Weighed down by lower tax revenues, empty non-tax revenue coffers and expenditure compression, the fiscal fallout could hurt private investment and growth.
In August 2018, we had pointed out (bit.ly/2T4U3SZ) how the Central government had been cornering much of the financial savings through off-balance sheet borrowings, thus pushing up long-term yields, and possibly ‘crowding-out’ private investment. The recent CAG audit report for FY17 of the FRBM Act, 2003, reveals more—it documents three known case studies of off-budget financing of revenue expenditure. Subsidy-related liabilities totalled to Rs 1.29 trillion or 0.85% of GDP in FY17 on dues to Food Corporation of India (FCI), private fertiliser companies and NABARD-funded irrigation scheme. Such off-budget financing isn’t new. The previous UPA government did the same. Only the amounts snowballed gradually. However, what is important to note is that the Central government collected enormous oil tax revenues of Rs 2.73 trillion in FY17, nearly Rs 1.47 trillion more than the Rs 1.26 trillion collected in FY15. These additional oil revenues could easily have paid for the above dues, had there been intent!
This apart, the current NDA government has also been particularly aggressive in off-budget capex financing to boost infrastructure investment. The CAG report documents two more case studies on off-budgetary capex financing by Indian Railway Finance Corporation (IRFC) and Power Finance Corporation (PFC). Here, the total liabilities aggregated Rs 3.05 trillion or 2% of GDP in FY17. And few more such entities could be borrowing as aggressively, especially the National Highway Authority of India (NHAI). It is an easy guess that such unpaid arrears and off-budget capex funded by fresh borrowings from the NSSF, LIC, banks or bond market have further increased in FY18 and FY19, gobbling up scarce financial resources, and crowding out private investment.
Market analysts largely ignored such concerns in the last three years as inflation declined while private investment remained subdued. But with early signs of private investment turning around, this would be hard to overlook. It could hurt the government’s claim on reasonable fiscal consolidation; raise doubts on the new debt consolidation road map. The immediate policy concern is to find ways to pull back, since rising interest rates with falling inflation could regenerate debt sustainability concerns.
Where is the fiscal space, however? On the revenue side, waning GST collections are alarming: December 2018 collections fell to Rs 94,726 crore, way below the government’s anticipated Rs 100,000 crore or more. The monthly average (April-December 2018) in FY19 is `96,782 crore and this is unlikely to improve in the last quarter considering projected economic activities are tapering off and GST rates on several items have been reduced, while exemption and composition scheme turnover thresholds have been raised to Rs 40 lakh and Rs 1.5 crore respectively.
The broader picture looks ominous. By current showing, average monthly growth in GST revenues in FY19 could be just 7.7% over the Rs 89,885 crore collected on average each month from August 2017 to March 2018. The comparison is certainly not alike as the GST Council has been reducing tax rates on several items, which would overstate the base somewhat. GST revenue growth rate may thus be slightly more, around 8%, which is still worrying when seen in relation to CSO’s advance estimate of 12.3% nominal GDP growth. It is not clear if initial GDP projections are over-optimistic and may later be revised down sharply, but the concern ahead ought to be how the Central government meets the 14% SGST revenue growth promised to all state governments for the next three years!
It is perplexing that, even after a year and a half, policymakers and analysts still escape/evade any serious scrutiny of the current GST regime. The optimism around GST to be a revenue spinner has come a cropper. In the event, a disproportionate burden could shift to direct taxes, collections of which, too, display early fade-out signs despite the record tax-return filings. Additionally, declining non-tax revenues—especially PSU dividends—could stretch the fiscal situation further. The sharp escalation in both scale and pace of PSU dividend payouts—an average of 29% growth in FY15-FY17, in which FY17 amounts doubled over FY14 levels—has emptied out this resource; in FY18, PSU dividend growth slowed to 5.7% against the projected 30%, as have ingenious disinvestments through convenient share buybacks of some public entities. It is no surprise in this light that the fiscal eye is now fixed upon higher dividend payouts by RBI as well as surplus capital transfers for which a committee has been appointed to draw a framework.
Topping all this are election-related populist expenditures such as loan waivers announced by newly elected state governments in Rajasthan, Madhya Pradesh and Chhattisgarh; cash payment schemes such as Kalia in Odisha; increased urea subsidy in Uttar Pradesh, and so one. These will have unpleasant side-effects of squeezing most fiscal spaces at states’ level. At the Central level, too, impending announcements of election giveaways for farmers are awaited.
So what has suddenly unfolded is a serious fiscal situation. A substantial revenue shortfall is anticipated this year which is not just confined to tax revenues but extends to non-tax revenues as well. PSU dividends have been largely extracted and dried out; spectrum and telecom revenues are affected by financial stress. Planned revenue and capital spending could collapse this year as election-related revenue expenditures are propped up and more subsidy expenses are passed over to FY20. Markets already expect these trends, including the damaging impact of reduced public expenditure upon economic growth.
The medium-term implications of prolonged, borrowing-financed revenue and capital spending by the Central government in conjunction with declining tax revenues and the emptied coffers of non-tax revenues are just as serious. Two effects are already visible. Firstly, the expected stimulation from the public investment multiplier has not materialised—growth has instead decelerated, while private investment hasn’t revived. Two, the adverse fallout of a borrowings-financed fiscal expansion amidst deceleration in financial savings, viz. crowding-out and higher borrowing costs have begun to emerge. Going forward, private investments will face higher cost of capital and a hike in the effective tax rate as the government is constrained by wider revenue deficits from the draining out of resources as explained above.
The unfortunate part is that this deterioration in the fiscal profile has come about despite an exceptional, positive terms-of-trade shock which fetched windfall oil revenues of Rs 10.3 trillion over the last four and half years. With such a bounty, it truly astonishes that spending quality could not be genuinely improved by freeing resources assigned for discretionary or subsidy expenditures to raise public capex levels. Such reorientation of public expenditure has yet to be achieved. This would not only have limited government borrowings, on- or off-budget, but provided the exact environment for eliciting the intended, positive effects of the public capex stimulus. What has unfolded instead is an alarming situation—lower tax revenues, empty non-tax revenue coffers, and expenditure compression that will, of course, weigh upon growth. It is hard to see how higher borrowing costs and effective taxes can be avoided.