A steep fiscal correction

With modest revenue effort, the burden of cutting the deficit will fall on a big expenditure contraction

About 10 days ago, the Union Budget for 2021-22 was presented to Parliament and it instantly made headlines for its bold announcements on privatisation, asset monetisation and transparent accounting of the government’s fiscal deficit. It is now time to take a closer look at the key numbers underlying the government’s projections on revenue and expenditure. Do the actual numbers bear out the claims made by the government or do they suggest something else?

The first question arises from the road map for fiscal consolidation given in the Budget. After conceding a huge increase in fiscal deficit at 9.5 per cent of gross domestic product (GDP) in 2020-21, the government is now aiming at a reduction in the deficit to 6.8 per cent in 2021-22 and to 4.5 per cent by 2025-26. In other words, a 2.7-percentage point reduction in the deficit in one year and by 5 percentage points in five years.

How feasible is the planned correction in the government’s fiscal deficit? Remember that never before in the last half a century has the Union government achieved a correction of 2.7 percentage points in one year or 5 percentage points in five years.

Even in the years following the global financial meltdown, the government’s fiscal deficit had widened from 2.54 per cent in 2007-08 to 6.1 per cent in 2008-09 and 6.6 per cent of GDP in 2009-10. The reduction in 2010-11 was only to 4.9 per cent, a decline of 1.7 percentage points.

In 2020-21, the extent of increase in the deficit over the previous year was 4.9 percentage points. The extent of correction in 2021-22 would be 2.7 percentage points, if the government manages to reduce its fiscal deficit to 6.8 per cent of GDP.

Note that the extent of correction would be sharper if the actual fiscal deficit numbers were to be considered. The government’s Budget documents now show that its fiscal deficit data were understated at least from 2016-17. For instance, instead of the official deficit numbers of 3.5 per cent of GDP for each of the years of 2016-17 and 2017-18, the actual number, including the impact of the extra-budget borrowing, for both these years was 4.01 per cent of GDP.

The divergence between the headline official number of fiscal deficit and the actual deficit became larger in the following two years. The official headline fiscal deficit was shown to have been reduced to 3.4 per cent of GDP in 2018-19, but the actual number, it now turns out, represented an increase to 4.26 per cent of GDP.

From 2019-20 onwards, the divergence did not increase any more as the government started reducing its reliance on extra-budget borrowing. Against a headline number of 4.6 per cent of GDP in 2019-20, the actual deficit was 5.32 per cent. For 2020-21, the headline fiscal deficit was 9.5 per cent, but the actual number was in double digits — 10.14 per cent of GDP. (See table)

The divergence is expected to narrow in 2021-22, when the headline deficit is targeted at 6.8 per cent, marginally lower than the actual deficit target of 6.93 per cent of GDP. But this would also mean that the extent of correction needed in the real deficit in 202122 would be higher at 3.21 percentage points, and not 2.7 percentage points.

It could be argued that the government’s revenue would be substantially more buoyant next year, when the economy is expected to bounce back with an expected nominal growth rate of 14.4 per cent, compared to a nominal contraction of over 4 per cent in 2020-21.

But that is not borne out by the government’s revenue estimates. It projects that gross tax revenue collections would be just marginally up at 9.9 per cent of GDP during 2021-22, compared to 9.8 per cent in the current fiscal year. Even at the projected rate, tax buoyancy would have to be 1.16 next year, a difficult target. Non-tax revenue too would continue to languish at just about 1 per cent of GDP. Indeed, the government’s efforts at increasing tax and nontax revenues have been woefully inadequate in the last five years. (See table)

Revenues from disinvestment and privatisation next year are expected to increase significantly to ~1.75 trillion, or about 0.8 per cent of GDP. But achieving this target is crucially dependent on the government’s implementation ability. So, will the contraction come from the expenditure side?

That raises the second question about the Budget. What is the nature of the increase in expenditure that the government has claimed for the current year and the coming year? In the current year, of course, overall expenditure saw a huge jump from about 13 per cent of GDP in 2019-20 to 18 per cent in 2020-21. But a little more than a fifth of the increase in the expenditure was accounted for by transparency and cleaning up of the government balance sheet by clearing arrears on account of food and fertiliser subsidies. The remaining extra spend was due to higher outlays on various schemes for social welfare in the wake of the pandemic.

However, the squeeze on revenue expenditure in the coming year will be sharp. Thus, in spite of a rise in capex, the share of total government expenditure in GDP will decline from 18 per cent in the current year to about 16 per cent next year. This is an unprecedented squeeze on expenditure, which will translate into just about 1 per cent increase in the government’s total spend, compared to a record increase of 28 per cent in the current year. The big question is whether the government can manage to cut its revenue expenditure next year.

Tailpiece: The government’s clean-up of its food subsidy account is likely to improve the financial health of the Food Corporation of India or FCI, the main agency that undertakes food grain procurement on behalf of the Centre. Already, ~1.5 trillion of FCI’S loan from NSSF has been repaid. Another ~1 trillion of outstanding NSSF loan will remain to be repaid in the coming year. The government has decided to stop using NSSF for food subsidy payments from 2021-22. A better balance sheet for FCI augurs well for the future of this public sector undertaking.

But the government’s policy on privatisation envisages all PSUS in non-strategic sectors to be sold or closed down. FCI is not classified as a company in the strategic sector. Will FCI also be privatised and what will this mean for the government’s future food procurement plan, required to maintain a minimum food grain buffer stock under the national food security law? At a time when the farmers are agitating over the continuation of food procurement under the minimum support price scheme, both the improved financial health of the FCI and its possible privatisation will have many implications.