Through the looking glass: India’s $550 billion stimulus

Last month was abuzz with many commentaries on the FY22 Budget—the document was dissected for its numbers and narrative. Many new and bold ideas such as privatisation of public sector undertakings (as the government confines itself largely to the strategic sectors), asset monetisation and its public register, a new development financial institution, and an asset reconstruction company to address non-performing assets of the banking sector have been introduced. As we settle into the many new paradigms introduced in the Budget, it is time to look at the longer-term impact of some of these new paradigms: in this article, we will focus on the enhanced fiscal space that India has created for itself with the relaxation in the fiscal deficit glide path.

Putting the numbers in place
Given the pandemic in the last financial year, governments worldwide implemented expansionary fiscal policies to help support lives and livelihoods. Many sectors and large sections of populations were cushioned from the sudden and dramatic impact of Covid-19. Increase in fiscal deficits were hence a natural corollary of the increased role that the governments had to play.

India estimated that the fiscal deficit of its central government for FY21 will be 9.5% of its Rs 196.2 trillion GDP. The central fiscal deficit is budgeted to be 6.8% of its GDP in FY22, a year in which the economy is expected to grow 15.4% in nominal terms. This number will trend down to 4.5% of GDP by FY26—the glide path has not been formally specified, so a reasonable assumption is a linear decline of ~0.6% of GDP per year over the next four years.

States in India have also been at the forefront of the response to Covid-19: they have been permitted to have a higher fiscal-deficit-to-GDP limit for FY21—this is pegged at 4.5%. It is expected that the states will come back to their fiscal deficit limit of 3% of the respective GDP by FY24. Again, a linear trend of a 50 bps annual reduction over the next three years is assumed.

To estimate what the expected amounts of the fiscal deficits can be over the next few years, we need to build an estimate of what the nominal GDP in the respective years can be. We have an estimate for FY21 and FY22 from the Budget documents. For the next four years, we assume a 12% per annum nominal growth: this can be decomposed in various combinations between real growth and inflation. We note that the inflation band of 4% +/- 2% is up for review in March; the Reserve Bank of India has indicated maintaining the band in the current range.

The above trajectories of central and state deficits are then compared to what the earlier Fiscal Responsibility and Budget Management (FRBM) Act mandated: a 3% limit for both Centre and the states. The difference between the erstwhile FRBM mandate and the current expected trajectory gives us an estimate of the increased fiscal space. The accompanying table attempts to quantify the magnitude of the change.

We estimate that India has created ~Rs 40 trillion (or ~$550 billion) of increased fiscal space over the next five years. Adding nominal numbers is not entirely appropriate from an economic perspective: however, given a low and stable inflation target, this calculation gives a reasonable estimate of the enhanced fiscal space available to both the central and the state governments cumulatively. This estimate depends both on the fiscal deficit trajectory that emerges and the nominal GDP. With these caveats, we note that the size and scale of fiscal stimulus that India has set itself up for is around 20% of its current annual GDP.

Build India better
The central government has indicated in the Budget that it has a special focus on capital investment. The world over, governments are being prodded to “crowd-in” private sector investments by leading with their own investment plans and projects. There has been a marked increase in allocation to capital expenditure this year—the large fiscal space allows governments to…