The latest estimates suggest that India’s economic output in 2021-22 is likely to, once again, reach the level it was at in 2019-20. If this happens, the pandemic would have delayed India’s journey to prosperity by two years. These two years have obviously been difficult for much of the economy, more so because the economy had already been slowing down – the growth rate had decelerated from 8.3% in 2016-17 to 4% in 2019-20.
During the pre-pandemic period, a few other emerging markets like Brazil, South Africa and Turkey saw similarly sharp slowdowns, while others like China, Indonesia and Malaysia saw only modest decelerations. Overall, the growth data from this period does not paint a picture of a global crisis, but rather, of varied outcomes. India was one of the countries where the slowdown was considerable.
Beyond the GDP numbers, the decade-long sluggishness in new private investments and exports did not augur well for India’s growth prospects.
The fiscal situation before the pandemic
Fiscal management in the pre-pandemic years needs to be considered against this backdrop. Certain facts about fiscal management during these years are worth keeping in mind while interpreting the numbers provided in budget documents and these numbers need to be adjusted for proper interpretation. But first, a brief overview of the fiscal context just before the pandemic.
The economic slowdown and the introduction of the Goods and Services Tax (GST) had created challenges for revenue collection. The Union government’s gross tax receipts (excluding the GST compensation cess, which is collected in lieu of state governments’ revenue collection and passed on to them) fell from 11.2% of GDP in 2016-17 to 10.1% in 2019-20. This decline was on account of a fall in indirect taxes, while direct taxes increased in the same time period.
Following the 14th Finance Commission’s recommendation, the states’ share in the Union government’s taxes had been increased from 2015-16 onwards, while some other transfers were discontinued or cut down to partially offset the impact. To make things more challenging, in 2017-18 and 2018-19, non-tax revenues (mainly, dividends and proceeds from telecom spectrum sales) were low, and in 2019-20, disinvestment receipts failed to meet the budget expectations.
Since the economy was slowing down, there were demands for greater expenditure. Since 2019 was the year of a general election, expenditure cuts were not on the table and the government made efforts to support the economy through fiscal measures.
Between 2017-18 and 2019-20, the government’s final consumption expenditure grew at an average rate of 8.7% while the average GDP growth was 5.8%. New measures, such as cash transfers for farmers, were introduced. In 2019-20, government expenditure was the only engine of growth that was still firing. In 2019, the Union government announced tax cuts for corporates in the hope of reviving investments.
The Union government ran large fiscal deficits and primary deficits in the years before the pandemic. Just before the pandemic, in 2019-20, the gross fiscal deficit of the Union government was 4.6% of GDP and the primary deficit (borrowing to meet interest payments) was 1.6% of GDP. Even after cyclical adjustments, the deficits were large. However, the government did not think this was enough. Faced with such situations, governments tend to get ‘creative’.
In addition to delaying fiscal consolidation, the Union government also tried other means to create more fiscal headroom for itself. The government pushed some of its expenditure off-budget and started meeting some of the expenditure through off-budget borrowing – bonds, fully serviced by the government, were issued by public sector agencies, the National Small Savings Fund (NSSF) was made to lend to the Food Corporation of India (FCI) to meet the expenditure on food subsidy and so on. These practices started in 2016-17 and kept growing thereafter. By March 31, 2020, the NSSF loan outstanding with the FCI amounted to Rs 2,54,600 crore.
The recapitalisation of public sector banks was also done through off-budget or ‘below-the-line’ securities. The government also raised cesses and surcharges, especially on petroleum products, as such collections are not shareable with the states. What’s more, the government also sold some public sector enterprises to other public sector enterprises to get cash from them. These are just some of the ad hoc measures taken to ease fiscal constraints.
Act 1: The pandemic hits
For budget management, the years between 2016-17 and 2019-20 were challenging. And then, the pandemic hit.
On account of the fiscal policy in the preceding years, the room for discretionary fiscal intervention was restricted. Still, the government doubled the fiscal deficit to 9.2% of GDP in 2020-21 (provisional actuals), and the primary deficit was at 5.8% percent of GDP. Almost the entire increase in deficit in 2020-21 came from increased expenditure, as non-debt receipts as a percentage of GDP remained about the same as what they were in 2019-20.
One adjustment that must be made while interpreting these numbers is for the expenditure on account of some of the previous years’ off-budget borrowing being brought onto the budget. The government took the opportunity of the pandemic to clean up its books by bringing a large part of this debt on its own budget and by stating that it will discontinue the practice of using the NSSF for financing the FCI. But it seems the practice of NSSF lending to other public agencies will continue, albeit to a smaller extent, as the budget did provide for some fund flow from the NSSF to such agencies.
