A growth-oriented Union Budget

DBRS Morningstar, a full-service global credit ratings business, expects the announced measures to be positive for recovery and medium-term growth, with execution being the determining factor.

Set against a backdrop of unprecedented economic disruption, India’s first post COVID-19 budget has a strong focus on growth with higher capital outlays directed towards infrastructure, healthcare, and the agricultural sector.

In addition, the Budget announced several growth-enhancing measures, which include raising FDI limits in insurance, setting up specialized institutions to manage stressed assets, and monetizing of infrastructure projects.

Effective and timely implementation will be key for sustaining the nascent economic revival currently underway and improving growth prospects over the medium term.

Growth over pace of fiscal consolidation

The Budget comes at the cost of a faster fiscal consolidation.

Following a deficit of 9.5% of GDP in FY21 (April 2020 to March 2021), the Budget pegs the deficit at 6.8% of GDP in FY22 and 4.5% of GDP in FY26.

The fiscal deficit target of 6.8% is GDP this year is based on credible macroeconomic assumptions. The expansionary fiscal stance is reflected in the government's decision to keep expenditures-to-GDP at the pandemic level, though the breakdown indicates a decrease in revenue expenditure while capital expenditures are budgeted to increase 26% YoY. By bringing some of the off balance sheet items (borrowings by the Food Corporation of India towards the food subsidy bill) onto the balance sheet, budget transparency has also improved. With limited changes to the tax structure, the revenue estimates are based on higher tax buoyancy through improved compliance and higher disinvestment proceeds. Authorities expect a gradual fiscal consolidation to 4.5% of GDP by FY26. However, authorities may need recalibrate fiscal targets over time in order to comply with the Fiscal Responsibility and Budget Management Act.

The Budget addresses the central bank concerns

With the COVID-19 shock adding to the existing stresses in the financial sector, the RBI in its Financial Stability Report warned that as the COVID-related regulatory relief measures are rolled back, there could be balance sheet impairments and capital shortfalls. Its stress tests indicated the banks gross nonperforming assets ratio could increase from 7.5% in September 2020 to 13.5% in September 2021 under the baseline scenario and to 15% under the severe stress scenario. Moreover, while banks have sufficient capital at the aggregate level even in the severe stress scenario, several individual banks may fall below the regulatory minimum if the severe scenario materializes.

In an effort to address these issues, the Budget announced the setting up of the Asset Reconstruction Company Limited and Asset Management Company to take over the existing stressed debt and eventually dispose the assets to Alternate Investment Funds and private investors.

In addition, the Budget earmarked funds towards recapitalization of public sector banks, announced the establishment of a development financial institution to fund infrastructure, and proposed the privatization of two public sector banks. Lastly, the decision to monetize operating public infrastructure assets could aid financing for future infrastructure projects. While some of these measures have been discussed in the past with limited follow-through, speedy implementation now would be credit positive.

Implementation of reforms is key

India’s medium-term prospects will depend in part on the government’s ability to improve the investment climate. The budgetary announcements and structural reforms announced as part of the COVID-19 relief package – mining, FDI, production linked incentive schemes, labor and agriculture reforms – are encouraging. Effective implementation of the reforms is likely to help address long standing bottlenecks.

These actions, coupled with India’s large diverse economy, favourable demographics, relatively high savings, and potential catch-up in technological knowhow suggest that India’s medium-term growth prospects are likely to remain strong.

Favourable growth and interest rate dynamics should support public debt sustainability over the medium term. Moreover, exchange rate flexibility and a relatively low level of external debt reduce external vulnerabilities.

Sovereign rating

The Negative trend on India’s sovereign rating of BBB reflects the high degree of uncertainty around the magnitude and duration of the coronavirus shock. This is in context of India's pre-existing structural challenges, including its large fiscal deficit, impediments to faster productivity growth, and asset quality concerns within the financial sector. The evolution of the ratings could be affected by the pace of the recovery, the extent of the scarring, and the potential crystallization of contingent liabilities on the public sector balance sheet.


The supportive fiscal stance outlined in the Budget should accelerate the recovery and reduce concerns associated with economic scarring. Moreover, if greater public investment is accompanied by reforms to boost medium-term growth prospects and address financial sector weaknesses, downside risks to the ratings could diminish. The plan is positive, but execution is key.

Source: Morningstar India Website