3 min read.Updated: 27 Feb 2020, 10:53 PM ISTAlok Sheel
The Centre could either roll back some investment plans or further slash its consumption outlays
The Union budget has set a fiscal deficit target of 3.5% of gross domestic product (GDP) in 2020-21, as against 3.8% in 2019-20. The target overshoots the 3% level mandated under the Fiscal Responsibility and Budget Management (FRBM) Act by 0.5 percentage points. Is this, then, a stimulative budget set against the background of falling growth? And, is the target realistic?
The deficit in itself is not a robust stimulus measure. Ceteris paribus, lower growth increases the (cyclical) budget deficit even in the absence of expenditure growth due to a contraction in tax revenue. But the structural deficit remains unchanged. Had the FRBM Act distinguished between the cyclical and structural components of the budget deficit by factoring in revenue shocks, Indian budgets could have found the fiscal space to increase expenditure and still adhere to FRBM targets. In the absence of such accounting, our budgets tend to be pro-cyclical, overestimating deficits during downturns, and underestimating them when growth is above potential.
The best measure of a fiscal stimulus is expenditure growth. Overall expenditure growth is budgeted to grow by just 12.7%, marginally higher than the nominal GDP growth, and much lower than the 13.2% growth in 2019-20. This could hardly be termed stimulative. It is, however, still too high to deliver on the budgeted deficit of 3.5%, as an analysis of budgeted revenue receipts indicates.
It is possible to achieve any deficit target, revenue shortfalls withstanding, by spending less than budgeted, as there are limits to the extent to which tax revenue shortfalls can be made good by non-tax revenues.
The tax revenue shortfall in 2019-20 was about 1.5% of GDP. This was partly made good by two developments. First, higher-than-budgeted non-tax revenue, in particular a sharp increase in dividends received from the Reserve Bank of India. Second, a reduction in the states’ share in total tax revenue. In 2019-20, the net tax revenue accruing to the Centre rose from 6.9% of GDP to 7.4%, thanks to a decline in the share of states from 4% of GDP to 3.2%. While this may have helped contain the Centre’s fiscal deficit, it cannot contain the consolidated deficit of the Centre and states. These two adjustments, combined with a compression of expenditure by 0.4% of GDP compared to what was budgeted, helped restrict the fiscal deficit at 3.8%. Had there been no expenditure compression, the deficit would have been 4.2%.
The most striking feature of the Centre’s pattern of receipts of late is the decline in tax revenue relative to growth in national income. Tax buoyancy was 0.75 in 2018-19, and just over 0.53 in 2019-20, or an average of 0.65 over the two years, on account of a broken indirect tax system and the sharp reduction in corporate tax rates. Seen against the backdrop of the 1.5% of GDP shortfall in tax revenue estimated this year, the revenue buoyancy implicit in the budget projections is an ambitious, and improbable, 1.2.
If tax buoyancy is assumed at 0.65, the projected tax-GDP ratio would be 10.6, lower than the projected 10.8. This would push the deficit to 3.7% from the budgeted 3.5%.
The budget expects to realize the equivalent of 0.9% of GDP through the sale of equity in public enterprises. This seems unlikely at a time of weakening growth and animal spirits, and when these realizations in the last three years were just 0.6%, 0.5% and 0.3%, respectively. If the realization in 2020-21 is 0.5%, the deficit would expand to 4.1%.
If the fiscal deficit target is to be adhered to, expenditure growth might need to be limited to 7.5%, as against the budgeted 12.7%. Where might this compression take place?
Unlike 2019-20, which was an election year, 2020-21’s budget privileges investment over putting more income in the hands of the middle class and rural consumers. The outlays on agriculture and rural development, taken as a proxy for rural upliftment, are budgeted to grow by just 13.4% in 2020-21, compared to an estimated 34.8% in the preceding fiscal year. The outlays on IT, telecom, transport and urban development, taken as a proxy for investment in physical infrastructure, are projected to grow by 28.9% in 2020-21, compared to an estimated 8.7% in 2019-20.
The option before the government would be to either roll back its enhanced outlays on investment, or further cut back its reduced outlays on consumption. Past history indicates that the former is more likely.
Alok Sheel is RBI chair professor at ICRIER
These are the author’s personal views
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