While in previous years part of the expenditure was incurred through off-budget borrowing, some of the expenditure in 2020-21 was towards discharging this off-budget borrowing for expenditure incurred in those years. Without considering this, the year-on-year change is misleading. The fiscal deficit in 2019-20 would have been higher by about 0.6% of GDP even if we conservatively add only the net lending from the NSSF to the FCI and the bonds issued by public sector agencies that are fully serviced by the government. The reason why we are not considering NSSF lending to other public agencies for this calculation is that it is not clear to what extent that was a substitute for government grants. So, the deficit would have been about 5.2% of GDP.
The decision to bring some of the previous years’ off-budget debt on the budget made the deficit in 2020-21 look higher than it was. Although we do not have information to give a precise estimate, even if we only deduct the net payment made to the NSSF to partially discharge the debt to the FCI, the deficit for 2021-22 would be smaller by about 0.7% of GDP.
So, after accounting for this extraordinary discharge of off-budget debt, the deficit was around 8.5% of GDP in 2020-21. This implies an increase in deficit to the tune of about 3.3% of GDP over the previous year. This was mostly on account of increased expenditure – 0.5% in capital expenditure and 2.8% in revenue expenditure.
What was this increase in expenditure directed towards? The increase in revenue expenditure was mainly towards interest payments (0.5% of GDP); food subsidies (0.4% of GDP, after netting out the adjustment for off-budget debt); transfers to states and union territories, mainly the special transfers to the newly formed UTs of Jammu and Kashmir and Ladakh, and post devolution revenue deficit grants based on Finance Commission recommendations (0.4% of GDP); fertiliser subsidy (0.3% of GDP) and rural development, particularly employment guarantee (0.4% of GDP).
The main avenues for increased capital expenditure were roads and highways (0.14% of GDP); defence (0.13% of GDP) and railways (0.22% of GDP).
Even after adjusting for the discharge of off-budget debt, the total expenditure was double the total non-debt receipts in 2020-21 and is budgeted to exceed the non-debt receipts by 74% in 2021-22. The government’s fiscal response to the 2008 global financial crisis was relatively more modest; the expenditure had exceeded non-debt receipts by 62% and 69% in 2008-09 and 2009-10, respectively. While that crisis was also nothing like the present crisis, the fiscal response to that crisis is now widely seen as excessive; leading to years of macroeconomic challenges for India.
This should also be seen in a comparative context. India’s discretionary fiscal response to the pandemic has been close to the median among emerging markets and basically consistent with its level of income. Most of the countries that made larger fiscal interventions were richer than India. The IMF estimates that by April 2021, the median on-budget fiscal response for emerging markets was 4% of GDP. Also, as a percentage of its GDP, India’s discretionary fiscal response was larger than some richer emerging market economies (EME) like Mexico, Turkey and the Philippines.
It is not reasonable to compare India with the advanced economies; for them, the median size of the discretionary fiscal response was more than 16% of GDP by April 2021. Even with its fiscal response, India’s public debt to GDP ratio at the end of 2020-21 was the highest among comparable EMEs (those rated BBB). The debt to GDP ratio was budgeted to fall marginally in 2021-22. The Union government’s interest payment was about 45% of revenue receipts in 2020-21 and it is budgeted to be more than 45% of the revenue receipts in 2021-22.
India’s discretionary fiscal response also came in the form of liquidity support, mainly as guarantees for loans and as equity and loans. As of July 2021, the liquidity support was 5.2% of GDP, while the median for emerging markets was 2.6% of GDP. Only a few other emerging markets had larger responses in this form. However, this number is the aggregate of the limits announced by the government. Actual utilisation of the guarantee facilities would be less than the upper limit.
This is an unusually high level of contingent liability for the government to take on. To benchmark this, the total outstanding guarantees given by the government as of March 31, 2020 were only 2.3% of GDP. The expenditure consequences of these interventions will be realised only in the years to come.
Act 2: the recovery begins
Now we turn to fiscal management in 2021-22. The deficit budgeted for 2021-22 is 6.5% (based on present GDP estimates), with the primary deficit aimed to be 3% of GDP. This implies a fiscal consolidation of about 2% of GDP, when compared to the deficit for 2020-21 (after adjustments, as discussed earlier). The budgeted non-debt receipts as a percentage of GDP are about the same as the actual collection in 2020-21. So, the consolidation is supposed to be done through cuts in expenditure as a percentage of GDP. While the nominal expenditure budgeted for 2021-22 is about the same as the provisional actual expenditure in 2020-21, due to the bounce-back in GDP (nominal GDP growth estimated to be about 17.6%), the consolidation appears large.
