Stimulating India’s economic revival: A look at Budget 2021 and beyond

Global prospects and challenges

The post-Covid global economy is likely to remain significantly challenged because of continued disruption due to flare-ups of new Covid-19 variants and the different pace at which major global economies are coping with the Covid challenge. The IMF, in its World Economic Outlook Update released in January 2021, estimated global growth at (-)3.5% in 2020 followed by a recovery to 5.5% in 2021 reflecting policy support in few large economies including US and Japan and the expectations of widespread vaccine availability. Global trade volume of goods and services is estimated to have faced a sharp contraction of (-)9.6% in 2020. Consistent with a recovery in global activity, global trade volumes are forecasted to grow by 8.1% in 2021. In line with global trends, Indian exports and imports also dropped sharply by (-)13.7% and (-)25.2% respectively during the period April 2020 to January 2021 as compared to growth of (-)2.4% and (-)7.1% respectively in the corresponding period of last year.

Global crude prices have been rising steadily in recent weeks. If the crude price movement is tracked on a daily basis, brent crude price has increased to US$63.76/bbl. as on 15 February 2021. This may be compared with earlier levels of US$36.33/bbl. on 30 October 2020 and US$9.12/bbl. on 21 April 2020. Clearly, the global economy is showing signs of transitioning out of the worst phase of Covid and global demand may have started picking up. There are also supply-side reasons for this persistent upward movement of global crude prices. In particular, OPEC+ countries in December 2020, agreed to a supply cut of 0.5 million barrels per day effective January 2021. These developments have a significant bearing on prices of petroleum products in India which have now crossed INR90/litre for petrol and INR86/litre for diesel. In some cities, these prices are even higher. The reason for these increased prices is the continued high tax load of central excise duties and state VAT on petroleum products on top of rising global crude prices. The persistence of this trend would have adverse implications for inflation and growth in India and on its trade balance.

Medium-term: revisiting fiscal policy framework

The Economic Survey of FY21 prepared the background for justifying a sharp departure of center’s fiscal deficit in FY21 (RE) and FY22 (BE) from the corresponding FRBM norms (2018) and the medium-term path of the fiscal deficit that was stipulated in the FY21 Budget. This justification was based on a comparison of the nominal growth rate and the effective interest rate on government borrowing. As long as the excess of nominal growth rate over effective interest rate is large, a relatively high primary deficit and fiscal deficit relative to GDP may be justified. The 15th FC had also examined this issue and had recommended a fiscal deficit of 6.5% of GDP for the center for FY22. Their proposed path indicates a gradual reduction in the fiscal deficit to GDP ratio of the central government by an annual margin of 0.5% points thereby reaching the level of 4.5% by FY26. The Commission also recommended that the FRBM norms may be examined afresh by a High-Powered Intergovernmental Group. 

In the ‘medium-term fiscal policy cum fiscal policy strategy statement’ appended to the FY22 Budget, an estimation of government debt relative to GDP for the center, which used to be given, has not been provided. According to our estimates, using the budget assumption regarding nominal GDP growth and the fiscal deficit numbers, center’s debt to GDP ratio is projected at 62.2% at the end of FY21 and 61.0% at the end of FY22. Also, the estimated combined debt-GDP ratio by end-FY21 and end-FY22 respectively are at 88.0% and 87.5%. At such high debt-GDP levels, the burden of interest payment relative to GDP and relative to revenue receipts will become inordinately high thereby reducing the scope for primary deficit for any given level of fiscal deficit.  In making international comparisons, we may note that for a number of developed countries, the general government debt-GDP ratio is projected to be higher than 100% by the end of 2020 and 2021 but in their case, the nominal interest rates are quite low, sometimes negative, and the revenue receipts to GDP ratios are much higher than that for India. 

Conclusion

Achieving a more sustainable fiscal deficit path would require substantial improvement in center’s revenue flows. A major fiscal challenge relates to the performance of center’s gross tax revenues which have contracted in two successive years namely, FY20 and FY21 (RE). A longer-term and critical issue in the management of India’s public finances is the decline in the growth rate of center’s GTR on trend basis since FY08. After rising to about 16.7% in FY07, the trend growth rate of center’s GTR has fallen to 4.8% by FY22 (BE). Unless the growth rate in center’s GTR increases to 10% or above on a sustained basis and revenues from non-tax sources become buoyant, the reliance on larger fiscal deficit may become necessary for some more years.

The budget has indicated that the fiscal consolidation framework would be re-examined with a view to amending the FRBM Act. For this purpose, there is a need to specify a steady state path of fiscal deficit consistent with the relative levels of trend GDP growth rate and trend interest rate. As a second step, around this steady state path, rules for countercyclical departure of fiscal deficit and its extent will have to be specified. It may be noted that in the 2018 amendment to center’s FRBMA, such rules were specified but they proved to be impractical and ineffective. This Act may now be re-amended in the context of India’s contemporary empirical realities in the post-Covid global economy.