Neelkanth Mishra, Chief Economist, Axis Bank & Head of Global Research, Axis Capital, says “the government may end up this year with maybe Rs 1.5-2 trillion extra in terms of money, cash in hand and therefore the next year’s borrowing would actually be much lower than what we had this year. Now will the government have the space to expand its capex? In our view, the growth in capex may slow down but there should still be some room given that subsidies will fall again and some of the basic expenditures like salaries and pensions do not grow as fast normally.”
Well the markets and the entire ecosystem, the macro of our country has been in such a great shape and rightfully so with a lot of nudge coming in from policy intervention as well. And that is perhaps why we have superior growth despite global challenges. On the fiscal consolidation path, the market is watching out if there will be a balance or not. What are your thoughts to start with?
Neelkanth Mishra: One of the reasons that India has withstood a very volatile global environment while adding dollar availability and funding rate is the certainty on what the path is going to be in the next one or two years is still quite high. In this context, I think the fact that Indian policy makers, the government and the RBI have been totally focused on macroeconomic stability and are prioritizing stability for growth is extremely important.
I expect that the government will continue down that path.This is going to be a vote on account. So from the markets perspective, the three important things are one, whether the government will continue down the consolidation path? It is a given that they will and then what will be the pace of it? Will they consolidate by 40 basis points or 70 basis points?
The second big uncertainty is will this be done on the back of credible assumptions? And at least our expectation is that the government will again be very conservative in its projections for tax growth. In fact, what we think is happening is that personal income tax as a percentage of GDP, had been climbing steadily from 2001 to 2019. Since then, it has accelerated. It was growing at five basis points a year, it is now growing at 20 basis points a year.
Corporate income tax to GDP had been declining for almost a decade. In the last two years, it has started to climb and this climb can continue. So on several fronts, the government can assume continued or improving tax buoyancy and the tax to GDP can keep going up. But we think that the government in its budget projections may choose to again be conservative.
The third big uncertainty, the first was the level of fiscal deficit; the second was on what basis this deficit is coming about. And the third is, of course, the quantum of borrowing. One of the reasons there is very tight liquidity in the banking system currently is that the government cash balance with RBI is at a significantly elevated level and some of this is possibly because the government is likely to meet its absolute fiscal deficit target and it is maintaining its borrowing target but the inflows through small savings schemes have been nearly one and a half lakh crores higher than what was budgeted.
So, the government may end up this year with maybe Rs 1.5-2 trillion extra in terms of money, cash in hand and therefore the next year’s borrowing would actually be much lower than what we had this year.
Now what happens to the quality of expenditure? Will the government continue to expand its capex? Does it have space to expand its capex? In our view, the growth in capex may slow down but there should still be some room given that subsidies will fall again and some of the basic expenditures like salaries and pensions do not grow as fast normally.
This time there would not be any Economic Survey but the finance ministry review report which was released yesterday is calling FY25 GDP growth closer to 7%. This is the second time we are hearing this number. The first time of course was when the RBI Governor himself upped the GDP estimate after the policy meeting. It appears that 7% is what the government machinery is aiming for the growth to pan out. You have upped your growth estimate as well. How are you seeing the elements which contribute to that kind of number?
Neelkanth Mishra: We have been quite constructive on India’s GDP momentum. In fact, we did not really up our estimates, we have always had a high estimate and we just said that the trend growth assumptions for consensus will keep getting bumped up. So consensus has been quite conservative.
In fact, in January last year, some forecasters were talking about a 4.8% GDP growth in FY24 because they thought that the economy had slowed down pre-Covid and then the Covid scarring would slow it down further. Whereas our view was that Covid scarring would not be that intense. And so I think 7% is quite realistic, quite achievable. That is if there are no global accidents and financial accidents, which is what I think the chief economic advisor has also commented on.
Now, if 7% growth is real and real growth is delivered, nominal GDP growth can actually be 11% plus. Given that we are apprehensive about the global financial conditions, we are running with a 6.5% growth in FY25. Therefore, our nominal GDP growth assumptions or what we think the government will come up with is 10.5. If they take 7 plus 4, maybe there is another 50 basis points, possibly another 100 basis points of nominal GDP growth, in which case the assumptions on taxes and on the scope for spending can be slightly higher.
