Budget 2021: Nirmala Sitharaman’s turn to remake the economy

PSU Bank privatisation

By M Suresh Babu and P Vinod Kumar

Budget 2021: Finance minister Nirmala Sitharaman will present her second budget in the Lok Sabha on February 1. The entire country is pinning its hopes on the annual exercise for steps to nurse the Covid-19 ravaged Indian economy back to the pink of health.

Sitharaman has the unenviable task of taking the economy back to high single-digit growth rates after a disastrous financial year that will see a contraction in the economy. On the brighter side, recent shifts in the macroeconomic landscape have taken the economy to a striking distance of positive growth. Also, easing inflation will give her enough space to deploy the full set of weapons in the policy tool kit.

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Inoculating the nation

To begin with, the finance minister is expected to present an action taken report (ATR) on the Narendra Modi government’s response to the Covid-19 outbreak. Budget 2021 may list the steps taken to contain the deadly coronavirus and to mitigate the hardships of the people. But what will be more interesting is the government’s strategy from now on, especially when educational institutions and business establishment have started opening in a phased manner.

This is important since the activity level needs to be restored to pre Covid-19 levels for the Indian economy to emerge from the recessionary phase. Sitharaman may also address the concerns pertaining to the technical glitch in the vaccine rollout as well the growing hesitancy to take the jab, even among the frontline healthcare workers. Above all, Budget 2021 will have to find resources — not just money, but people and supporting systems including infrastructure — to inoculate the entire nation to stop another wave Covid-19 hitting the nation.

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Spending big: Budget 2021 need to raise resources

The second most important item on the Budget 2021 agenda is the spending programme of the Union government. This is all the more important due to a number of reasons. First, the Modi government’s stimulus packages have fallen far short of expectations with most of the funds coming from already committed expenditure. The additional expenditure comprised only a small share of the country’s gross domestic product (GDP).

Second, the private sector capital expenditure has hit an all-time low and so is the private final consumption. Though the slowdown in private activity level in the Indian economy preceded the Covid-19 pandemic, the virus outbreak has worsened the situation. The net effect of these two factors has led to the lack of consumption demand and income losses. Against this backdrop, the only way forward for the economy is a massive increase in public spending.

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Research has shown that when an economy is hit by a slowdown, public spending is the surefire way to lift it out of trouble. There is enough evidence from around the world to show that an elevated public spending leads to a spurt in demand in the economy, luring the private sector to pump in money. All advanced economies have rolled out massive packages to tide over the recession triggered by the Covid-19 outbreak.

Budget 2021 should take the lead in spending and the finance minister should find enough resources to back the additional expenditure. Contrary to the popular notion, public spending financed through government borrowing programmes actually ‘crowd in’ the private sector and not the other way. The low interest rates elsewhere will make the government’s borrowing plans viable.

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Deficit, inflation worries should not constrain Budget 2021

Most economists agree that deficit financing in itself is not the issue, but the quality of deficits is more important. Here the finance minister is expected to tread carefully by putting money in sectors that will offset demand contraction and income destruction. The focus of the spending should be the creation of employment. It will be prudent for the finance minister to fund projects in sectors that have the highest forward and backward linkages in the economy. Ideal candidates could be agriculture, housing, infrastructure, tourism, healthcare and education.

A call for high government spending will land us in the old growth vs inflation debate. The resource-starved government with no immediate means to raise money through tax and non-tax sources will have to settle for a large borrowing programme. This is bound to stir a hornet’s nest since inflation vigilantes are bound to up their ante. But the finance minister is left with no other option in her efforts to revive growth.

The spending programme, however, will boost the government’s revenue collection in a big way. Therefore, the finance minister could ignore this for the time being and should spend big now. She could address the deficit and inflation concerns later and a reasonable inflation is expected in an economy that grows at a fast rate. Using administrative means to keep the prices artificially depressed will prove counterproductive.

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Budget 2021 should not raise taxes

Taxation proposals of Budget 2021 will be keenly watched. Taxes will have a telling effect on demand revival in the economy and this is not the right time to burden the businesses, and individuals, both the salaried and the self-employed, with fresh taxes. Sitharaman should have her eye on the larger cause of economic growth.

The FM should consider tax concessions to the middle class by slashing payroll tax rates. This will put more money in the hands of people who are likely to spend it, boosting the aggregate demand in the economy. Finally, it is only natural to expect some sort of income supporting measures in the form of direct transfers to mitigate the miseries of the poor.

The finance minister must focus on demand revival, the time-tested approach to put economy back on track. The benefits of such measures will far outweigh the costs, as they help people who are struggling since the onset of the Covid-19 pandemic. Sitharaman has raised the hopes of people by saying that this is a once in 100 years budget. It is only natural to expect her to pull out all the stops to make the Indian economy great again.

(M Suresh Babu is professor at IIT Madras. P Vinod Kumar is Kochi-based independent economist. Views expressed are personal.)