7 !{ArticleDetails-ReadTime} 28 Dec 2020
Union budget 2021 expectations – EY India

Will high divergence between expenditure needs and revenues severely constrain budget 2021’s growth push?

!{LinkedContent-author-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.

7 !{ArticleDetails-ReadTime} 28 Dec 2020
Related topics Tax

This issue of Economy Watch examines whether the continuing fiscal weakness will severely constrain the much-needed growth push in the upcoming Union Budget 2021.

The International Monetary Fund (IMF), in its October 2020 issue of the World Economic Outlook had projected a sharp contraction of (-)10.3% in FY21 for India. However, after the subsequent release of the 2QFY21 GDP data which showed a milder contraction of (-)7.5% as compared to (-)23.9% in 1QFY21, many analysts assess India’s recovery to be better than the IMF’s assessment. For example, Rangarajan and Srivastava (2020)[1] assess the FY21 full year GDP growth to be in the range of (-)6.0 to (-)7.0%. The Monetary Policy Statement issued on 4 December 2020 by the RBI assesses mild positive GDP growth rates of 0.1% and 0.7% in 3Q and 4Q of FY21. These together with the CSO’s real GDP growth estimates of 1Q and 2QFY21 take the estimate of contraction in real GDP to (-)7.5% in FY21. This implies that the large contraction in 1QFY21 would be roughly neutralized by mild recovery in 3Q and 4QFY21. With the likelihood of a strong base effect in 4QFY21, the recovery in this quarter may turn out to be higher than what is being expected by the RBI, particularly if fiscal support gathers momentum January 2021 onwards.

Assessment of FY21 fiscal deficit

The central government had announced a borrowing target of INR12 lakh crore on 8 May 2020[2]. If the government insists on adhering to this target for FY21, it would amount to 6.3% of the estimated FY21 nominal GDP at INR190.5 lakh crore. However, given the revenue trends, this level of fiscal deficit would involve a contraction in government expenditures. In the first seven months of FY21, center’s gross tax revenues have contracted by (-)16.8%. Center’s non-tax revenues also showed a contraction of (-)48.2% during this period. Even with some improvement in direct tax revenues in the remaining months of FY21, we assess that there would be a contraction of about (-)14.5% in center’s gross tax revenues for the full year. Non-tax revenues and non-debt capital receipts may also continue to languish well-below the FY21 budget estimates. At these levels, considering a fiscal deficit of 6.3% of GDP for the full year, there would still be an expenditure contraction of (-)15.5% as compared to budgeted FY21 expenditure level. With an enhancement of fiscal deficit of say, up to 6.9% of estimated GDP, this expenditure contraction would be moderated to (-)11.7%. This will finance an expenditure of INR26.9 lakh crore, which is exactly equal to the actual expenditure in FY20. This may serve as a benchmark to consider the contours of Union Budget 2021 (FY22).

Prospects of Union Budget 2021: divergence between expenditure needs and revenues

The mainstay of the union government budget consists of centre’s gross tax revenues. The Ministry of Finance (MoF) has to assess the base magnitude in FY21 and the growth rate that can be applied on it in order to project centre’s gross tax revenues for FY22. There was a contraction in centre’s gross tax revenues even before the Covid shock hit the Indian economy. In FY20, centre’s gross tax revenues fell by (-)3.4%. As discussed above, in FY21, the contraction is expected to be sharper. This implies that in absolute numbers, the base figure for gross tax revenues estimated at INR17.2 lakh crore in FY21 would be well-below the actual gross tax revenues of INR20.1 lakh crore in FY20. In fact, centre’s gross tax revenues were at INR17.2 lakh crore in FY17. Given the structural changes in GST and CIT in recent years, nominal tax revenue growth rate may be expected to be less than the nominal GDP growth rate. The expected buoyancy of centre’s gross tax revenues in FY22 may be similar to that in FY19 at 0.8. In fact, in FY20, it had become (-)0.5. The IMF has projected India’s FY22 nominal GDP growth at 12%. It would be unrealistic if the MoF considers a growth in centre’s gross tax revenues at any rate higher than 10%. Thus, centre’s gross tax revenues may be estimated for FY22 at INR18.9 lakh crores (Table 1).

Table 1: FY22 union budget: broad contours

FY22 union budget: broad contours

Source (basic data): CGA, Union budget FY21, MoSPI, IMF and EY estimates

Even as revenues eroded, centre’s expenditures continued to increase although at rates that were much less than desirable in the face of an economic slowdown in FY20 and FY21. Total expenditure in the first seven months of FY21 grew by only 0.4%. It may be noted that centre’s total expenditure in FY21 was budgeted at INR30.4 lakh crore, a growth of 13.2% over FY20 actuals. Taking into account a fiscal deficit level of 6.9% of nominal GDP for FY21, we estimate that the central government may be able to finance a total expenditure of INR26.9 lakh crore which may serve as the base number for the FY22 budget. If at least a growth of 10% is provided on this base figure, the FY22 total expenditure would work out to be INR29.5 lakh crore which is lower than what was budgeted for FY21. But financing this would require a fiscal deficit of 6.8% of GDP. Thus, the way the resource gap has evolved, financing even a moderate increase in expenditure would call for departing from the FRBM norm in FY22 and beyond for some more years. This trend may be arrested only if center’s gross tax revenues begin to show a sharp increase in buoyancy.

Why may the US$5 trillion target be delayed by about six years?

Given this continuing fiscal weakness, budgetary push to growth is likely to remain constrained thereby delaying India’s ambitious target of becoming a US$5 trillion economy by FY25.  Even if India achieves a GDP growth rate in the range of 7 to 8% in the medium-term, we will experience delay in achieving this target, which may be considered largely an outcome of the Covid shock. In Chart 1, we consider three simulations namely, S1, S2, and S3 corresponding with real GDP growth rates of 6%, 7%, and 8% respectively. These are applied from FY24 onwards. FY21 reflects the Covid shock, FY22, a very strong base effect, and FY23 indicates a normalization of growth which is the base year. These three years are independently projected using the OECD projections (December 2020) as a reference point.

Chart 1: Expected slippage from the US$5 trillion target: simulations

FRBMA targets

Source (basic data): IMF, MoSPI, RBI, and EY estimates

The original year for reaching the US$5 trillion target was FY25 but by this time, the Indian economy would reach a size of US$3.4 trillion, missing the US$5 trillion target by US$1.6 trillion (S1). Taking a real growth rate of 7%, this target would be achieved in FY31 (S2). This is to say that the Covid shock, largely if not entirely, would have effectively delayed reaching the US$5 trillion target by six years (Table 2)

Table 2: India’s nominal GDP levels (US$ trillion) under alternative simulations

India’s nominal GDP levels (US$ trillion) under alternative simulations

Source: EY estimates
Note: FY23 indicates the base year

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Given the continuing fiscal weakness, budgetary push to growth is likely to remain constrained thereby delaying India’s ambitious target of becoming a US$5 trillion economy by FY25.

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!{LinkedContent-author-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