The joker in the pack

Government's fiscal headroom is crucially linked to a realistic assessment of its net revenue collection

The Union government’s current thinking seems to suggest that a fiscal stimulus may be announced later in the current financial year. The chief economic advisor (CEA) in the finance ministry told a group of industry leaders last week that the question of a demand-side fiscal stimulus was not of “if” but of “when”. The obvious question is whether the government has the fiscal headroom to announce any such package in the remaining months of the year.

In any debate on fiscal stimulus, one of the key concerns pertains to the extent of slippage in the deficit that such an initiative would entail. This concern has gained more salience under the Narendra Modi regime, which has taken pride in its achievements on the fiscal consolidation front. From 4.5 per cent of gross domestic product (GDP) in 2013-14, the last year of the United Progressive Alliance regime, the fiscal deficit declined, slowly but steadily, in the first five years of the Modi government. In 2018-19, the fiscal deficit was 3.4 per cent of GDP.

The second term of Mr Modi did not begin too well, with the fiscal deficit rising to 4.6 per cent of GDP in 2019-20 and in 2020-21, it is all set to widen further by a significant margin. Hence, any proposal of a fiscal stimulus elicits questions from the prime minister’s office as also from the finance ministry bureaucrats on how the government’s fiscal consolidation track record can be maintained.

But this debate over the government’s fiscal headroom seems to be taking place without a proper assessment of the current state of public finances. It is also influenced by a series of measures taken by the government in May, which created an impression that the government was keeping its powder dry for any fresh fiscal stimulus that it would like to announce later in the year. As the CEA has pointed out, the government is waiting for the right time to make that announcement. You may not agree with that timing or even question whether the powder will actually remain dry, but that is how the government seems to have planned its policy interventions for the coming months.

Illustration: Binay Sinha

Remember that the government has spent very little money out of its own budget to finance the  Rs 21-trillion economic package it announced in May to tackle the after-effects of the coronavirus pandemic. Just about 10 per cent of this package, or  Rs 2.1 trillion, is funded by the government’s budgetary resources.

However, the government has also raised taxes and cess on petrol and diesel to garner an additional revenue of Rs 1.4 trillion in the current year. This is based on an assumption that there would be a 12 per cent fall in the consumption of these petroleum products. The data so far shows that the consumption of petrol and diesel has bounced back to near pre-March levels. Thus, the government’s additional revenue from the oil sector may be a little more than Rs 1.4 trillion.

Simultaneously, the government has reduced its expenditure on payment of dearness allowance to its employees and effected an annual saving of Rs 37,000 crore in the current year. Thus, the net burden of the Rs 21-trillion package on the government’s finances is only about Rs 33,000 crore. Even this burden will be taken care of by yet another decision. That is to increase the government’s borrowing by Rs 4.2 trillion, or about 54 per cent, to Rs 12 trillion.

In other words, even after announcing a Rs 21-trillion economic package, the government is left with some more fiscal firepower of around Rs 3.9 trillion. But will this amount be enough?

The worry is not on account of the budgeted government expenditure, which has already been reined in. The April-May 2020 figures show that overall government expenditure is marginally lower than in the same period in 2019, even though the Budget had provided for a 13 per cent increase. Careful planning has ensured that even as capital expenditure has risen by 16 per cent, revenue expenditure has shrunk by about 2 per cent.

Significantly, within revenue expenditure, a reshuffling of priorities has led to an increase in spending on agriculture, rural development, fisheries, animal husbandry, road construction, health and family welfare. This has also meant corresponding expenditure cuts in other departments to achieve an overall reduction. 

The big question, therefore, is whether the cushion of Rs 3.9 trillion will be enough to offset the revenue shortfall that 2020-21 is bound to see on account of a contraction in the economy. And whether anything will be left after that to enable the government to announce a new package of demand-side fiscal stimulus.

Not surprisingly, hopes of a fresh fiscal stimulus have risen after finance ministry officials sounded optimistic about personal income-tax and corporation tax collections. In the April-June 2020 quarter, these tax collections were reported at 77 per cent of the amount collected in the same period of 2019. However, this hides the real stress in public finances.

The 2020-21 Budget had projected a 27 per cent increase in direct tax collections over the actuals of 2019-20. An achievement of 77 per cent of last year’s figures would imply a shortfall of 40 per cent, against the Budget target for the current year. The trend in the goods and services tax collection is similar. The shortfall in non-tax revenues would be larger because of the Budget target of garnering over Rs 2.1 trillion through disinvestment — an ambitious exercise that should begin this year but may fail to realise the expected valuations and, therefore, the required revenues, given the current volatile market situation.

If the Budget targets are to be realised, the government’s net revenue should increase by 20 per cent to Rs 20 trillion in 2020-21. But, on the other hand, a 20 per cent shortfall in net revenue would wipe out the entire cushion of Rs 3.9 trillion available to the government from the enhanced borrowing limit it has already planned for. And if the net revenue shortfall is limited to just 10 per cent, the government will have the firepower of providing an additional fiscal stimulus of Rs 1.9 trillion.

The joker in the pack, therefore, is the government’s net revenue collection. Its fiscal deficit, keeping in mind the enhanced borrowing plan, could be 5.9 per cent of GDP, based on the 2019-20 estimate or could even widen to 6.6 per cent, if the GDP contracts in nominal terms by 10 per cent. The government cannot possibly afford a fiscal deficit that is larger than this range. The government’s capacity for a fresh round of fiscal stimulus will thus depend on how well it manages to reduce the shortfall in net revenue collection.