Why the budget gets our attention

Budget is one document/announcement among many other documents/announcements which is released every year, but holds paramount significance in the public. Why? It comes once a year, and the Finance Minister reads it out and perhaps because it is read out by a politician, we listen a little more closely. I wonder how many of us read the quarterly GDP numbers, or the RBI policy which is held every 2 months, or the CPI number released every month.

Budgets rarely do much towards changing the course of the year ahead of it, but we are optimists, and we hope for a better future each 1st of February.

When the Finance Minister walks in with the red file in her hand, we are all glued to the screens to listen for the next 2 hours. She talks about a lot of things, on a lot of subjects, penalizing a few sectors, liberalizing others, touching upon on almost everything that could have been relevant the past year, launching schemes left, right and centre. And if it is an election budget, all of this more so. What remains a consistent concern is that each budget is less accountable to its predecessor.

After the speech, the real work begins

Once we listen through the budget, then the actual play starts when we have the budget document, which has the revised estimates of the running financial year and the budget estimates of the next financial year.

When we prepare the budget math, we work through a set of estimates, beginning with arriving at a full-year number for the running financial year, to see how far we have come and how much still needs to be done to meet the budgeted targets. Even though the actuals do not always line up neatly with the estimates, we repeat this exercise each year, partly out of habit, partly out of hope, and largely because the Budget invites that scrutiny.

Revenue and expenditure - the core of budget math

The budget math is ideally divided in two sections, the expenditure and the revenue. Think of it how you’d run your own household, you’ll have some income which will be the revenue and you will have whatever expenses which will be the expenditure. Only, as a household budget, your expenses are usually constrained to your income, and it can only reasonably go beyond that to the extent you’d borrow. It works slightly differently for managing budget at a national level. First, your expenditure is not constrained to the revenue you’re earning. Second, it is also not constrained to the extent you can borrow, because there are no bounds to how much a nation can borrow, because a nation prints its own currency, and can do that as much as it wants. Obviously, there are regulations to monitor this, because printing too much currency can be inflationary, and too much debt can obviously make the nation too indebted.

Budget essentially comes down to how well the balance sheet of the nation is managed, and by well managed it doesn’t mean that a nation should always have a clean balance sheet, well managed in the sense of how the economy is performing then and how beyond its means it is going to support it.

Understanding the deficit

This brings us to the deficit. Deficit is the extent to which receipts fall short of expenditure. India, by construct, is a consumption heavy economy i.e. we consume more than we produce, which also means we spend more than we earn.

Where the revenue comes from

Let’s start with where the revenue of the economy comes from, the major chunk, as you all guessed right, is the taxes. The taxes you pay out of your income, income tax and corporate tax. And then the taxes on what you consume, the GST. The non tax revenue makes up for a much smaller share of the revenue receipts, and is relatively miscellaneous in nature and does not typically have a trend it follows.

Where the money is spent

Coming to the expenditure side, this further breaks down into revenue expenditure - Revex and capital expenditure - Capex. Revex covers more day to day to expenditure (read salaries, interest payments, subsidies, pensions, allowances) , the unavoidable, smaller expenses. Capex is where the real deal lies, this is the outlay towards creating assets, think of building roads, highways, manufacturing capacities, railways, metros, capacity for power, energy. Both these expenditures are carried out through different ministries, across different segments, the major being defence, railways, roads and highways, housing.

Managing the deficit and the economic cycle

So now when we know how the deficit is generated, the more important question is how this deficit should be managed. The government for this reason, budgets each year based on revenue estimates, how much should each segment spend. Ideally, when the economy is struggling for growth, the government budgets for higher expenditure, expansionary fiscal policy, to support the economy, even if it might mean running higher deficit (think of Covid).

The government has the space to run a rather conservative budget - contractionary fiscal policy, when the economy is looking up. These are called countercyclical budgets, government policy moving in the opposite direction to the cycle of the economy.

For the past two years, India has run procyclical budgets, tightening even as the economy slowed, largely to unwind the highly expansionary fiscal stance adopted during the Covid period.
One thing to note is that fiscal policies are not run in isolation. The monetary policy usually supports it, but fiscal policy usually runs the show.