What are your thoughts on capex? Over the last few years, we have been seeing that the government’s contribution to capex has been rising. In fact, it has been spearheading overall capex in the country, even at a time when private capex was soft now, early signs that it is also picking up. Do you think we will have that shades and a clear stamp of that, this budget as well? And do they have room for further upping it?
Neelkanth Mishra: Correct. Both of those are important variables as the government thinks about what to spend on and whether to spend. And the first is that there is a very clear sign that profits of industrial companies are rising at 20-25% CAGR for several years going forward and which suggests that at least some kind of private corporate capex has started coming back.
I do not think it has come back fully yet and therefore, some support is needed. Remember the primary objective of the government is and should be to bring down the debt to GDP to much more sustainable levels, meaning that 80% plus is not healthy. It needs to be at least 70, if not 60, which is what the FRBM review committee has suggested.
For that to happen, you need to keep the GDP growing. So if you consolidate too fast, and if you consolidate poorly, your nominal GDP growth slows down and in which case the debt to GDP does not come down as much as expected. So the government needs to keep doing capex. The quality of expenditure needs to be kept high, even as the top line spending is being controlled. So it is very important that the government continues to spend on capex.
Is there scope for a lot of capex? I think on national highways, the pace of construction perhaps does not need to rise meaningfully from here. So we are already about 14,000-15,000 kilometres done. I think 20,000 would be pretty much the max because if you have 200,000 kilometres of highways and you repair them or rebuild them once every 10 years, I do not think the run rate can be meaningfully higher than where we are already. But in railways, there is significant scope for further expansion.
I think on the telecom side, BSNL’s expansion may need some more money as well. But about a 15% increase is what we think the government can afford to have. There is some scope for savings because fertilizer prices are lower, so subsidy bills can fall off or should fall off in FY25 as well. But given that there are other expenses that also need to be incurred, I am not sure that stronger than that is possible.
Remember that if you compare the fiscal numbers as a percentage of GDP versus what happened or what used to happen pre-Covid, the capex numbers are already 1.8% of GDP higher than what we were pre-Covid. And remember that interest expenses are because of the borrowing that happened during the pandemic. We are already 0.5% of GDP higher than what we had pre-Covid. So the scope for the government to expand it meaningfully is somewhat limited.
What are your thoughts on this matter of tight liquidity? Many of the big lenders we speak to are also complaining that it is making the operating environment tougher. At the same time, we all know that liquidity is being put on leash so that inflation which has been sticky does not start rearing its head again. How long do you think it will take this equation to even out?
Neelkanth Mishra: So, I will make three points there. It is a very important question. The first is that the tight liquidity stance is a deliberate one. And if you think about money in the deposit system, there are only four moving parts.
The first is how much money is the RBI injecting? Second is how much is bank credit growth because as you know when banks lend, they create money. The third is, is money being withdrawn at an accelerated pace and is currency in circulation? So, when you take money out of ATMs, the circulation becomes parallel. It goes out of the deposit system. And the fourth is the cash balance of the government because when the government collects taxes and is not spending fast enough or borrows from the market and is not spending fast enough, it sits in a separate account with RBI. It does not really become part of the deposit system.
So, these are the only four moving parts in the deposit system. And if your credit growth is strong, if your currency in circulation growth is not strong, which means that not too much of money is going out of the deposit system, then there are only two variables. So, first is how much money is RBI injecting and second is what is the government’s cash balance? Now, on the first point, over the last 18 months, RBI has injected nearly zero money. This is what I have called for the last seven-eight months, India’s quantitative tightening, that the RBI is deliberately keeping conditions tighter. It has meant that the marginal overnight rate has shifted from the repo to the MSF, so there is a 25 basis hike, so this is intentional.
