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India's Union Budget 2021: Why this budget is like no other

This year’s union budget, presented in the backdrop of unprecedented circumstances because of the pandemic, is being billed as a watershed.

Failure is not an option for India’s Finance Minister Nirmala Sitharaman in what’s being billed as a ‘once in a 100-year budget’. But expectations can be at odds with the grim reality because of the limited options a Covid-19 ravaged exchequer can offer in the world’s sixth-largest economy.

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India's Union Budget 2021: Rosy ring to growth tale

This year’s union budget, presented in the backdrop of unprecedented circumstances because of the Covid-19 pandemic, is being billed as a watershed. Finance Minister (FM) Nirmala Sitharaman herself stoked expectations when she promised a summit, hosted by the lobby group Confederation of Indian Industry (CII), a ‘once in 100-year budget’. It may well be that this moniker may come to haunt the FM when constituents, on February 1, weigh their (always exaggerated) expectations against the limited options a Covid-ravaged exchequer can offer.

The FM is right though in describing this as a once-in-a-century moment. The pandemic, which originated in central China’s Wuhan brought the world to its knees. Lockdowns to stem the spread of the virus, as in the case of the United Kingdom (UK) and the United States (US), met with little success.

Worse, the consequence was devastating as economic activity ground to a standstill. According to the International Monetary Fund (IMF), the world economy will contract by 4.4 per cent in 2020; India is projected to contract by a record 8 per cent.

Effectively, the pandemic will shrink most economies to the levels they had attained in 2018. It is like turning the income clock three years back.

The last time the world was hit by a pandemic of this proportion was the Spanish Flu of 1918, which infected a third of the world’s population. As a result, there is no playbook on offer. Worse, with private enterprise severely hobbled and some struggling to survive, especially in the contact economy such as civil aviation and hospitality, the primacy of government and central banks has been restored. So, the top item on the agenda of every policy planner world over continues to be restoring the Covid-19-torn economy. Also, the reason all eyes are on this year’s budget.

India’s response

In India, we witnessed a rare duet with the union government and the (normally adversarial) Reserve Bank of India (RBI), the country’s central bank, working in tandem. The strategy was simple: survive, revive and thrive. Yet, extremely difficult to execute as the threat of being overwhelmed by the Covid-19 pandemic in a country with inadequate health infrastructure, high population density and poor hygiene standards were for real.

Yet, somehow India managed to dodge the bullet—by avoiding the worst forecasts— with the initial focus on protecting lives. Subsequently, this was recalibrated to restoring livelihoods. As a result, most of the last one year has gone by in first surviving—protecting lives—and then reviving—largely through three stimulus packages from the union government and the RBI’s continuous greasing of the financial wheels by ensuring more than adequate money supply.

The outcome is more than apparent. The advance estimates of gross domestic product (GDP) or national income for 2020-21 released by the Central Statistical Office (CSO) project a contraction of 7.5 per cent for 2020-21; much better than what was anticipated when the economy contracted by a staggering 23.9 per cent at the end of the first quarter ended June 2020. Clearly, the last six months has seen the economy respond to the economic stimuli and revive.

However, this seemingly respectable overall growth number masks the economic scarring caused by the Covid-19 pandemic. It reflects the rebound of the formal economy. What it doesn’t reveal is that those at the bottom of the pyramid who mostly depend on the informal economy are worse off. Not only did they lose their jobs, they suffered a severe erosion of their savings, and their relative spending power vis-à-vis the well-off diminished further—providing fresh impetus to an existing trend of growing inequality.

More worrying is that the number of the new poor has surged with many dropping out of the ranks of the neo-middle class. Exactly why several economists dub this the K-shaped recovery—while the well-off managed to ride out the pandemic, the others faced declining economic fortunes.

To be sure, the Economic Survey released on January 29 predicted a V-shaped recovery for the next fiscal. It maintained that it would take at least two years to achieve pre-Covid-19 pandemic levels.

The FM, in this sense, has her task cut out. She has to dwell as much on restoring the growth momentum as in ensuring the quality of growth.

The new deal

This piquant circumstance sets the backdrop for this year’s Union budget. It is easy to see that the country is transitioning to the thrive phase of the three-pronged strategy worked out by the government last year. So far, this growth revival is excluding large tracts of the population. And as we have seen with the recent violent farmer protests, it won’t take much for the disaffected to take to the streets.

