India needs more than an infrastructure-friendly budget to improve its risk profile

Minister of finance and corporate affairs Nirmala Sitharaman presented the government’s Union Budget for fiscal year 2022/23 (to end-March) before parliament on February 1.

In 2020/21, the overall fiscal deficit widened substantially to 9.2% of GDP because of pandemic restrictions constraining the economy and increased public expenditures required to support vulnerable groups.

Current estimates suggest the gap has narrowed to 6.9% of GDP in 2021/22 – a little higher than the original budget projection of 6.8%.

The deficit is expected to fall again to 6.4% of GDP in 2022/23; and with increased infrastructure spending supporting economic growth, India’s risks have eased slightly.

Even so, India’s risks remain heightened overall.

The world’s largest democracy is nestled in the fourth of Euromoney’s five-category risk ratings, at 92nd out of 174 countries, with its score down by more than 5.5 points over the past five years.

By comparison, China is 44th, in tier 3, and on a gradual upward trend.

Part of the reason is that although India's economy is back up to speed, real GDP growth is predicted to slow to between 8% and 8.5% in 2022/23 from 9.2% in 2021/22, with much of it a rebound from the pandemic.

That exceeds China’s growth rate by some margin, but India requires consistently high economic growth to foster development, and one of the reasons for its failure to improve more in Euromoney’s risk rankings has been a secular decline in growth in recent years, notes Prachi Gupta, adjunct professor at Temple University.

“Even in 2019, prior to the Covid-19 pandemic, GDP grew at its slowest in the decade, at 4.04%,” she says. "For 2022, the initial estimate of 11% growth has now been lowered to 8.5%."

Gupta goes on to note that the economy requires policy reforms to improve manufacturing output, the banking sector, and support the rural economy. 

“The budget has a strong focus on generating growth through supply-side factors, such as infrastructure development,” she says. "With a belief in trickle-down economics, there has been a lack of focus on demand-side factors, such as creating jobs, increasing rural and urban employment, and welfare programmes”.

Income inequality has been on a rise. According to a recent Oxfam report, the top 1% of Indians hold about 77% of the country's wealth 

 - Prachi Gupta

Pitabas Mohanty, professor in finance at Xavier School of Management (XLRI), highlights the fact the government has taken a few bold steps, including demonetization in 2016, which aimed at curtailing the shadow economy, and introducing a goods and services tax in 2017.

Such proactive steps often affect the economy in the short run, he says, while the unemployment rate also increased during this period.

“Country-risk scores often represent a short-run view of the country's current macro-economic fundamentals rather than long-run sustainability”, he adds.

Mohanty notes that India’s lower GDP growth rate (since 2016) and higher worldwide inflation must be borne in mind when considering the budget.

The government, he says, has taken the bold step of focusing on growth and employment generation at the cost of higher inflation in this budget, noting that probably for the first time the budget talked about the government's plans for the next 25 years.

“The government has also taken a calculated risk by deciding to finance the increased infrastructure spending with borrowing rather than raising more taxes. This will increase the interest rate in the short run, [and] may lead to crowding out and higher inflation.”

The 10-year benchmark government bond yield has increased as a result, currently to 6.7%.

Gupta says the inability of youth to find enough jobs is creating a lack of demand and dissatisfaction in the lower and middle classes, with India's unemployment rate currently at a high of 8%.

“Just to illustrate, in a recent government railway recruitment programme, about 12.5 million applicants applied for 35,000 job openings," says Gupta. "Income inequality has been on a rise. According to a recent Oxfam report, the top 1% of Indians hold about 77% of the country's wealth.

“Clearly, the growth is not trickling down.”

Gupta goes on to mention two other related factors that remain a challenge: India's low female labour force participation and incomes.

“India, with 27% female labour force participation, lags far behind China (at 64%) and even Bangladesh (58%)," he says. "An average Indian female worker who is still a farmer earns less (GNI per capita of $2,331) than her Bangladeshi counterpart (GNI per capita of $2,873), who is now a factory worker”.

Johan Krijgsman of Krijgsman & Associates says it is a good thing that the Union budget contains infrastructure spending, but not the resultant deficit, and adds that the government also seems to be dithering in the face of opposition to its privatization and agricultural reforms. 

He runs through a list of other problems holding India back, including inflation that is running higher (reaching 6% in January); the lack of multi-cultural development, which leads to groups becoming marginalised; a GDP deflator that is misleading; and the fact that India has been hesitant in supporting its Western allies’ position on Ukraine.

Overall, he believes the national government could have done much more to set India on the path of sustainable economic growth. 

“In the short term, I foresee reshoring tendencies will have an adverse impact on trade, and in the long term the coal dependency of India will be an increasing problem in a world concerned about climate change”, he says.  

There are also political risks arising out of India’s democratic status, and its regional and ethnic divisions.

Elections in India are held frequently – at central or state level – and the politicians in power are often forced to adopt populist schemes to keep the voters happy, notes Mohanty.

The month-long process of voting for the Uttar Pradesh state legislature began on February 10 is a test of popularity for Narendra Modi’s ruling Bharatiya Janata Party (BJP) in the wake of the pandemic, growing inflation, the wealth gap, farm-reform failure and unemployment.

Mohanty says the focus on short-term populist projects has moved the Indian economy away from its long-term growth target.

However on a positive note, he adds, it is a good thing that despite elections in a few states occurring now, the government decided not to announce any populist schemes in the budget.