From 2020-21 to 2021-22, the main change was that the focus of the budget was shifting from providing relief to stimulating growth. Therefore, the budget laid emphasis on capital expenditure. While the revenue expenditure was budgeted to fall marginally, the capital expenditure was budgeted to rise by 26% year-on-year and comprise 16% of total expenditure.
While this does not appear to be that large, it actually marks a big increase since the average share of capital expenditure in total expenditure between 2010-11 and 2019-20 was only 12.8%. The cuts in revenue expenditure are spread across many areas.
Since this fiscal year began with the ferocious second wave of the pandemic, there were worries that the fiscal strategy would become irrelevant.
There were many risks; the receipts budget may not be realised because of the dampening of economic activity during the second wave; the capital expenditure push may suffer because of restrictions in response to the wave; there may be more demands for revenue expenditure, especially to give relief to those affected by the second wave. The second wave was not expected when the budget was made, debated and approved and thus, some adjustments were expected.
Provisional estimates of actual receipts and expenditure are available for the period between April and November in 2021. The estimates for these eight months indicate a few trends.
First, while the revenue expenditure has outpaced capital expenditure, the capital expenditure push also seems to be going at a reasonable pace. About 60% of the budgeted revenue expenditure and about 50% of the budgeted capital expenditure had been incurred by November. However, in key infrastructure areas, – roads and highways, railways, housing and urban affairs (for metro projects) – about two-thirds of the budgeted capital outlay had been spent by November.
The fear in India is often that capital expenditure would not be done within the timeframe. But the provisional estimates suggest that until November, capital expenditure in these areas was happening at a reasonable pace, in spite of the setback of the pandemic’s second wave.
Second, there would have to be adjustments across areas of expenditure as it seems that the expenditure on some schemes will, most likely, exceed the budget estimates by a significant margin, while the actual expenditure in a few other areas will fall well below the budgeted amount.
For the employment guarantee, more than 70% of the budgeted amount had already been spent by November and many people who had demanded work through the scheme were still waiting for the same. Similarly, about 70% of the food subsidy budget had also been used by November.
On the other hand, the department of drinking water and sanitation had utilised only about 30% of its budgeted amount. It is worth noting, however, that the budget for this department was more than triple of the actual expenditure last year. It is likely that not all of the amount will be spent. The department of school education and literacy had spent only about 40% of its budget.
Thirdly, this year, the government seems to have unusual flexibility to choose how to use its fiscal power during the rest of the year. Usually, by November-end, about half of the year’s total non-debt receipts are collected and about two-thirds of the expenditure is incurred. So, there is not much flexibility for the remainder of the year. However, this year, about 70% of the non-debt receipts were collected and less than 60% of the budgeted expenditure had been incurred by November. This frontloading of receipts also helps the government, as many state elections are scheduled in the last quarter of the financial year.
Since the disinvestment target is not likely to be met, – so far, just over 5% of the budgeted receipts have materialised – some of this fiscal headroom will be used up by that shortfall. The extent of this shortfall will mainly depend on whether the LIC IPO happens in this fiscal year and how much it is able to fetch. The government also cut excise duties late last year, which would reduce the collections during the rest of the year. Still, the government seems to be in a position to exercise much more discretion during the remainder of the year than it usually is. The main risk to this fiscal space is the alarming rise in crude oil prices. As of now, this is eating into fiscal space every day, as the government seems wary of raising the prices in view of the upcoming elections.
So, an important question that will be answered on budget day is: what is the government doing with this discretion? Administratively, this question would have been settled in the process of making revised estimates to be presented on budget day; February 1. In this process, the budget estimates are updated to reflect the realities and priorities that emerge during the course of the year. Usually, the revised estimates are not very interesting as they tend to deviate from the budget estimates only for tactical and operational reasons. However, this year, the revised estimates are more interesting, since they will reveal how the government is strategically using its fiscal space.
Act 3: Reading Budget 2022-23
Now, with this background, how should we read the budget for 2022-23? I will be interested in four interrelated types of information from the budget documents.
