6 minute read 27 Feb 2020
Watering a plant

Has Budget 2020 provided adequate stimulus to the Indian economy?

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.

6 minute read 27 Feb 2020
Related topics Tax Tax planning

Show resources

Out of the fiscal deficit slippage of 0.5% points of GDP in FY20 and FY21, only 0.1% point in each year has been used for augmenting capital expenditure indicating a marginal fiscal stimulus.

Economic slowdown: real and nominal dimensions

By the time the FY21 budget was presented, it had become clear that both real and nominal GDP growth rates had significantly fallen. As per the Central Statistical Organization’s (CSO) advance estimates for FY20 and the first revised estimate (RE) for FY19, the real GDP growth for FY20 was estimated at 5.7% and the nominal GDP growth at 7.8%. In fact, both these growth rates have been falling over successive quarters since FY17, when the real growth rate was at 8.3% and the nominal growth rate was at 11.8%. Such a low nominal GDP growth translates into a low tax revenue growth, which has also suffered from a low tax buoyancy both for direct and indirect taxes in FY20.

The FY21 budget proposals need to be assessed in terms of four major considerations namely: (1) whether the FY20 RE of tax revenues are likely to be realized since these constitute the base year numbers for FY21 budget estimates (BE), (2) what is the true extent and quality of fiscal deficit in FY20 RE and FY21 BE, (3) what is the credible quantum of fiscal stimulus inherent in the budget proposals for FY20 and FY21 and (4) to what extent the proposed National Infrastructure Pipeline (NIP) is dependent on center’s budgetary support. These issues are discussed in detail in the February 2020 issue of the Economy Watch.

Budget FY21: starting with downward tax revenues projection

Considering the ongoing economic slowdown as also discretionary policy initiatives of the government, the union budget for FY21 kept the annual growth in center’s gross tax revenues in FY20 (RE) at 4% against a projected growth of 18.3% in the budget estimates of the budget presented in July 2019.

Center’s gross tax revenues for FY20 (RE) were lowered to INR21.6 lakh crore from the corresponding BE at INR24.6 lakh crore. The corporate income tax (CIT) revenues were revised down by INR1.55 lakh crore in FY20 incorporating the effects of the CIT rate reforms undertaken in September 2019 and the economic slowdown. Similarly, personal income tax (PIT) revenues in FY20 were revised down by INR9,500 crores while the indirect tax revenues were revised down by INR1.3 lakh crore. However, the actual tax revenues may fall short of even these lowered targets. As per the CGA data covering the first three quarters of FY20, there is a contraction in the center’s gross tax revenues of (-) 2.9%. This implies that in the last quarter of FY20, a growth rate of 19% over the corresponding period of FY19 is required to achieve the full year growth of 4% as envisaged in the RE. Such a high growth in the last quarter has not been achieved in recent years. Considering individual categories of taxes, this task appears uphill. In the case of PIT, to meet the full year RE, a growth of 51.6% is required in the last quarter of FY20 and for indirect taxes, a growth of 18% is required against an actual growth performance of only 0.1% in the first three quarters. If FY20 actual revenues, which would serve as the base for FY21, are lower than the RE, it would upset the FY21 BE projections. This revenue uncertainty might also affect the fiscal deficit projections.

Growth stimulating policy initiatives: pre-budget and budget

One of the most important policy reforms aimed at attracting investment particularly investment in the manufacturing sector was rolled out between the FY20 and FY21 union budgets in the form of an overhaul of the CIT structure as also the structure of the related exemptions and deductions. Although this reform offered a major concessionality to domestic companies, the related cost in terms of foregone revenues was borne by the government. According to the government’s estimates, the revenue cost could be as much as INR145,000 crores for FY20. In the October 2019 issue of the Economy Watch, we had estimated this cost for FY20 to be somewhat lower at close to INR1 lakh crore. The revenue impact of the CIT reform is immediate and would continue in successive years until CIT revenues pick up as a result of an increase in the corporate tax base, which depends on additional investment by current or new companies and their profitability. The base widening effect is expected to progressively neutralize the revenue eroding effect of the CIT rate reduction. However, its impact may only be felt after a few years.

In order to push up demand, the union budget FY21 relaxed the fiscal deficit targets from 3.3% of GDP to 3.8% in FY20 and from 3% to 3.5% in FY21. Additional stimulus was also introduced by providing an optional PIT rate structure and by abolishing the dividend distribution tax (DDT). The estimated revenue costs of these reforms amount to INR40,000 crores and INR25,000 crores respectively limiting the extent budgetary fiscal stimulus at a maximum of INR65,000 crores.

National Infrastructure Pipeline: promise and prospects

The most important demand enhancing policy initiative relates to the proposed NIP. This is a medium-term expansion plan covering the six-year period from FY20 to FY25. Its financing is to come from central government, the central public sector enterprises (CPSEs), the state governments including the state public sector enterprises (SPSEs) and the private sector.  Of these, it is the central government’s non-defence capital expenditure, which is pivotal. This is meant to leverage the investments from the state governments and their PSEs and the private sector. Examining the proposed investment path over the six-year period, the center’s average per year budget-based investment amounts to 0.9% of GDP. This may be compared with the actual non-defence capital expenditure of the central government in recent years, which is 1.1% of GDP on average per year. Therefore, the proposed NIP may not constitute an additionality in the form of non-defence capital expenditure financed by the central budget. It is this additionality which is critical for generating the positive multiplier effects over and above the current situation. The contribution of state governments and the private sector depends on their own resources and the nature of the projects they invest in.

Finance Commission and prospects of state finances

Another critical economic news in the context of fiscal policy relates to the first report of the Fifteenth Finance Commission (15th FC) pertaining to FY21. The report of the 15th FC followed an additional Terms of Reference (ToR) given to the FC, extending its term up to FY26. The reason that the Commission was asked to give only a one-year report relates to revenue uncertainties pertaining to union finances and the difficulties that the Commission is facing in making robust forecasts of union tax revenues for the next five years.

In its first report, the 15th FC made assumptions about GDP growth and the growth of union tax revenues which have already proved to be optimistic. The magnitude of union tax revenues in FY20 may fall well short of both the RE given in the budget and the FC estimates for FY20 as discussed earlier. This will also reflect in the magnitudes for FY21 since FY20 revenues provides the base year figures. Accordingly, states’ revenue receipts are also expected to face significant revenue uncertainty both because of lower transfers from the center and subdued own tax revenues due to the economic slowdown. This may hamper their capacity to complement center’s effort to bring about fiscal stimulus in the economy.

The final report of the 15th FC is to be submitted by end-October 2020. Forecasts for the union and state tax revenues may have to be made by May 2020. One may hope that by that time, current revenue uncertainty may be mitigated. At the present juncture, the fiscal capacity of both the central and state governments appear highly constrained to combat the ongoing economic slowdown.

Summary

The union tax revenues in FY20 may fall short of both the revised estimates given in the budget and the estimates in the first report of Fifteenth Finance Commission. Consequently, states’ revenues may face significant revenue uncertainty, hampering their capacity to undertake a fiscal stimulus.

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 Tax planning