Union Budget hopes for private sector capex revival: Will it fructify?


Union Budget 2022 reflects higher-than-expected conservatism. The emphasis is on attempts to crowd-in private capital expenditure along with a dose of import substitution. However, hardening G-sec yields can also cause a crowding-out effect. The contraction in revenue spending amid peaked out global trade would imply that the problems of lack of consumption demand and private capex will need to be sorted out endogenously. The fruition of the Budget gambit is conditional.

Fiscal conservatism galore, revenue spending on contraction mode
The aggregate fiscal construct of FY23 Union Budget reflects higher-than-expected conservatism with a very modest expenditure expansion of 4.6% at Rs 39.45 trillion. The emphasis continues to be on attempts to crowd-in private capital expenditure by continued acceleration of government capital outlay. Capital outlay for FY23 is budgeted at Rs 7.5 trillion, which is a growth of 24.6% YoY. Revenue expenditure, which constituted 84% of total expenditure in FY22RE, is slated to decline to 81% in FY23BE at Rs 31.95 trillion, which is flat on a YoY basis (0.9% YoY). Reflecting an even more conservative view, the total revenue spending net of interest payments at Rs 22.56tn in FY23BE is a decline of 4.1% YoY.

The fiscal support to the rural sector is slackening with rural spending (excluding-food subsidy) budgeted at Rs 3.6 trillion, up 2% YoY. But including food subsidy it is down 11% YoY. Thus, it is fair to presume that the heightened support to farm sectors by way of aggressive government procurement of cereals, and elevated cash flow at MSP at Rs 2.5 trillion in FY22E will recede going forward. Excessive government buffers at over 83mn tons and peak production will likely contribute toward declining in terms of trade for the farm sector.

Effective capital expenditure growth lower at 14%
The budgeted capex allocation of Rs 7.5tn includes Rs 1tn of interest-free loans to states, which will be over and above their permissible limit of 4% for fiscal deficit in FY23. However, given the elevated public debt/GDP for states (30% of SGDP) it is unlikely to be fully utilised and hence it is an aggressive assumption to make. Further, adjusting for non-capex items such as i) Air India allocations, ii) equity infusion into NABARD and BSNL, and iii) NREGA as an allocation for capital asset creation, we still arrive at an upper limit for effective capex growth of 14% YoY instead of the headline 24.6%.

Elevated fiscal deficit despite cut back in revenue spending
Fiscal deficit FY23BE at Rs 16.6tn is merely an expansion of 4.5% over FY22RE; as a ratio of GDP it is projected to decline to 6.4% from 6.9% in FY22. But more importantly, reflecting the cutback in revenue spending, the revenue deficit at Rs 9.9tn is budgeted to decline by 9% YoY or to 3.8% of GDP from 4.7% in FY22BE. Also, the effective revenue deficit (net of revenue spending in the nature of capital outlay) is budgeted to decline by a huge 20% or to 2.6% of GDP in FY23BE from 3.7% in FY22RE.

Contribution of fiscal in GDP growth to diminish
Nominal GDP growth is assumed at Rs 258tn or 11.1% YoY (real growth~7%), which is a marked deceleration from FY22E at 17.2% (real at 9.2%). Hence, with both net tax revenue growth at 9.6% and total spending growth of 4.6% lower than nominal GDP growth, the role of fiscal support to the overall GDP trajectory in FY23 is expected to diminish.

Emphasis on capex and manufacturing sector revival, including through protectionism
Sector specific announcements can be broadly clubbed under three buckets: a) domicile bias reflected in 68% reservation for domestic players in defence spending, custom duty rationalisation & removal of exemptions to protect domestic manufacturing, and encouraging import substitution, b) enhance allocation for infrastructure, roads, railways, PM Awas Yojna, and c) reformative measures like giving infrastructure status to data centres, extension of PLI scheme for solar power and battery swapping policy.

Rising market borrowings could harden G-sec yields more than expected
The budgeted fiscal deficit of Rs 16.6tn for FY23BE translates into a larger market borrowing of Rs 11.58tn vs Rs 8.7tn in FY22RE. The net market borrowing of Rs 11.18tn for FY23BE thus stands significantly higher than Rs 7.76tn in FY22BE.

A major reason for higher market borrowing in FY23 despite a lower fiscal deficit/GDP ratio than FY22RE is the steeply lower assumption for small savings collections (Rs 5.91 in FY22RE vs Rs 4.25tn in FY23BE). Also, there is a step up in cash withdrawal for FY22RE (Rs 1.74tn vs. budgeted 713bn) which implies negligible amount for FY23BE (Rs 0.75bn). Assuming the borrowings for states to remain similar to last year’s level (~Rs 10tn) the combined gross market borrowing by the GoI and states can be Rs 25tn.

In view of the rising US treasury yield, lower external capital flows, widening current account deficits, and rising credit-deposit ratio of banks, we now believe that India 10-year benchmark can rise beyond our earlier projection of 7.5% to 7.75% in the next 12 months (currently at 6.82%, post-pandemic low at 5.8%).

The fruition of the Budget gambit is conditional
Overall, the Budget gambit hinges crucially on hopes of improved traction in India’s private sector, quick revival in private capex, pick up in employment, wage growth, and leveraging potential of the banking sector. Private sector capex is attempted to be encouraged with a considerable element of protectionism from imported goods, thereby deepening the import substitution theme. Contraction in real revenue deficit of the GoI will create a negative fiscal multiplier effect over the next four quarters that will need to be counterbalanced by a very strong revival in household spending. The supply-side positive multiplier effect from higher capital outlay comes with a lag of 6-12 quarters starting from the initiation of investment projects.

The risk to the gambit can arise from continued slack in consumption demand. The effectiveness of protectionist strategy on private capex will critically depend on what it does to productivity and costs. These measures assume that revival in private capex requires profitability support, while the bigger problem is on the demand side which reflects in low capacity utilisation, high unemployment and lack of household income generation. Large corporates have gained considerable market share and oligopolistic power amid the pandemic and previous shocks at the cost of small businesses and unorganized players. The abnormal upsurge in profit and cash flow for large companies has motivated balance sheet deleveraging instead of investment spending.



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