The impossible trinity facing Budget 2021-22 What has been the nature of the fiscal response so far?

The Indian economy has been hit by two distinct shocks during the pandemic. The first shock, similar to many other contraction phases, reflects a sharp reduction in investment and exports, leading to a drastic decline in output and employment. However, the second shock is unique to the pandemic and involves a drastic change in the pattern of aggregate demand due to the technological-cum-structural changes unleashed by the pandemic. Such changes include a shift in expenditure against sectors which provide face-to-face services and are less amenable to remote work. In India, these sectors typically provide a livelihood for lower-income workers. A contraction in demand for these sectors entails an additional squeeze on the incomes of the poorest. An effective counter-cyclical strategy should keep both these challenges in mind. Whether or not the forthcoming budget can deliver on this depends on how the government deals with an impossible trinity.

With respect to the November 2019 figure, the November 2020 deficit ratio was 1.5 percentage points higher. A break-up of different components of the sources of fiscal deficit shows that while the KX, NKPX and interest payments (IP) are lower than what they were up to March 2020, corporation tax is a major source of a rise in the fiscal deficit. To be sure, a shortfall in other taxes (other non-debt receipts) has also shown an increase. The rise in cyclical component indicates the effect of lower GDP on the fiscal deficit ratio.