9 minute read 23 Feb 2021
Economic recovery

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

By D. K. Srivastava

EY India Chief Policy Advisor

A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.

9 minute read 23 Feb 2021
Related topics Tax

This issue of Economy Watch examines the key steps taken in Union Budget 2021 towards India’s economic revival.

The first post-Covid budget of the central government has favored a significant fiscal stimulus with a view to supporting recovery of real GDP growth from the trough of (-)7.8% in FY21. The sectoral priorities have been changed towards supporting growth. Additional allocations were announced for augmenting capital expenditure relative to GDP and health expenditure. A qualitative improvement in budgeting practices relates to emphasis on transparency which involved bringing explicitly on to the budget, some of the food subsidies which were given to the Food Corporation of India (FCI) through National Small Saving Fund (NSSF) loans. These changes required sharply raising center’s fiscal deficit to unprecedented levels of 9.5% of GDP in FY21 (RE) and 6.8% of GDP in FY22 (BE). This upsurge in fiscal deficit may be justified in the short run provided the central government returns to a sustainable fiscal consolidation path in the near future. As per the budget documents, the central government will gradually reduce its fiscal deficit to 4.5% of GDP by FY26 which is well-above the current FRBM norm. However, the budget has indicated that the fiscal consolidation framework would be re-examined with a view to amending the FRBM Act. The impact of large fiscal deficits of the central and state governments in FY21 and beyond will be felt on increased levels of debt relative to GDP and correspondingly increased levels of interest payments relative to GDP and to government revenue receipts. 

Some major initiatives were unfolded in the budget 2021 with respect to non-tax revenues. One critical item pertains to spectrum sales relating both to 4G and 5G which are likely to be brought on to the market in the last quarter of FY21 and in FY22. Another important initiative relates to the idea of monetization of government and public sector owned assets including defence assets. In the budget, a National Monetization Pipeline has been proposed as a first step towards making an assessment of the potential value of government-owned assets and devising strategies for their monetization. Monetized government assets if leased or rented out, may yield a stream of periodic incomes which may be counted under non-tax revenues. However, outright sale of assets would generate one-time receipts and may be considered as part of government’s non-debt capital receipts. In the case of non-debt capital receipts, mainly covering disinvestment, a budgeted growth of 304.3% in FY22 stands in contrast with a contraction of (-)32.2% in FY21 (RE).

Budget initiatives related to infrastructure include setting up of a Development Financial Institution (DFI) with an initial capital of INR20,000 crore, to serve as a catalyst for facilitating infrastructure investment which will also be augmented by enabling provisions relating to the financing of InVITs and REITs by foreign portfolio investors. In order to manage non-performing assets of public sector banks, there is a proposal to set up an Asset Reconstruction Company and an Asset Management Company.

Challenges of fiscal consolidation

Constrained by a falling revenue receipts-GDP ratio even prior to the onset of Covid, and the Covid-induced erosion of growth has led the fiscal authorities to suddenly relax on the target of fiscal deficit in the medium-term in order to prioritize fiscal support to growth. This called for a sharp jump in the fiscal deficit-GDP ratio of the central government from a budgeted level of 3.5% to 9.5% in the revised estimates (RE) of FY21 facilitating an y-o-y expenditure growth of 28.4% in FY21 (RE). Thus, clearly, a significant fiscal stimulus has been provided in FY21 largely based on borrowing. In fact, in FY21, the magnitude of center’s fiscal deficit at INR18.5 lakh crore exceeded center’s non-debt receipts including tax and non-tax revenues at INR16 lakh crore. This has happened for the first time in India’s fiscal history at least since 1970s. The upsurges in the level of fiscal deficit relative to GDP in FY21 (RE) and FY22 (BE) would have implications for center’s debt-GDP ratio and the stream of future interest payments. One redeeming feature of this large departure from norms is that a good part of this fiscal deficit is proposed to be spent on capital expenditure. However, in FY21 (RE), the share of capital expenditure in fiscal deficit has remained limited to close to 24%. The level of fiscal deficit is to be brought down to 6.8% of GDP in FY22 (BE), and in graduated steps, further to 4.5% of GDP by FY26. This is based on the suggestion of the Fifteenth Finance Commission (15th FC). With such a medium-term slippage, there would be an increase in the debt-GDP ratio and a clear need to re-examine the path of fiscal consolidation given India’s current empirical realities.

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.

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.

Summary

While preparing the ground for economic recovery, Budget 2021 spells out certain bold moves including postponement and re-examination of India’s approach to fiscal consolidation, significant changes in expenditure priorities, and a clear move towards budgetary transparency by way of including some important off-budget borrowings.

About this article

By D. K. Srivastava

EY India Chief Policy Advisor

A noted economist, D.K. Srivastava is an Honorary Professor at Madras School of Economics and Member of the Advisory Council to the 15th Finance Commission.

Related topics Tax