Yet every crisis is also an opportunity. It serves up the moment for India to roll out its version of ‘A New Deal’ that was unveiled by US president Franklin D Roosevelt in the aftermath of the Great Depression of 1929. The six-year programme beginning in 1933 dramatically transformed the US, pitchforking it to the top of the country tables.

While India may not harbour the very same lofty ambitions, it certainly faces the structural challenges similar to what confronted the US. At the least, a New Deal can bring the economy back on target to achieve the $5 trillion benchmark and also etch the contours of an entirely new framework for the next stage of growth—one which makes it easier to leverage the democratic power underlying digital technology to chart inclusive growth.

The good news is that the Sitharaman has some things going for her.

The economic rebound has surprised on the upside. The IMF in its latest prognosis projects the Indian economy to grow at 11.5 per cent in 2021; back home some analysts believe it could be higher at around 13-14 per cent.

If we go by the optimistic estimates, then together with an inflation rate of about 5 per cent, this would return a nominal growth rate of of 18-19 per cent. Yes, it partially reflects the base-effect of last year’s record contraction. Yet, such a spectacular number will no doubt contribute to the feeling of feel-good or at the least dampen the sentiments of cynics. It also means a recovery in tax buoyancy, something that will replenish the otherwise depleted exchequer and consequently help the government reduce its borrowings.

Similarly, the big spending (spread out over three stimulus packages) undertaken by the union government is reviving economic activity and holding up consumption levels in the economy. Indeed, this correlation is great news as it shows the spending interventions are kickstarting the economy. With the vaccination being rolled out and the fear economy, which had devastated the contact economy, retreating, the economy is primed to absorb another round of big spending. It is no rocket science that infrastructure spending on small-ticket projects, like roads with short gestation periods, will generate the maximum multiplier impact.

But there is a big cause of worry for the FM. The economic growth since the turn of the Millennium has not been employment friendly. If anything, it has been a case of jobless growth, and every government has been subjected to severe political scrutiny for this. So even a nominal growth rate of 18-19 per cent will not necessarily result in the creation of jobs. To top it there have been noticeable dropouts from the workforce as employees got laid off over the last year.

India desperately needs to create jobs. Providing employment means creating income in the hands of the people which, in turn, contributes to consumption. It is the worst-kept truth that since 2008 new investments have all but dried up. As a result, the Indian economy has been running on the single-engine of consumption. However, with most of the less well-off on the fringes of the consumer economy—how many cars, refrigerators, etc can the upper classes buy—the consumer economy has been sputtering. As a result, it is imperative that the growth revival is inclusive in nature.

Small is big

There is one sector which can deliver the desired political results for the FM: the micro, small and medium Enterprises (MSMEs). These unsung heroes, located mostly in the informal sector, have rarely been in the limelight and even less likely to make it to the front pages of the pink papers. Worse, banks have always treated the credit needs of these self-employed with scepticism, forcing them to often tap usurious sources to raise working capital.

And this despite:

• MSMEs contributing about 30 per cent of the country’s gross domestic product (GDP)

• Contributing about 40 per cent of exports

• Employing about 110 million, approximately a quarter of the country’s workforce

• Being a key cog in the supply chain

Further, MSME units have an amazing appetite for risk, are resilient and get by with very little. In short, the MSMEs have the potential to be a force multiplier. So, by making them a centrepiece of the union budget, the FM can kill two birds with one stone: revive growth quickly, distribute its gains evenly and most importantly generate jobs. A case of good economics and good politics.

At one level, the government, working in tandem with the RBI, can tilt the scales by addressing the biggest challenge faced by the MSME sector: access to credit. An evolving constellation of circumstances in the digital economy may have just provided the FM with an opportunity to turn this year’s budget into a watershed moment for the MSMEs.

The expansion of the digital economy got a big push during the pandemic with social distancing becoming mandatory. It has spurred the pivoting of the country towards a formal economy. At the same time, what this has also done is to create a digital trail for most economic entities. As a result, some entirely new set of metrics are being generated. Fintechs, with their ability to mine data, are now tapping these metrics to create an alternative lending platform. This model of embedded lending is poised to get scale with the imminent launch of OCEN, or Open Credit Enablement Network, being shepherded by Nandan Nilekani, the former chairman of Aadhaar, verifiable 12-digit identification number issued by the Unique Identification Authority of India (UIDAI) to a resident of India.

