Finance minister Nirmala Sitharaman has promised that this year’s Budget will be one “like never before”. She has repeatedly said that the government won’t refrain from spending more to lift a sluggish economy.
Matching her words with action, India’s fiscal deficit is projected to rise to 7.5 per cent of the country’s gross domestic product (GDP) in this financial year, which is twice the target she had set for the year.
Hard-pressed for funds to combat the crisis, the government had in May increased its gross market borrowing for the current financial year by more than 50% to Rs 12 lakh crore from Rs 7.8 lakh crore budgeted earlier.
This, along with economic stimulus packages under the Atmanirbhar Bharat Abhiyan and announcement of comprehensive monetary, liquidity and regulatory measures by the Reserve Bank of India (RBI), among other measures are most likely to push up the fiscal deficit for FY21.
What is fiscal deficit
The difference between total revenue and total expenditure of the government is fiscal deficit. It is the negative balance that arises whenever a government spends more money than it receives in the form of taxes and other revenues. The latter comprises disinvestment and interest income.
India has had fiscal deficit for over 40 years, the last year of fiscal surplus being in the mid-1970s.
The most common way for government to finance fiscal deficit is by borrowing. Like private players, it can borrow from banks, financial institutions, public and overseas investors.
The government has always been criticised for not being transparent with the deficit numbers.
Writing for TOI, leading economist Swaminathan Aiyar has said: “We need a budget for truth, forgiveness and reconciliation. For too long the truth about the government’s spending and borrowing has been hidden by layers of financial fudging. Such fudging has been done by all political parties.”
Fiscal deficit and the economy
Fiscal deficit has a direct impact on a country’s growth, price stability and inflation. When an economy is in a slowdown or recession, governments tend to run a higher deficit to counter the negative impact of slowdown in private demand.
Higher government spending, by keeping the public investment high, has the potential to push up overall demand in the economy.
However, if the timing and size of deficit isn’t kept under watch it could create inflation by raising the cost of inputs like labour, raw material.
Further, when government borrows from the market it leaves a lesser share for the private sector to finance their investment plans. This phenomenon is called ‘crowding out’ effect. It tends to drive up interest rates.
However, when fiscal deficit is used for investments (building physical or social infrastructure) it creates long term assets in the economy and helps generate additional income for the poorer sections which in turn helps in reviving demand.
Fiscal Responsibility and Budget Management (FRBM) Act
Enacted in 2003, the FRBM Act sets targets for the government to bring down fiscal deficit. It requires the government to limit fiscal deficit to 3 per cent of gross domestic product (GDP) by March 31, 2021 and central government debt to 40 per cent of GDP by 2024-25.
However, the Act allows invoking of an escape clause in situations of calamity and national security. In such situations, the government can deviate from its annual fiscal deficit target.
In her Budget speech last year, Sitharaman had invoked the escape clause and taken a 0.5 per cent deviation. The fiscal deficit target for FY20 was revised to 3.8 per cent, while pegged the target for FY21 at 3.5 per cent.
How Covid impacted India’s fiscal situation
The Union Budget for 2020-21, presented before the Covid-19 ravaged the economy, had provided for a counter-cyclical fiscal support to the slowing economy.
As a result, the fiscal consolidation goal of achieving a gross fiscal deficit to GDP ratio of 3 per cent in 2020-21 was shifted to 2022-23 (3.1 per cent).
But all those calculations have gone awry in the wake of Covid-19. The Centre’s fiscal deficit widened to 145.5 per cent of the full-year’s Budget Estimates (BE) at Rs 11.58 lakh by December 2020, according to data released by Controller General of Accounts (CGA).
For the current fiscal, the government had pegged the fiscal deficit at Rs 7.96 lakh crore or 3.5 per cent of the GDP
Fiscal deficit at the end of December in the previous financial year was 132.4 per cent of the Budget Estimate (BE) of 2019-20.
India’s fiscal deficit had breached the Budget target in July itself as the economy faced the most stringent lockdown in the first quarter to contain the outbreak of the coronavirus pandemic.
Shortfall in government revenue
The shortfall in Centre’s revenue collection owing to the interruption in economic activity and the additional expenditure requirements to mitigate the fallout of the pandemic on vulnerable sections, created immense pressure on the fiscal resources.
According to the Economic Survey 2021, the government may register a fiscal slippage in 2020-21 due to revenue shortfall and demand for higher expenditure.
The capital expenditure during April to December 2020 stood at Rs 3.17 lakh crore, 24 per cent higher than the capital expenditure during the corresponding period in the previous year.
An analysis of the monthly expenditure also shows that the total expenditure registered an increase during the last three months of the year 2020 by 9.5 per in October, 48.3 per cent in November and 50.2 per cent in December compared to the same months in the previous year.
Capital expenditure during the last three months of the year 2020 recorded a phenomenal growth of 129.5 per cent in October, 248.5 per cent in November and 81.9 per cent in December as compared to same months in previous year, the survey noted.
According to CGA data, the centre’s total expenditure stood at Rs 22.80 lakh crore or 75 per cent of corresponding BE 2020-21 in December 2020. Out of this, Rs 19,71,173 crore was on revenue account and Rs 3,08,974 crore was on capital account.
Of the total revenue expenditure, Rs 4,72,171 crore was towards interest payments and Rs 2,27,352 crore is on account of major subsidies.
In comparison, total receipts till December 2020 works out to be 49.9 per cent of the BE.
Fall in tax collections
One of the major reasons for India’s stretched fiscal position has been its low tax collections.
The tax revenue collection was 42.1 per cent of BE of 2020-21, compared to 45.5 per cent of BE (2019-20) during the corresponding period a year ago.
Non-tax revenue was 32.3 per cent of BE. During the corresponding period of the last fiscal, it was 74.3 per cent of BE 2019-20.
GST collections (both Centre and states) took a severe hit too on account of the lockdown but recovered during June-December period as consumption spending revived, backed by pent-up demand and festive spending.
SBI report pegged FY21 fiscal deficit at 7.4% of GDP
A report released by State Bank of India (SBI) research pegged the Centre’s fiscal deficit for FY21 to be at 7.4 per cent of GDP. While, it pegged the combined fiscal deficit of the Centre and states at 12.1 per cent of GDP.
It said that the current trends in GDP for FY21 will translate into Rs 3.2 lakh crore net revenue shortfall for the Centre. Similarly, expenditure will be higher by around Rs 3.3 lakh crore. Thus, the fiscal deficit will be around Rs 14.46 lakh crore.
The SBI economists also pitched for avoiding new taxes and urged the government to mount “honest attempts” to settle past litigations to raise resources instead. As of data available till FY19, the total amount under tax dispute was around Rs 9.5 lakh crore.
What more can be done
The measures stated above along with aggressive and well planned sale of government stakes in public sector companies will not only raise one time revenue, but also prevent financial bleeding in some cases — like Air India that has piled up losses of about Rs 90,000 crore (debt-cum-liabilities).
Then there is the Finance Commission award which is likely to be made public on the Budget day. It is stated to transform the fiscal situation of the Centre and the states for the next five years. If the report is good then it, combined with International Monetary Fund’s (IMF’s) projection of 11.5 per cent GDP growth in 2021-22 will provide the government enough head room to spend big and yet not derail its finances next year.