The second part is, will the RBI be forced to change its stance? Remember that headline inflation is still high and in global uncertainty, there is excessive borrowing by the US government because the Federal Reserve is still doing quantitative tightening, so you need to be a bit careful and so that factor is also still there. And the third is growth. It is actually surprising the RBI on the upside. If your growth forecasts are going up, there is no reason to really change your liquidity stance. So, the third point and which is the most important one is that currently given excessive cash balances of the government and which you can imagine is not a permanent situation, this is not by any means deliberate, eventually will ease.
Either the government, which has collected the taxes or borrowed from the market will spend that money or in case it is struggling to spend that money, it will cancel auctions in which case the liquidity kind of comes back into the banking system. So, I think some amount of tightness is deliberate, but the current situation which has been exacerbated by significantly higher government cash balances should be temporary. It is much easier to control and does not really require a policy shift.
The other thing I wanted to talk to you about is that in continuation with this budget and a lot of reform work which is happening outside the budget as well. Going into the election year. people are wondering where else is there scope for reforms. Which are those areas where you see scope for further work if they have already started or commentary from the government if I may call a guidance from the management that probably in the coming years, that is where the area of focus would be on the reform front, something which you have analysed?
Neelkanth Mishra: Here, one has to be prescriptive and not predictive because clearly the government will have its own priorities. What one can do sitting outside the government is prescribed, meaning that what are the areas which require work and therefore should be the government’s priority. There are many such areas.
Remember that we are still a lower middle-income economy, so there are many warts in the system that we need to clear up. One of the most important is taxation. Our personal income tax should really be improving, but it is well below where it needs to be on taxation in general, the base at which you sign advanced pricing agreements and that is very important giving tax certainty to foreign firms which are coming to India or which should be coming to India and bringing their global value chain linkages and FDI.
So, we need to move faster on that, clear those things up. I think we need to radically transform our urban administration. I think the cities are going to be a very important vehicle of growth. We have thankfully, at least in our national consciousness, moved from looking at Delhi for all changes to actually looking at state governments which can control land, labour, environment, and every other thing which affects the business on a day-to-day basis. I think that granularity has to go down to the district level. I think the states need to devolve quality, even maybe some fiscal powers to district administrations because our districts themselves are actually very large. We need to do, significant changes on the education front, on the healthcare front.
Remember that when India as an independent nation turns 100, the people who are going to be in their prime working age are children now. So, making sure that they are well-fed, they have good brains and good bodies and also that education that they get, the skilling that they get, all of these are very important developments. We also need to start preparing India to become a product nation, becoming owners of intellectual property, creators of intellectual property.
Remember that if you have to prevent getting stuck in the middle-income trap, you need to create frameworks which encourage R&D to happen. When you are moving from low-income to middle-income, there is what is called, you are sort of using foreign technology, the diffusion of foreign best practices and technologies happens, like think about telecom in India, so that takes you to a certain level.
But to become a rich country, you need to have very different frameworks because you will have to experiment with different technologies. You cannot rely on time-tested cheap technologies to come in from abroad. As a nation we need to start evolving and so those frameworks. We need to do a lot of pre-commercial R&D. The government needs to be involved in that. We need to do changes in how we regulate ourselves because if the regulator is not supportive, how can innovation happen? There are many such changes that will be necessary but these are all prescriptions. I would not call them predictions.
Where do you stand on this argument that in a base case format, the case is looking very strong that for next five to seven years, growth could be in the range of 6% to 7%. But worst case is it may not go below 6%. So, the band could be 6-7%. Do you think 6% to 7% prolonged growth is possible?
Neelkanth Mishra: So, I have been saying for a while now, in fact, starting late 2021, we put out a note that the real estate cycle was starting to turn and that construction was the reason that India’s GDP growth was almost 1% point below where it should have been in the years before COVID. But the real estate cycle has turned and when it turns, it supports growth for several years.
Secondly, I think we have under-invested in several capacities, several sectors where capacity needs to be added. And that itself means that gross fixed capital formation can grow faster than it did. And you can see that when you compare various parts of GDP versus their pre-pandemic path, GFCF, which is the investment part of GDP, is only about 3% below where it should have been, whereas private consumption and government consumption are 10% to 12% below where they would have been. When something like this happens, it creates more sustainable GDP and one should be reasonably sure of that range of GDP growth.