In short, the ecosystem is rapidly evolving. All it needs is a big nudge from the FM.

Every budget the middle class eagerly awaits deliverance from the finance minister. More often than not their cup has remained half-empty. Could this be the turning point? After a long time, the middle class—by their sheer numbers (upwards of 200m), critical electoral constituency and their potential spending power—is figuring in the budget math. Given this circumstance, the FM is likely to provide more purchasing power on the one hand and incentivise short-term spending on the other—like she did last year while loosening the tax rules on claims of Leave Travel Concession (LTC). The effort will drum up the ‘feel good’ factor with the limited giveaways at her disposal. This could take many forms and shapes. One example could be to raise the income tax exemption limit from the current Rs250,000. Effectively this limit is, taking advantage of existing Income Tax law provisions, Rs500,000 for most people. The FM could formalise this but make it conditional on spending the additional income received.

At the same time, it is a fact that the booming stock markets have driven up valuations of mutual fund investments. The liquidity driving the stock markets are unlikely to be wound down either abruptly or immediately. But that doesn’t mean it won’t ever. So, the middle class can see their portfolios grow till the liquidity party lasts. But as wealth managers caution, it is not the time to get greedy and go big on equity—maintain the current distribution between equity and debt and in fact err on the side of debt.

For non-resident Indians (NRIs), most of whom are an extension of the middle class, the surging stock markets—which crossed Mount 52,000 last week—are a similar source of succour. Another big play from their point of view is real estate. Very visibly the space for affordable housing is growing—not for investment purpose, but more from the point of view of consumption. With interest rates plumbing near record lows, it may well be a good time to fulfil the dream of acquiring a home on a loan.

Though there is one policy the FM can orchestrate, it does not necessarily flow from the budget. After years India’s ecosystem is now friendly to entrepreneurs. Ideologically the Bharatiya Janata Party-led National Democratic Alliance (NDA), with its mantra of ‘pro-poor and pro-business’, has made entrepreneurial ambitions legit. Among millennials, it is now an aspirational profession. However, the legacy of seven decades, when doing business was considered evil, still persists. The next phase of ease of doing business has to make it not less difficult for wannabe entrepreneurs; instead, the focus has to make it super easy (like it is to set up a business in the UAE). If the FM delivers this, it may well be the biggest takeaway for the middle class—who would rather fish for themselves than being fed by the government.

A new social contract

The pandemic is a grim reminder that unmanaged health risks in a globalised world have the potential to cause greater devastation than even the economic meltdown the world witnessed in 2008. What started out as a health crisis last year rapidly snowballed into an unprecedented and full-blown global economic crisis.

In the Indian context, it exposed the vulnerability of the country operating with a sell past the date health infrastructure. The FM presumably will acknowledge this health risk and could well launch a massive spending plan to ramp up the health infrastructure. At present India’s spending on health is a little over one per cent of GDP—this is grossly inadequate.

Similarly, the pandemic has brutally exposed the frailness of the existing public policy framework, especially in its inability to underwrite the welfare of those at the bottom of the pyramid. So the FM may hit reset and refocus public policy to ensure the quality of living.

Politically, it will be great optics if the FM is able to signal the government’s intent to ink a new social contract to protect both lives and livelihoods at the bottom of the pyramid. The plumbing undertaken in the last six years has minimised leakages in social welfare spending. The acceleration in Direct Benefits Transfer (DBT) over the last one year due to mandatory social distancing has further ensured better targeting. The government estimates the cumulative savings from DBT at the end of March 2020 was Rs 1.78 trillion—enough to fund the first stimulus package the government unveiled last year. This number would have only grown in the last year when social welfare transfers peaked in the aftermath of the pandemic.

In the final analysis, it is clear that the pandemic has caused an unprecedented crisis. It is akin to the perception of whether the cup is half-empty or half-full. It’s an opportunity for the NDA to launch its ‘New India’ campaign. For her part, by dialling up expectations ahead of her third essay, FM Sitharaman has thrown down the gauntlet.

She is right, failure is not an option.

Anil Padmanabhan is a Delhi-based journalist who writes on the intersection of politics and economics. His weekly column Capital Calculus is published on Substack