Fiscal math of the imponderables

Growth holds the key to the government's fiscal deficit slippage

How large will be the Union government’s fiscal deficit in 2020-21? The Union Budget for the current year had projected the deficit to be at 3.5 per cent of gross domestic product (GDP), a little lower than the 3.8 per cent shown in the revised estimate for 2019-20. Those estimates were made in a pre-Covid world. The lockdown for about two months has played havoc with the prospects of economic growth and government finances. Nobody believes that the 2020-21 fiscal deficit target set in February can be achieved.

Not surprisingly, the government took early measures to increase its borrowing plan by about 54 per cent. Against the Budget estimate of Rs 7.8 trillion, the government had announced additional borrowing of Rs 4.2 trillion during the year — a total borrowing of Rs 12 trillion. That decision alone had raised the likely fiscal deficit number from the earlier budgeted 3.5 per cent of GDP to 5.3 per cent, assuming that the nominal growth projection remained unchanged.

Yet, when asked by a journalist last Sunday what the likely slippage in the Union government’s fiscal deficit during 2020-21 could be in the wake of the Covid-19 pandemic, the lockdown and the announcement of the Rs 20-trillion economic package, Finance Minister Nirmala Sitharaman was less than forthcoming in her reply. She said that with about 10 months still to go before the year would end, it was too early to make such an estimate. Her response was noteworthy because several economists and analysts had already forecast a significant slippage in the government’s fiscal deficit for the current year.

Of course, her reluctance to reveal what she thought of the fiscal situation is understandable. As finance minister, she is entitled to keep all her options open and disclose her assessment as and when she thinks it is necessary and at a time it would not upset the government’s overall plans to manage its finances. It goes without saying that the finance minister, more than anybody else, is aware that there are real dangers of a slippage in the deficit from the figure of 3.5 per cent of GDP that she announced in February 2020.

But the critical question, which she avoided answering, is how large that slippage would be. And what would be the considerations and scenarios that the finance minister must be pondering while assessing the government’s fiscal situation? Here is an attempt to highlight some of her key concerns and issues with regard to the challenges of reining in the fiscal deficit.

One of her biggest concerns arose from the large hole the promised economic package of Rs 20 trillion could have punched in the government’s finances. Now that the details of the package are available, it is clear that the hit on the government’s finances would be relatively small at just about 1 per cent of GDP. The actual additional expenditure from the government’s Budget would be around Rs 2 trillion. The remaining Rs 18 trillion would be riding, among other things, on the Reserve Bank of India’s liquidity and refinancing measures, loans from the financial sector, borrowing by state governments and funding by state-owned enterprises.

Illustration by Binay Sinha

 

Note that the impact of the additional outgo of Rs 2 trillion will be neutralised by as much as 89 per cent by two decisions the finance minister has already taken. The first decision was to suspend the payment of three instalments of dearness allowance to 5 million central government employees and 6.1 million pensioners till July 2021. The instalments were due to take effect from January 2020, July 2020 and January 2021. The savings for the Centre as a result of this decision in 2020-21 would be Rs 37,530 crore, or about 0.2 per cent of GDP.

The second decision was to increase the additional excise duty and cess on petrol and diesel, taking advantage of a steep fall in global crude oil prices. The government, as a result, would collect more revenue but there would hardly be any impact on retail prices. Analysts have estimated that even after assuming a 12 per cent fall in consumption of petrol and diesel (these two items account for about half of India’s petroleum products consumption), the government’s additional revenue from higher taxes and cess would be Rs 1.4 trillion, or about 0.7 per cent of GDP.

Consumption of petrol and diesel fell 60 per cent and 56 per cent, respectively, in April. The decline in consumption may be a little lower in May as some economic activities had resumed during that month. Even after assuming that the growth in consumption of petroleum products in the remaining 10 months of the year remains flat, the annual contraction in consumption would not be more than 12 per cent. Thus, an estimate of an additional tax revenue of Rs 1.4 trillion is reasonable. The only uncertainty is about the global crude oil prices. If they climb up again, the government may be under pressure to roll back its taxes and the increase in revenue collection may not be as high as Rs 1.4 trillion.

If, however, crude oil prices remain within the current range, the government’s worries on the fiscal deficit front will be largely manageable. This is because the net impact of the economic package, after taking into account the savings on dearness allowance and extra revenue from the oil sector, will only be Rs 20,000 crore, which will be easily absorbed by the additional borrowing of Rs 4.2 trillion, planned by the government. What’s more, the government will be left with Rs 4 trillion of extra borrowing after adjusting the net impact of the economic package.

The big imponderable that Ms Sitharaman has to deal with is whether the remaining Rs 4 trillion will be adequate to meet the tax revenue shortfall during the year. Last year, even without Covid, the revised estimate of revenues fell short of the Budget estimate by as much as Rs 2.6 trillion. The provisional actuals, due to be released soon, may perhaps show an even bigger shortfall for 2019-20.

But if the finance minister can manage to keep the government’s revenue shortfall and the burden of any extra expenditure during the current year within Rs 4 trillion, the Centre’s fiscal deficit will become manageable. It would certainly see a slippage to at least 5.3 per cent of GDP and it could be even bigger than that. The extent of the slippage will be principally determined by the seriousness of the growth shock. Remember that the deficit number for 2020-21 assumes an increase in the nominal size of the economy by 10 per cent. If that growth declines significantly, as is being feared, the deficit too would widen by a bigger margin.