The turn of the Centre

The Centre should maintain the current year's fiscal consolidation pace to give states more time to adjust

Union Finance Minister Nirmala Sitharaman will present her fourth consecutive Budget in just about eight weeks from now. Independent India has so far seen 23 finance ministers (excluding three prime ministers), who presented at least one Budget during their tenure. But only eight of these finance ministers had the privilege of presenting at least four consecutive Budgets. When Ms Sitharaman presents the Budget for 2022-23 on February 1, she would become the ninth finance minister to have achieved that feat.

Is the fourth consecutive Budget by a finance minister a significant indicator? No clear trend on this emerges from the past. But it is also true that finance ministers take their own time to grow into the job. They become far more adept in dealing with the challenges on the economic policy front by the time they present their fourth Budget. Not surprisingly, many of the ideas they present in their fourth Budget go on to define their entire tenure as the finance minister. Of course, there are exceptions to this trajectory, but the broad trend can hardly be missed.

Take a look at the budgets in post-reforms India. The presentation of Arun Jaitley’s fourth Budget in 2017 was advanced by four weeks, a practice that continues even now. In addition, his Budget reduced the corporation tax rate to 25 per cent for all companies with an annual turnover of up to Rs 50 crore, accounting for 96 per cent of all companies in the country. He also announced the controversial electoral bonds scheme and the rollout of the goods and services tax later in the year. Pranab Mukherjee introduced in 2012 his controversial retrospective tax, which gave rise to charges of tax terrorism against the government and that tax had to be scrapped nine years later.

Illustration: Binay Sinha

In 2007, P Chidambaram announced a steep cut in Customs duty on a wide range of goods and the launch of the goods and services tax by 2010, a promise he could not fulfill. In 2001, Yashwant Sinha made the rupee partially convertible even on some capital account transactions and phased out the administered price mechanism for oil products by March 2002. And even though Manmohan Singh’s first Budget had an ambitious fiscal consolidation and reforms programme, he used his fourth Budget in 1994 to announce further cuts in Customs duty on many goods and a plan to phase out the use of ad hoc treasury bills to meet the government’s borrowing needs.

What will Nirmala Sitharaman do in her fourth Budget? There are no clear indications of the big initiative she could take, which could define her tenure as India’s 23rd finance minister. What is clear, however, is that the fiscal consolidation path that she will lay down will be keenly watched as the Indian economy recovers from the adverse impact of Covid-19. 

Available trends on revenue and expenditure suggest that Ms Sitharaman could well be on her way to setting a record of achieving the biggest single-year reduction in the government’s fiscal deficit. Tax revenues in 2021-22 so far are doing well and expenditure, even though under pressure because of various Covid-related relief measures, is not likely to see a slippage that cannot be made good by the jump in overall receipts. She would most likely achieve a 2.7 percentage point reduction in the deficit from 9.5 per cent in 2020-21 to 6.8 per cent in 2021-22. Even a marginal slippage would make her fiscal consolidation efforts to be the best so far.

Only in two years in the past has the fiscal deficit seen a steep reduction of about two percentage points. In 1991-92, Manmohan Singh achieved a deficit reduction of 2.22 percentage points and in 2010-11, Pranab Mukherjee secured a 1.66 percentage point decline in the fiscal deficit. The previous years in both the cases had seen a huge fiscal deficit number, thanks to India’s economic crisis of 1990 and the impact of the global financial crisis of 2008-09 on the Indian economy. Ms Sitharaman too had to weather the impact of the Covid crisis on government finances. But it appears that she has made far more progress on fiscal consolidation in one year, compared to the past two occasions.

Indeed, her performance on fiscal consolidation in 2021-22 will determine the nature of the task she will have to complete on this front in the next few years. She has already committed the government to reaching a fiscal deficit level of 4.5 per cent of gross domestic product (GDP) by 2025-26. The journey from 6.8 per cent to 4.5 per cent over a period of four years would surely be far less difficult than the single-year reduction that she would have achieved in 2021-22.

This is going to give her a lot of headroom and flexibility in managing the Budget not only for 2022-23, but also for the following couple of years. She now has the luxury of even targeting a reduction of just about 0.75 percentage point in each of the next four years and stay ahead of the target of 4.5 per cent by 2025-26. It would, of course, be a pity if she adopts a slow process of fiscal consolidation in the coming years, taking advantage of the easy target for the Centre by 2025-26.

That is because the condition of the state finances does not look too rosy. The target for the combined fiscal deficit of the states has been set at 4 per cent of GDP for 2021-22. It is unlikely that the states would be able to meet this target. Moreover, the states have been given a tougher target of fiscal consolidation; they must reach a deficit level of 3 per cent of GDP by 2023-24, while the Centre would reach 4.5 per cent two years later in 2025-26. It appears unfair that while the Centre should enjoy a more relaxed fiscal consolidation schedule, the states should be expected to be more fiscally responsible.

There is also an equity issue here. Before the pandemic struck, the states kept their combined fiscal deficit below the target of 3 per cent, which gave the Centre some leeway. For instance, the states’ deficit was 2.4 per cent in 2017-18, while the Centre was over 3.5 per cent. In 2018-19 and 2019-20 as well, the states’ fiscal deficit was lower than 3 per cent and helped rein in the overall government deficit because the Centre was well above 3 per cent in this period.

It is time for the Centre to return the favour by achieving a faster pace of fiscal consolidation and giving the states more room to stagger their deficit reduction to 3 per cent of GDP over a longer period of time than in just two years.