Why bringing down revenue deficit to acceptable levels is a difficult task

The collapse of the economy following the Covid-19 outbreak may have dealt a body blow to efforts to achieve the targets set forth by the N K singh Committee on FRBM

While much commentary has been made on the fiscal deficit scenario of the Centre, little emphasis has been laid on the revenue deficit situation. Though part of fiscal deficit, revenue deficit assumes importance because of its non-capital generating nature. 

The N K Singh Committee on the Fiscal Responsibility and Budget Management (FRBM) review recommended that the Central government reduce its revenue deficit-to-GDP ratio steadily by 0.25 percentage points each year, to reach 0.8 per cent by 2022-23 from a projected value of 2.3 per cent in FY17. 

The panel said the distinction between revenue and capital accounts is, in fact, rooted in the history of the budget making process, and even in the Constitution. The revenue deficit broadly measures the extent of borrowings to be used for revenue expenditure. The Committee believed that borrowings for expenditure that is of a recurrent nature, and which needs to be incurred every year, may not be desirable, and should be tax-financed – the idea underlying the so-called ‘golden rule’. 

The envisaged path of revenue deficit implies that the revenue-to-fiscal deficit ratio would reduce steadily to 32 per cent, from the current level of 66 per cent (budget estimates for 2016-17), and from a high of 80 per cent in the early 2000s, and leave sufficient room for increased capital spending to maximise growth, the panel said. 

However, the envisaged path was less ambitious, albeit more realistic, than the medium term fiscal policy (MTFP) statement presented in the FY17 budget, which assumes a one percentage point of GDP reduction in revenue deficit over the next two years. 

In fact, the 2016-17 Budget had projected the ratio of revenue deficit-to-fiscal deficit to rise to 66.3 per cent (BE) from 63.83 per cent in the previous year (at the revised estimates level). 

However, when the next year's budget was tabled, the ratio rose slightly to 64.3 per cent in 2015-16 (actual), but was projected to further decline at 58.1 per cent in 2016-17 under revised estimates. Later, the actual ratio slightly increased in 2016-17 as well.  

As can be seen from the chart, though the initial projection of the ratio was quite moderate in 2017-18, it crossed 75 per cent when actual figures came in.

The next two years, 2018-19 and 2019-20, saw not-so-ambitious projections. In fact, the actual projection of the ratio for 2018-19 worked out to be about 70 per cent and for 2019-20, it crossed 70 per cent. 

At the outset, it seems that the Budget was bit realistic for 2020-21, by assuming the revenue deficit and fiscal deficit at the level where the ratio was to be 76.5 per cent. However, the April numbers showed that even that was very ambitious as the outbreak of coronavirus hit the country. The April numbers showed that the ratio stood at 90 per cent. 

It is yet to be seen how much the ratio would work out to be when the government starts spending on infrastructure to drive the economy, which is capital expenditure. It also depends on the rising expenditure on food subsidy and MNREGA allocations, among other heads, which have now become necessary and come under the revenue head.

As can be seen, the goal of bringing the ratio down to 32 percent is nowhere in the sight, though it was not to be achieved in the current year but "steadily". In fact, going back to 64 per cent also seems an uphill task now. 

The task seems challenging even in terms of the other parameter of revenue deficit--as a percentage of GDP. 

Though the goal of reducing the deficit to 0.8 per cent of GDP is to be achieved by 2022-23, it seems difficult now. In fact, the target of reducing it by 0.25 percentage points from the level of 2017-18 was never achieved. However, it was close to that at 0.2 percentage points in 2018-19. 

Revenue deficit as a percentage of GDP or its ratio to fiscal deficit has also not been coming down to the desired level due to falling share of the Central taxes in GDP. The ratio of central taxes-to-GDP slid further in FY20 to a 10-year low of 9.88 per cent, driven by a decline in collections from customs duties and corporation tax, while excise duty posted marginal growth. The goods and services tax (GST) collections did not achieved the Rs one trillion-a-month mark for the whole of FY20. This was despite the fact that only a week was under lockdown in the year. The ratio stood at 10.97 per cent in FY19, and at 11.22 per cent in FY18. It is only estimated to decline further, with revenues falling on account of a slump in economic activity.

Madan Sabnavis, chief economist, CARE Ratings said the recommendations of the N K Singh panel can't be achieved. 

"When the committee was set up, it was generally assumed that the economy would not collapse as it has now. In 2019-20, the growth was one of the lowest," he said. 

The problem was always more on the revenue front when the economy was slowing down, he said. 

Sabnavis said one has to ignore the N K Singh committee road map and come out with the new one. 

"Nobody expects it to be met this year. The problem with the lockdown is that it will have ramifications for the coming year as well. It is not possible to cut revenue expenditure beyond a point because 60-70 per cent of it is committed expenditure," he said. 

What can help rein in the revenue deficit is the softening prices of international crude prices, even though they rose in May compared to April in 2020-21. From average price of $69.88 a barrel in 2018-19 and $60.47 a barrel in 2019--20, the prices of Indian basket of oil came down to $25.5 per barrel in the first two months of 2020-21. 

Petroleum subsidies are projected to grow to Rs 40,915.21 crore in 2020-21 (BE) from Rs 38,568.86 crore in the previous year (RE).