India’s first union budget after a once-in-a-century global pandemic – and only the fourth to follow a contraction in its independent history – voted for an infrastructureled, counter-cyclical fiscal stimulus to mend the broken economy. The idea clearly, was to push the growth multiplier rather than stoke consumption steroidally, even if that meant stretching the glide path of fiscal deficit. A sharp rise in fiscal deficit surprised us the most in Union Budget 2021-22. In the current milieu of weak revenues, the government decided to normalize spending to support growth, while making budgetary transactions transparent. This means fiscal deficit at 9.5% in fiscal 2021, 6.8% in fiscal 2022 and a very gradual normalization to 4.5% of gross domestic product (GDP) by fiscal 2026, a level higher than what the conventional wisdom informed us so far. The aspirational target of fiscal deficit at 3% of GDP, which has only been met once in past 25 years, needed a rethink anyway.

We find that the budget pulls up expenditure to its trend value in fiscal 2020. Even better, the normalization of expenditure relies more on capex than revenue expenditure. The story is completely different on revenues, where the government is dependent on the base on which taxes are collected (the nominal GDP), and the tax rates. Nominal GDP, even with a growth of 14.4% assumed in the budget for next fiscal, is a good ~10% below its trend value in fiscal 2022. This shrinkage of base means revenues would remain below trend value in the next fiscal, too. More so because the government does not rely on tax changes to shore them up.

With the permanent loss in GDP of ~10% over the next couple of years, revenues will take time to normalize. So a new-normal in fiscal correction is on the cards over the medium term. For the Reserve Bank of India (RBI), that would mean normalizing a super accommodative monetary policy – with non-disruptive conduct of the government’s humongous borrowing program. The February 5 monetary policy review reiterated continuation of the RBI’s accommodative stance, with a very gradual increase in the cash reserve ratio over the next couple of months. We foresee the RBI a tad less accommodative with the economy growing faster than expected. This means a gradual rise in 10-year gilt yield to 6.2-6.5% by March 2022.

In addition to the expansionary fiscal policy, the budget was also used as a platform to signal reforms – the notable one being privatization of public sector banks, transfer of non-performing assets to a ‘bad bank’, adequate allocation for recapitalization, and increase in foreign direct investment limit in insurance. Relentless implementation of these measures is crucial.

Factoring in the growth-supportive stance of the budget, we have cranked up our GDP growth forecast for next fiscal to 11%, or 100 basis points more than what waspredicted in December. But this is contingent on there being no second Covid-19 wave.

So far, the tidings look good.