The first of these is the medium-term fiscal outlook presented by the government. Last year’s budget did not include medium-term fiscal projections as the Fiscal Responsibility and Budget Management (FRBM) Act was being amended. The fiscal policy statement was also vague about the intent beyond the year. This year’s budget will give a better picture of the fiscal projections and the fiscal policy strategy that the government intends to implement in the medium-term. It is not easy to scale down a large fiscal intervention of the kind we have seen in these two years. It is easy to make mistakes in terms of timing and scale. It would also be interesting to see how the government sees the contingent liabilities impacting the budget in the coming years.
The medium-term outlook will also help us understand the approach towards public debt. India’s public debt has suddenly become more important than it has ever been in recent years. Although the debt to GDP ratio was high in the early 2000s, rapid growth and fiscal consolidation – and later, high inflation – helped reduce the ratio. Assuming that the inflation regime will not change, the most important factors are the real growth of the economy and the primary balance.
If the interest on debt goes above the growth rate in the coming years, given the large primary deficits being run for the last three years, a large adjustment will be required. Some reduction of the primary deficit in the coming years could help avoid the pain that would become inevitable under such a scenario.
We should keep in mind that talks of debt sustainability have a very different character in India’s context. Because of its fiscal dominance, it is relatively easy for the government to get its deficit financed and to get favourable terms by exercising financial repression. This makes it all the more important to address the debt specifically, before worse policy options become more politically attractive. So, it would be interesting to see what pathway the finance minister presents to keep public debt manageable.
For these and other reasons, the medium-term outlook becomes very important. Although in a situation of radical uncertainty, such statements may not survive the test of reality, they do provide an anchor to understand what the government is intending to do unless the situation changes drastically.
Secondly, I would be interested in knowing if there is any direct focus on alleviating urban poverty. Multiple sources of information suggest what we suspected intuitively – that the pandemic has hugely increased income poverty in India, especially in urban areas. If the economy revives, this problem will be mitigated over time. However, at present and in the near future, there is a need to find innovative ways to help those who are most in need.
It is not that nothing has been done; the increase in the food subsidy would have helped. The government has also made small cash transfers to citizens’ Jan Dhan accounts, but only a third of these accounts are in urban areas.
The loan guarantees may have helped save some employment in formal sector micro, small and medium enterprises. However, while there are automatic stabilisers, like employment guarantees in rural areas, there are no suitable mechanisms in place to address the problem in urban areas. It would be interesting to see if the budget suggests a change in approach towards this problem – reaching the urban poor with more support and reaching the informal sector enterprises.
The third type of information is regarding the fiscal policy strategy for boosting employment and growth. While employment and growth are always priorities for a country at India’s per capita income level, these have become even more urgent in recent years. The recovery from the pandemic has not brought employment back to the pre-pandemic level, which was not good anyway. Rapid growth would solve many problems, including the problem of public debt. While it is tempting to think that fiscal policy can generate growth, fiscal policy has a limited role in boosting growth in a country at India’s stage of development, especially under the present constraints.
The pre-pandemic years were marked by a flexible fiscal policy, but the impact was questionable, as the slowdown persisted. Fiscal policy initiatives to boost growth must be carefully designed and implemented. India’s experience suggests that capital expenditure has a much higher positive effect on growth than any other form of fiscal intervention. Further, fiscal initiatives that enhance export competitiveness are also worth building and expanding. While the government has started large production-linked fiscal support, it is important to link such support to exports. Exports are key to reviving India’s growth. It is also more difficult to game export competitiveness than it is to game production-related facts.
It would be interesting to see what initiatives, in terms of expenditure and tax policies, the government will adopt.
Fourthly, what will the budget reveal about the policy priorities on privatisation and asset monetisation? In 2016, the government had announced its intent to privatise public sector enterprises, but not much progress was made. Now, with the privatisation of Air India, it is possible that this agenda has made its way onto the list of priorities and, if the budget indicates large receipts from strategic disinvestments, it would reveal that the shift is real and not just a one-off transaction.
In 2019, the government had announced monetisation of operational infrastructure assets to raise resources to increase capital expenditure. Not much happened on this until 2020. In last year’s budget, the finance minister had announced a few measures to enable the scale-up of this initiative. This year’s budget should provide important information about whether this initiative has actually picked up pace.
In a democratic developing country, budget management is always interesting and challenging. There are many consequential choices to be made. The stakes are high, but it is also not easy to take the right decisions. The political economy makes many demands for expenditure, which are settled through a complicated and often opaque political and administrative process. Even if the right decisions are taken, constraints of institutional capacities also create differences between expectation and implementation.
These challenges are always there. But the pandemic has made them more daunting. There are now many more demands on fiscal policy. One can only hope that the prudence of fiscal management will not crumble under this load of expectations, as it had during the previous crisis.