Budget 2023: Fiscal house has to be in order, inflation is biggest macro threat, says India Ratings’ Devendra Pant

Devendra Pant, Chief Economist and Head - Public Finance, India Ratings & Research

India should aim to keep the fiscal house in order as a part of the wider efforts by authorities to ensure that the economy is buffered from the impact of price rises, according to Devendra Pant, Chief Economist and Head - Public Finance at India Ratings & Research, a Fitch Group company.

“The biggest risk which generally people brush under the carpet is inflation. If you don’t take care of inflation at the right time, it is going to hit economies very badly,” Pant told Moneycontrol in an interview.

“The other side of the story is that the fiscal house has to be in order. Just like you can’t hike repo endlessly, because that will kill demand, the fiscal deficit also has to correct because fiscal policy’s impact on inflation is instantaneous, whereas monetary policy’s impact is lagged.”

Finance Minister Nirmala Sitharaman is due to present the Union Budget for 2023-24 on February 1 amid expectations she will keep up capital expenditure, while lowering the budget gap which has ballooned since the pandemic hit.

The economy is projected to grow at 7 percent in the current financial year, with inflation estimated at 6.7 percent. The Reserve Bank of India (RBI) has raised interest rates sharply since early May in a bid to curb red-hot inflation which has stayed above its medium-term target of 4 percent for over two years. The government had also taken a slew of measures to cool prices.

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RBI has said that it is not going to go for the kill at one go, Pant points out. Next year, inflation may come down to 5-5.5 percent and that’s how it will progress to 4 percent, which may be in FY25, he added.

The economist expects another policy rate hike of 25 basis points (bps) in February 2023, after the Budget.

Meanwhile, the Centre’s fiscal deficit target of 6.4 percent for this financial year looks achievable but the journey to 4.5 percent deficit target for FY26 “will be tough,” Devendra Pant said.

The government’s task will also be complicated if the global economy continues to be in the current mess, he added.

Ultimately, meeting the fiscal deficit will be a function of how fast India’s economy grows.

“To me the journey to sustained fast growth starts from sustained low level of inflation,” the economist said.

Growth prospects

The potential growth rate of the Indian economy, which used to be around 8-odd percent earlier, has slowly come down to between 6-6.5 percent, Devendra Pant said.

A slowing globe will impact outbound shipments and monetary tightening will hurt consumption. On top of that, there is the demand shock, both globally and in part, domestically.

“Domestic is very confusing. You look at the upper end of the consumption level, there is no issue. Lower end, there is pressure,” he said.

Meanwhile, just like domestic demand, investment is also a sectoral story.

“You continue to see infrastructure, road, power, especially renewables, those investments grow. But it is unlikely you will see investment in FMCG. Or at best brownfield, not greenfield.”

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As such, India’s growth in the next financial year will most likely come to the potential growth rate.

For now, the reducing gap between net household financial savings and government funding requirements is also worrying.

“If this continues to go down, rate cuts will not have a commensurate effect on government bond yields. If this pie continues to shrink, and funding requirement continues to be high, chances of interest rates coming down are very low."

In the Budget, the government must also undertake further reforms on improving the tax collection system, plugging leakages and bringing more people into the tax net. It should also look at getting rid of some untargeted subsidies, the economist said.