Union budget and the unresolved tensions in national policymaking

The 2023-24 Union budget is a stark reminder of the deep, fundamental tensions between the imperatives of growth and the limits of State capacity that constrain national policymaking today. The policy direction is clear – prioritising capital expenditure whilst staying the course on fiscal consolidation. The big bet made is that public investment in physical infrastructure will have, in the Finance Minister’s words, “large multiplier effects on growth and employment”. But the path adopted to achieve this goal, and indeed the choice of emphasising capital expenditure itself, tells us more about the limits of State capacity in India today than the post-budget commentariat (bouquets and brickbats included) is willing to acknowledge.

There are three capacity challenges that this budget tries to navigate. First, capacity for revenue mobilisation. In 2019, economist Rathin Roy coined the phrase “silent fiscal crisis”, brought on by a consistent failure to meet stated revenue targets, to describe the reality of Government of India (GoI) finances. Consequently, borrowing to meet committed revenue expenditures increased (alongside increased off-budget borrowing to “manage” fiscal deficit targets) even as total government expenditure stagnated, indeed shrank, pre-pandemic.

In the pandemic years, the government made a concerted effort to clean up its act and restore the credibility of its fiscal math. Since the 2021 budget, revenue projections have been conservative and actual collections somewhat higher than budgeted estimates. Importantly, as the government embarked on the path to fiscal consolidation, post the 2020 deficit surge, it slowly reduced borrowing for revenue expenditures (which accounts for the bulk of government consumption, including welfare), re-directing it to capital expenditure.

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This is prudent macro-fiscal management. But as Roy argues, it reflects an admission that the State simply cannot improve its revenue-raising capabilities. Indeed, it has given up on disinvestment. The 11.14 per cent gross tax revenue-to-GDP target for FY24 is lower than targets for FY19 and FY20, despite claims of being the fastest growing economy in the world.

It is against this backdrop that the implications of the choice of enhanced capital expenditure need to be understood. For when revenue capability is weak (and arguably the State has given up on trying to build capacity for revenue mobilisation), the trade-off was a significant reduction in revenue expenditure. Welfare expenditures, first time since 2009-10, dropped to 18 per cent of total government spending, even though the pandemic recovery has been K-shaped with continued unemployment, stagnant and declining real rural wages indicating continued distress in large parts of India.

Second, implementation capacity. That the Indian State suffers from corruption, inefficiency and incompetence are well-known realities and big infrastructure projects are thus vulnerable to capacity failures. New infrastructure projects have long gestation periods as they require complex contracting, land acquisition, environmental clearance.

This, in turn, requires bureaucratic competence, failing which, allocated budgets remain unspent. For instance, between April and December 2022, only 65 per cent of the capital expenditure budget had been spent. Smart policymakers hide behind clever accounting to address these challenges, which ironically results in more realistic budgeting aligned with implementation capacity, behind the headlines! Thus, the headline-grabbing 3.3 per cent-of-GDP capex allocation is offset by a decrease in outlays for public sector units’ capital expenditure, leaving total capital outlays exactly where they were in 2020.

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Further, a deep dive into the spread of capital expenditure within departments shows that departments have struck a balance between enhancing existing projects and new ones – aligning budgets with what they can do. For instance, about 40 per cent of the capex in railways is allocated to stores and workshop manufacturing suspense, essentially expenses on components in stock or work-in-progress on shop floors.

Importantly, the Government of India’s strategy for capital expenditure expansion rests in large part on state governments becoming active partners in that project. Toward this goal, the GoI introduced a 50-year interest-free loan of over Rs 1 lakh crore for capital expenditure in last year’s budget. This brings me to the third challenge – cooperative federalism.

Two conditions need to be met for Centre-state cooperation: Dialogue, and collective goal-setting, so that state government priorities and capacities align with the goals set. This can only be achieved through an institutional framework that enables Centre-state interaction through credible and independent processes. But none exist. Thus, the Centre makes announcements and expects states to play ball. But if the budget numbers are an indicator, states are refusing to play ball.

Until November this year, states’ capital expenditures were extremely sluggish. Even releases from the loan sanctioned to states were just about half of the approved loan amount. To push states along the capex path, the GoI added a set of reforms (urban governance, disinvestment), as incentives for loans. But state governments have shown no enthusiasm for reforms pushed by the Centre. As reported in the economic survey, no significant monies have been released this financial year for reform-linked loan amounts.

Arguably, the vacuum in federal institutions and the consequent breakdown in federal cooperation keeps capital expenditures in line with states’ implementation capacity. And at the end of each financial year, both levels of government (state and Centre) can blame the other for failure!

Against this backdrop, budget 2023-24 is not a grand economic vision. Rather it is an attempt at charting a path within limits set by a weak state. This involves a smoke and mirror game with budget numbers, but more important about serious trade offs. The government in its wisdom has chosen to prioritize investments in physical capital rather than human capital. Our policy makers seem to be of the view that implementation capacity failure for physical infrastructure is easier to overcome than building state capacity for health, education and social protection.

And so you have it. We enter Amrit Kaal on the back of a growth strategy premised on investments in physical capital at the cost of human capital, a strategy legitimized by the limits imposed on policy in a weak State.