Stimulus 3.0: The fiscal maths simply do not add up
November 14, 2020 5:45 AM
Without additional resources, we see a risk of a sharp contraction in overall government spending to minimise fiscal slippage
At the press briefing, the FM maintained that the additional borrowing already announced (worth Rs 4 tn or 2.1% of GDP) will be sufficient to fund all measures. In our view, the maths do not add up.
By Sonal Varma & Aurodeep Nandi The government’s fiscal interventions are increasingly shifting from income support to a demand boost, with a firm eye on the fiscal bulge. Close on the heels of a conservative set of demand measures in October, the government announced another set of measures aimed primarily at stressed sectors and employment generation. Four key themes emerge as the focus areas of today’s measures (see graphic):
1. Employment and livelihoods: For the formal economy, the government has announced a programme for firms to subsidise provident fund contributions of low wage workers that have been freshly recruited. For the rural informal economy, the government has expanded outlays for its public works programme. For farmers, it increased the budgetary outlay for fertiliser subsidies.
2. Construction and housing: Increased budgetary outlays for affordable housing and income tax sops to residential real estate developers and buyers. The government also relaxed norms for construction contractors to ensure ease of doing business.
3. De-stressing sectors: The government expanded the scope of its scheme of offering fully guaranteed and collateral-free credit to stressed sectors and entities—extending its duration, and now including more stressed sectors that are at the risk of restructuring. The aim is to ensure that the lack of liquidity does not lead to insolvency.
4. Boosting exports and reducing import dependence: The government intends to expand its existing Production-linked Incentive (PLI) scheme that offers incentives to manufacturing firms equivalent to 4-6% of incremental sales over the next five years, to include 10 more sectors (see graphic).
The fiscal cost of the measures announced totals Rs 2.65 tn, i.e. ~1.4% of GDP. However, the fiscal incidence on this year’s budget is likely to be much lower. The outlay of the PLI scheme is distributed over five years, and is unlikely to involve spending in the remaining five months of this fiscal year. The key item likely to affect the FY21 budget the most is the increase in the fertiliser subsidy of `650 bn (0.35% of GDP) if it comes over the already budgeted existing outlay of Rs 713 bn. Overall, we expect the current year’s budgetary impact from the measures announced today to be Rs 1.2 tn (~0.64% of GDP).
We expect the central government’s fiscal deficit to balloon to 8.3% of GDP in FY21 (year ending March 2021) vs the original budgeted target of 3.5% of GDP, with risks skewed towards an even higher deficit. The latest round of announcements highlight three broad priorities of the government.
First, measures to incentivise job creation and credit guarantees for the stressed sectors are aimed at minimising the scarring effects of the pandemic (higher unemployment and bankruptcies). Second, with the pandemic under control, much of the economy having reopened and interest rates on housing loans also sharply lower, the government is using this opportunity to boost the housing sector, which is employment-intensive and has multiplier effects on sectors such as steel and cement.
Third, the PLI scheme is a medium-term supply-side reform that takes advantage of global value chains diversifying away from China. Hence, the government has adopted a targeted strategy on both the demand and the supply-side.
The funding of these measures remains a key puzzle. At the press briefing, the FM maintained that the additional borrowing already announced (worth Rs 4 tn or 2.1% of GDP) will be sufficient to fund all measures. In our view, the maths do not add up.
Across the three stimulus measures announced so far, total additional cash outgoings from the budget amount to 1.8% of GDP. Meanwhile, revenue collections on tax, non-tax and disinvestment proceeds are running 5% of GDP below the budgeted target, even after assuming a recovery in tax collection in the remaining months.
Hence, the total budgetary shortfall (higher spending + lower revenues) is around 6.8% of GDP, much larger than the additional borrowing (2.1% of GDP) announced so far. Possibly reflecting the strained fiscal position, government spending is already in contraction mode; it fell -15.2% y-o-y in August and -26% in September. We believe that other sources of financing (small savings, T-bills) are unlikely to be enough to plug this funding gap, and the government is likely to choose between borrowing more, later in the year, cutting other expenditures, or a mix of both.
From an economic perspective, therefore, while the headline stimulus announcement in the third package is much larger than the second one, we see growing risks that overall expenditure will still be contractionary, and is unlikely to result in a positive growth impulse.
However, the focus on the housing sector, at a time when banks are also keen on retail lending, could lead to some vigour in this sector. We maintain our growth forecasts, with GDP growth likely to improve to a still-weak -10.4% y-o-y in Q3 (July-September), from -23.9% in Q2, before averaging around -4.5-5% in Q4 and Q1 2020, due to contractionary fiscal policy, fading pent-up demand and weaker global growth due to rising infection cases in the US and Europe.
Edited excerpts from Nomura’s Asia Insights (dated November 12)
Varma is chief economist, India and Asia ex-Japan, and Nandi is India economist, Nomura Views are personal