The RBI is likely to stay dovish in the near term, but the baton of driving growth may shift from monetary policy (in 2020) to fiscal policy (in 2021).
In its first budget since the pandemic, the government set a significantly higher fiscal deficit target of 9.5% of GDP (compared to Nomura’s 6.8%) in FY21 and 6.8% in FY22 (compared to Nomura’s 5.3%) to support the economy. However, we think part of this reflects ‘kitchen sinking’ as the government has moved towards greater transparency and shifted below-the-line food subsidy to above-the-line.
The government’s decision to accelerate spending, a volte-face from its earlier strategy, reflects its view of higher multiplier effects during the unlock phase and higher growth as a pre-condition for debt sustainability, moving into fiscal activism. Its revised targets suggest government spending will be frontloaded and rise by 55-60% y-o-y in the final quarter of FY21 (Jan-Mar 2021). Even after adjusting for higher food-subsidy, revenue expenditure will be ~12.5% of GDP in FY22. With the economy now normalizing, government spending is likely to have a greater bang-for-the-buck. Second, the government has shed its concern around sovereign ratings threat, arguing that they are flawed, and that higher growth is a pre-condition for debt sustainability, and not vice versa.
The RBI is likely to view the budget as a medium-term positive. It also has its task cut out to ensure the borrowing program is smooth. However, with the return of fiscal activism, the baton of driving growth has passed from monetary policy to fiscal policy.
Sectoral highlights from the budget include increased allocation towards health (0.16% of GDP for vaccine rollout and 0.3% of GDP for centrally sponsored schemes); it has also announced a scheme for universal water supply and sanitation. There will be increased focus on infrastructure, plans to set up an asset management company to take over stressed debt from banks’ balance sheets, a cess to fund agriculture infrastructure and higher customs duty (to protect domestic firms as part of the self-reliant India strategy).
For more details on the 2021 India budget, read our insight here.
Chief Economist, India and Asia ex-Japan
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