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

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).

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.