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Budget 2021 takes a historic gamble on growth revival. Hope now on RBI to do the job

An underestimated growth projection could give Modi govt more spending room, while initiatives to improve NPA recovery could prove crucial for India's financial sector.

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The Narendra Modi government’s Budget for 2021-22 has unveiled a spending jugular to revive growth. There has been a massive jump in investment in infrastructure. Despite a deceleration in the Gross Domestic Product growth in FY21, the fundamentals of the Indian economy remain strong and GDP growth is expected to rebound from the first quarter of FY22.

Three points need to be strongly reemphasised. First, the Union Budget estimate of 14.4 per cent nominal GDP growth rate. Assuming a conservative 10 per cent real GDP growth rate, this translates into an inflation of around 4.4 per cent. We believe, if growth comes back riding on the spending prowess, the nominal GDP projection may be an underestimate. This may thus provide even some more additional spending room for the Modi government.

Second, even as the market is apprehensive of financing of the large fiscal deficit estimates, the markets have clearly missed the finer details. The government has carefully removed the overt reliance of the Food Corporation of India (FCI) on the National Small Savings Fund (NSSF), thus making Budget numbers transparent. In fact, the stand-alone fiscal deficit of the Centre that when includes the extra budgetary borrowings in FY22 are nearly identical at 6.8 per cent, which has always diverged in the past. This only implies that fiscal deficit numbers reflect the true extent of indebtedness in Budget 2021. The net borrowings of the Centre and states are budgeted at Rs 18.1 lakh crore, which is marginally higher than Rs 17.8 lakh crore in FY21 Budget. We must understand that out of estimated 9.5 per cent of fiscal deficit for FY21, 1.6 per cent of GDP is solely because of the jump in food subsidy bill, which underlines the humanitarian aspect of India’s pandemic response.

Meanwhile, the Centre’s cash balance with the Reserve Bank of India (RBI) has increased significantly to around Rs 3.4 lakh crore, of which we believe at least 85-90 per cent belongs to the states. This clearly indicates that states are preserving cash because they are uncertain about spending in the current pandemic.

Third, the massive focus on health infrastructure. Taking a holistic approach to health, Budget 2021 focusses on strengthening three areas: preventive, curative, and wellbeing. The Budget outlay for health and wellbeing at Rs 2.24 lakh crore is 137 per cent more than the Budget estimate of FY21. This expenditure is 1.8 per cent of GDP, now closer to South Asian countries like Malaysia. Interestingly, given the information asymmetries that make unregulated private enterprise suboptimal in healthcare, a sectoral regulator that undertakes regulation and supervision of the healthcare sector is sine qua non for India. This is especially pertinent because regulation has grown in importance as a key lever for governments to affect the quantity, quality, safety and distribution of services in health systems.

Also read: Winners & losers: Who got what in Nirmala Sitharaman’s Budget 2021

Fixing NPA, changing insurance outlook

There are several other initiatives in Budget 2021 that are important for the financial sector. One such is the proposal to set up an asset reconstruction company (ARC) and an asset management company (AMC) to hive off non-performing assets (NPAs) in the banking sector into a separate entity. With banks now holding a significant amount of provisions for the stressed assets, a wholesale transfer of the bad assets to the proposed entities is just a technical issue and the process of recovery and resolution could be carried out in a much better way. Removing troubled assets from the balance sheet would have a positive impact on the view of credit rating agencies, investors and potential investors, lenders, depositors, and borrowers. This approach also allows for consolidation of debt and bringing in specialist skills for turnaround. The net effect of this approach would be to build an open architecture and a vibrant market for stressed assets.

The desire to introduce a Development Financial Institution (DFI) is also a laudable step. It has been decided to provide Rs 20,000 crore to capitalise the new DFI, with an aim to have a lending portfolio of Rs 5 lakh crore in three years.

The government also proposes to take up the privatisation of two public sector banks (PSBs) and one general insurance company in FY22. This will ensure that markets stay in a buoyant mode, which will act as a double-edged sword for the government and banks in terms of market mobilisation of taxes on capital gains and funds mobilisation by the PSBs.

The Modi government has proposed to increase the foreign direct investment (FDI) limit in insurance companies to 74 per cent from the current 49 per cent, with Indian management control. The Covid-19 pandemic has shown that further penetration of insurance in India is needed with a significant change in behavioural habits of individuals towards more insurance products and for that capital infusion is required. The move is the need of the hour and expected to aid the sector in increasing insurance penetration in the country, which is at 3.76 per cent (life 2.82 per cent, non-life 0.94 per cent; 2019), compared to the world average of 7.23 per cent (life 3.35 per cent and non-life 3.88 per cent).

Also read: Modi govt’s plan for a Development Finance Institution will reduce infra burden on banks

A humanist approach

Budget 2021 is also humanist in its approach. To this end, senior citizens aged 75 years and above with only pension and interest income will be exempted from filing their income tax returns. Although, this will necessitate building up additional infrastructure for the banks, specifically the PSBs. Additionally, to further facilitate credit flow under the scheme of Stand-Up India for the Scheduled Castes (SCs), Scheduled Tribes (STs), and women, the Budget has proposed to reduce the margin money requirement from 25 per cent to 15 per cent, and to also include loans for activities allied to agriculture.

Overall, Budget 2021 has taken a historic gamble to revive growth. With the RBI and the Modi government following on a coordinated approach to resurrect growth, the market now expects the RBI to take up the mantle as it has been doing so assiduously since 2019.

The author is Group Chief Economic Advisor, State Bank of India. Views are personal.

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  1. Indians have been waiting for ache din since 2014. Minimum government, maximum governance. 5 trillion economy. A tomorrow that never arrives. You can count on Indians to forget yesterday’s dream and move to the next.

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