linked to the global crude prices, determining the magnitude of subsidy would be sensitive to assumptions made regarding the movement and extent of reduction in global crude prices.

The budget states that directionally they expect the crude prices to come down, but they do not indicate by what margin. In the current year, the average price over the period from April to December was US$97.30 per barrel and currently it is, let us say, US$83.50 or so. If the marginal reduction is not very substantial, the possibility of reducing the magnitude of subsidies in India by a large margin would not be there. 

So, it is quite possible that the government has shown a significant reduction in major subsidies based on the assumption of a significant reduction in crude prices. But that may not yet happen because global demand has once again started to increase, particularly because after opening up, the Chinese economy has started to show higher growth rates and higher demand.

We will have to carefully watch the movement of global crude prices and see if there is a significant reduction.

Ragini: Thank you so much for your views, Dr. Srivastava.

Srivastava: Thank you very much.

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