Feasible fiscal path
Quality of expenditure shouldn’t be compromised
Union Finance Minister Nirmala Sitharaman will present what is perhaps the most consequential Budget in recent history on February 1. The broad direction of the Budget will be critical in determining the medium-term outlook for the economy. Apart from the broad policy thrust, it would be vital to see how the government intends to manage its finances. The Covid-induced economic disruption, which is projected to cut the size of the Indian economy by 7.7 per cent in real terms during the year, has significantly affected the government’s revenue and expenditure. The fact that government finances were already under pressure even before the Covid crisis only complicated matters. The fiscal deficit in 2019-20 is estimated to have gone up to 4.6 per cent of gross domestic product (GDP), compared to the Budget estimate of 3.3 per cent of GDP. The final fiscal deficit number for the current year is bound to go up considerably from the budgeted 3.5 per cent of GDP.
As revenues fell sharply in the first half of the year, the government increased its borrowing target by about 50 per cent to ~12 trillion. While the revenue collection is improving with a pick-up in economic activity, analysts expect the fiscal deficit to expand to about 7 per cent of GDP for the year. Thus, the real challenge for the finance minister will be to design a credible medium-term path for fiscal consolidation. To be sure, the government has the option of delaying the fiscal consolidation process and focusing on growth in the immediate short run. However, it would do well to front-load the consolidation in the next fiscal year itself. The revenue collection will improve significantly on the back of higher growth, though from a lower base. Delaying fiscal consolidation can push up public debt, which is expected to go up to about 90 per cent of GDP in the current year. Rising public debt can affect growth in the medium to long term and increase risks to macroeconomic stability. The government should also use this opportunity to clean up its finances and end the business of creating off-budget liabilities. This will certainly increase the headline deficit, but make government finances more transparent and boost market confidence.
The government is reportedly preparing a glide path to bring down the fiscal deficit to 4 per cent of GDP by 2025-26. This could be a tough ask, particularly if off-balance sheet items are also added. Further, the government benefited materially by increasing taxes on petroleum products in the current year, which may need to be rolled back to some extent because of rising oil prices. While it’s good to have an ambitious target, the government will need to make sure it doesn’t end up tightening too much too quickly, which will affect economic recovery. Besides, a lot will depend on the quality of expenditure in the coming years. The government will need to push capital expenditure. This will not only generate demand immediately but also increase potential growth. Resources for increasing capital expenditure can be generated by an aggressive asset sale. The government should use the equity market buoyancy to its advantage and aggressively offload stake in public sector companies to generate resources. On balance, it will be critical for the government to ensure that the quality of expenditure is not compromised in the consolidation process.