Budget 2020 India: The Budget has left a slew of questions regarding GDP growth and state finances, and tensions around fiscal deficit numbers in its aftermath
Union Budget 2020 India: As the dust settles on the FY21 budget, there are some lingering questions we want to address, and points we want to reiterate:
Impact on growth
The fiscal situation was tight to begin with, leaving very little wiggle room. Reliance on non-tax revenues has been dramatically increased for the coming year. At a record high of Rs 2.1 lakh crore, disinvestment receipts are budgeted at 0.6% of GDP, higher than FY20.
If the asset sales target is met and enough money is available to support the budgeted expenditure, the fiscal impulse on growth could be meaningful, at about 0.4% of GDP. If there is some slippage on asset sales, for e.g., Rs 80, 000 crore, or 0.4% of GDP lower than expected, and expenditure has to be cut by the same amount to stick to the 3.5% fiscal deficit target, the fiscal impulse will be zero.
An even higher slippage on asset sales requiring a commensurate expenditure cut will impart a negative fiscal impulse.
Watch Video: What is Union Budget of India?
Sanctity of fiscal deficit target
The big question, then, is: Is there some flexibility around the 3.5% fiscal deficit target? If asset sales disappoint, can the deficit be increased instead of slashing expenditure?
The Centre has already triggered the escape clause in the FRBM Act for FY20 and FY21, which allows it to run a fiscal deficit that is 0.5% of GDP higher than what was budgeted. This has enabled the government to announce a fiscal deficit of 3.8% of GDP in FY20, and target 3.5% in FY21. Since the escape clause has already been used once, triggering it a second time for a given year may spark uncertainties around the FRBM Act.
But, triggering it again is not impossible either—even in the FY20 budget, the Centre was meant to establish a Fiscal Council, which would advise if the escape clause should be triggered at all. It triggered the escape clause without establishing the Fiscal Council. The bar for missing the 3.5% fiscal deficit target is high due to the legislation around it. But, it is not impossible.
Dependence on the National Small Savings Fund
The Centre’s reliance on the National Small Savings Fund (NSSF) has been rising. In FY16, 10% of the fiscal deficit was funded by the NSSF. That number has risen sharply to 30% in FY20. Alongside, NSSF has also been an important funder of the Centre’s off-budget spending, for example the unpaid food subsidy bill.
As India’s states moved on from borrowing from the NSSF to borrowing from the market (by issuing state bonds), NSSF funds became available for the Centre and the PSEs to dip into. And, prima facie, there is no problem with that. Issues arise when one looks into NSSF’s books and realises that the Centre and the PSEs have utilised all the extra space the NSSF had.
Relying on NSSF to fund 30% of the fiscal deficit can continue—the NSSF corpus increases gradually every year—but raising the proportion to much higher than 30% may not be possible. Henceforth, the Centre may have to look elsewhere for funding large unbudgeted increases in the fiscal deficit.
Squeezing India’s states?
Going by the revised estimates for FY20, revenues transferred from the Centre to the states seem to have fallen (see graphic). As per the 14th Finance Commission, 42% of gross tax collections was meant to be transferred to the states. Instead, 30% was shared in FY20 (versus ~35% in the last few years).
The Centre is expected to see a gross tax revenue decline of Rs 3 lakh crore this year (as per the RE numbers). The states are budgeted to see a decline of Rs 1.5 lakh crore. So, the states are sharing 50% of the losses, but only 30% of the gains.
How is this possible? One explanation is that the Centre is not required to share revenues from select cess and surcharges. And, the Centre has been levying more of these lately. In that sense, it may seem that states are getting squeezed. And this, in turn, will hurt their ability to spend. But, there is some additional complication in the data. The year-to-date numbers seem to suggest that tax transferred to states is falling at the same rate as the tax retained by the Centre. In contrast, the full fiscal year numbers show that transfers to states will fall much more than tax retained by the Centre (see graphic). This can mean two things. Either the states are expected to get sharply squeezed over the remaining months of the fiscal or the Centre has overestimated its share of tax revenues for the January-March quarter.
Cost of the corporate tax rate cut
The FY20 corporate tax revenues came in Rs 1.55 lakh crore lower than budgeted. But, all of this shortfall cannot be attributed to the corporate tax cuts alone. Some of it has also come on the back of the GDP growth slowdown.
One back-of-envelope method to distinguish between the two causes of corporate tax revenue shortfall is to increase last year’s corporate tax revenues by this year’s nominal GDP growth—that would give a sense of the shortfall due to the economic slowdown (assuming a tax buoyancy of 1). The remainder can be attributed to the tax rate cut. This shows that Rs 1 lakh crore (~70% of the Rs 1.55 lakh crore) shortfall is because of the tax rate cut. The remainder is because of the economic slowdown. When announcing the tax cuts, the government had assumed a Rs 1.45 lakh crore revenue loss. It ended up costing the government 70% of that.
Sudden urge to attract foreign inflows
In the budget, the Centre announced several incentives to attract foreign inflows, both equity and debt. Recently released data show that India’s household saving rate has been falling. If the country wants high sustainable growth, it must raise the investment rate. But, investment needs funding. If domestic saving is falling, the government is right to tap into foreign saving.
Another way of saying this is that in the Saving (S), Investment (I) and Current Account Balance (CAB) identity, whereby S – I = CAB, in order raise I at a time when S is falling, CAB will have to fall, needing more foreign inflows for funding.
Lack of steps for the housing and NBFC sectors
There was a concerted effort to minimise government incentives and interventions. This is in line with the 2020 Economic Survey, a chapter of which, using examples of interventions in the food trade and drug pricing, outlined that many times, government interventions end up undermining the ability of the market, leading to outcomes opposite of those intended.
This is the reason why there wasn’t any NBFC-related intervention, or any special incentive to get rid of the large stock of unsold houses. It also seems to be the reason the Centre wants to gradually take away the 70-odd personal income tax exemptions.
The author is Chief economist, India, HSBC Global Research Views are personal
Co-authored with AayushiChaudhary, Economist, HSBC Global Research
Edited excerpts from HSBC Global Research’s India Economics Comment (February 4, 2020)