Global growth: Recession, or at least a major slowdown, in all developed economies led by the US is an unambiguous negative. Whether it will be deep or shallow remains an open question. (The Fed’s latest forecast is for a bare 0.5% growth for the US). The bottom line is that even in the best case of a ‘soft landing’ for the global economy, India’s growth will be affected adversely. Most forecasters are forecasting a percentage-point drop in the growth rate next year to 6%. Slower growth will affect tax collections among other things. It’s something to fret about.
(Tax breaks, jobs or plan to beat China: What will Budget 2023 offer? Click to know)
Inflation: The worst of price pressures seems to be behind both the global and the domestic economy. RBI’s forecast for the first half of 2023-24 is roughly 5.2% compared to 6.25% for the second half of 2022-23. A global slowdown has taken the sheen off most commodity prices – oil is perhaps the most stable of the lot – and this is likely to continue.
Surprisingly, the impact of inflation on the budget is tricky. Why? Tax collections depend on the value of goods and services produced (nominal GDP), and faster that grows, so do taxes. This year, the budget got a helping hand from much-faster nominal GDP growth than the finance ministry had assumed, largely because of high inflation. Estimates of GDP deflator (simply the price that measures the value of all goods and services) inflation – a mix of retail and wholesale inflation – is estimated to be 8.5-9.5%, much higher than the 4% or so assumed.
The upshot is that nominal GDP growth is likely to grow by 16-17% this year compared to the 11% factored into the budget. This would have pulled the growth rate of taxes up. 2023-24 will see this reverse as both growth and inflation – possibly just 4.5% for the deflator – tamp nominal growth down.
That said, depending on inflation to manage the ‘fiscal’ has its problems. Inflation also hurts affordability, pushes interest rates up and, hence, the cost of the government’s borrowing. Falling interest rates could reverse that. A split verdict, then.
Tax collection efficiency: Tax collections could not have risen so sharply on the back of a rise in nominal GDP alone. Alongside the nominal GDP momentum, every rupee increase in GDP eked more in taxes than was assumed. Strong goods and services tax (GST) collections and direct tax collections (demonetisation could finally be paying off!) contributed to this efficiency. This ‘tax buoyancy’ will remain a support going forward and should it rise, help the finance minister further.
Interest rates: With inflation coming off and a slowdown approaching, it might be safe for the finance minister to assume that interest rates could peak soon and then fall slowly over the course of 2023. That’s good news for her since it means that the government can borrow at lower rates from the market. Lower interest rates could also help demand and help fight the growth slowdown.
However, while inflation might be moderating, it is far from dead. An average of 5%-plus inflation likely in 2023-24 for India is certainly better than 2022, but considerably above RBI’s medium-term target of 4%. This means that RBI will keep, as it put it in its recent monetary policy, an ‘Arjuna’s eye’ on inflation. Thus, RBI (or any central bank) is unlikely to either cut rates soon or start pumping money in. Fiscal authorities could get far less support from the monetary policy than in more ‘normal’ times when the risk of slowdown moved in tandem with a sharp fall in inflation that helped central banks prime the economy aggressively.
Debt burden: This brings us to the nub of our problem. GoI’s debt at 84% of GDP (IMF projections for 2022 end) for the Centre and states together is way too high for comfort. Peers like Indonesia have a ratio of 40%. Some of the escalation in the ratio came because of the unavoidable fiscal burden of the pandemic.
However, instead of kicking the can down the road, a serious effort has to be made to reduce this. High debt levels affect virtually all macroeconomic variables directly or indirectly. Most critically, it puts the government on a hamster wheel of borrowing more to service the interest charges that come with high debt and raises the prospect of large tax increases or desperate expenditure cuts in the future to avoid a crisis (a sovereign debt downgrade by rating agencies, for instance).
Macro 101 tells us that debt can reduce in two ways:
Increasing the excess of GDP growth rate over the interest rate. That’s unlikely to work in our favour next year.
By reducing the primary deficit (the fiscal deficit net of interest payments). This brings us back to the familiar dilemma of which expenditures to prune and how much to reduce the primary fiscal gap.
Covid came with its fiscal challenges. GoI handled it extremely well by resisting the temptation to overstimulate the economy. Alas, the post-Covid years starting 2023-24 come with another set of challenges and the need for hard, often painful decisions.