Union Budget 2019: So, if a government adopts a fiscal consolidation strategy at a time of no fiscal space but with pressures of reviving growth, how does it set its fiscal policy?
Budget 2019 India: With decelerating growth, an amply evident slowdown of consumption and the exceptional Rs 1.6 trillion shortfalls in revenues last year, the government’s challenge of weighing a countercyclical fiscal response against the tight financial constraints was understandably tough. The budgetary check was binding even more because of the visible, undesirable effect of excessive public borrowing upon interest rates and thereby private investments.
How does the Budget fare in this light? And what possible impact might this balancing have?
To start with, the government has done the right thing in sticking to the fiscal consolidation path. Not only has it stuck to the fiscal deficit target of 3.3% of GDP, it has gone one step ahead and included the extra-budgetary resources it has been raising into the stock of central government public debt—at 0.7% of GDP last year, the addition of extra-budgetary liabilities show the debt-GDP ratio at 48% of GDP in FY20 against an estimated 47.3% a year ago. The Centre’s public debt-GDP ratio is seen declining 40 basis points from 48.4 last year. Equally laudable is the medium-term target outlined by the government to reduce accretions to the EBR stock to zero in five years’ time.
So, if a government adopts a fiscal consolidation strategy at a time of no fiscal space but with pressures of reviving growth, how does it set its fiscal policy? How does it stimulate growth and stick to fiscal consolidation at the same time? With such a macroeconomic configuration, a government should not raise taxes (procyclical) and more specifically, focus on revenue expenditure reform to move scare resources to public capex to encourage growth. On this measure, the Budget scores very poorly. There should have been dramatic revenue expenditure reforms to release resources for spurring growth. Unlike structural reforms, expenditure reforms are very much a part of the Budget, which makes no such effort.
There is no cut in subsidies, where their respective shares in GDP remain constant. Even the food subsidy, which could have constituted a great start for reforming expenditure at an optimal time of low food prices, increases by Rs 129 billion. It is most unfortunate that there not even a single reform step in this direction to carve out space for scaling up public expenditure.
This aside, many commentators have noted the discord in growth assumptions underlying the budgeted revenues.
Specifically, these are predicated upon the older, revised estimates of FY19 (RE) instead of the most recent, provisional estimates (PE) that have been published by the government accounts controller. The problem is the vast gap in tax revenue growth between these two sets of estimates: Substitute PE in place of RE to see the incredibly overoptimistic projections: in reality, net tax revenues would have to grow nearly double the more sober growth rates shown in the Budget, personal income taxes would have to grow more than three times and GST revenues would have to increase four-fold! The government is not oblivious to these factors, but is hoping to turn the tide.
To be fair, the government has not departed from tradition—in FY15 too, the full Budget rested upon revised estimates for FY14. But then the Interim Budget was presented in March, when a reasonably credible idea of tax collections is obtained. The problem is that since then, the Budget presentation has advanced to February 1, when there is little or no information available about the last quarter’s outturn. This is leading to larger gaps between revised and provisional tax revenues. In turn, this is becoming an issue of credibility and a source of uncertainty. The government must re-look this pattern in the context of advancing its Budget presentation time.
Consider last year’s (FY19) revenue performance in this context: Overall net tax revenues grew a mere 6% on comparable base against the 21% budgeted growth; income taxes grew 13% against a projected 20%. The revenue deficit as per CGA’s provisional estimates is actually 2.3% of GDP even as the FY20 Budget based upon revised estimates continues with 2.2% of GDP!
So, while markets may have responded positively to fiscal discipline of the 3.3% line, as also the prospects opened by the sovereign borrowing abroad in foreign currencies, reality is bound to sink in sooner than later once agents have seen through the numbers. All stakeholders go by the latest information on revenue outturns no matter what the FY20 Budget may show.
The real consequences of such overoptimism on the revenue side could be serious and negative for growth should actual performance not match projected outcomes. GST revenues have grown a measly 7.2% in April-June so far, while corporate revenue growth was -51% in April-May. These facts are neither unknown nor gone unnoticed. A replay of last year’s interaction between overoptimistic revenues and sharp expenditure compression with dire growth consequences cannot be ruled out therefore. In the second half of last year (FY19), as tax revenue collections lagged severely behind, the government was forced to cut spending, pulling down growth into a vicious spiral compounded by the negative shock of the NBFC crisis. While total expenditure cut was 6% against revised expenditure estimate, the pressure to retain spending in an election year spilled over upon off-budget borrowings and subsidy rollovers with disturbing consequences for long bond yields and monetary policy transmission.
There is some hope that RBI may decide to transfer a good sum of past reserves to the government. We don’t know yet its quantum and if this comes free of conditions attached. Once agents have seen through the actual revenue performance and factor that in, bond yields could respond adversely. Uncertainty could increase as agents speculate on how the government could possibly meet its targets—through off-budget borrowings, even more subsidy rollovers, and so on. On its part, the government could once again be compelled to cut expenditure, extracting a cost from growth and causing uncertainty on this front as well. Producers would bear the brunt of higher interest rates and the refusal of monetary easing to transmit. Consumers would suffer from reduced spending as expenditures are squeezed. The promise of sustained welfare spending in the first Budget of the second tenure of the government may not materialise.
The government selling an aspirational goal of a $5-trillion economy by 2024-25 must remember the old adage ‘hope is not a strategy.’ It must come to terms with prospects of low tax revenues, focus upfront upon divestment proceeds and other non-tax revenue sources. A return of fiscal dominance could close the window for further easing of monetary policy; it would also disincentivise global capital the Narendra Modi government plans to attract.
(The author is a New Delhi-based macroeconomist)