Meeting the deficit target

The pressure to rein in capital expenditure and collect more tax revenue may increase

The latest narrative about the Union government’s finances is that they have stayed within the norms of fiscal prudence so far. Endorsing this view are the official numbers for the April-September period of 2023-24, which show that the Centre’s net tax collections in the first half of the year have grown by a healthy rate of 15 per cent, higher than the Budget’s annual target of 11 per cent. It is also argued that the poor performance of disinvestment will be offset by sharp gains in non-tax revenues, mainly due to higher dividends from state-owned banks and the Reserve Bank of India. 

 What about the Centre’s expenditure? That is where doubts start surfacing over the government’s ability to adhere to its fiscal deficit target of 5.9 per cent of gross domestic product (GDP) in 2023-24. To be fair, the expenditure pattern in the first half of the year reflects a mixed picture. The government’s conscious decision to frontload its capital expenditure in the first half has been implemented effectively. In line with its commendable decision to boost capital expenditure (almost trebling it in the last four years), the government has shown a 43 per cent increase in its capex during April-September 2023. The annual target is 36 per cent.

 This increase has not only helped prop up an economy where private sector investments are yet to revive, but has also acted as a trigger for higher capital outlays by the states. Remember that about 13 per cent of the Centre's capex Budget of Rs 10 trillion is meant for the states. And the states have responded remarkably well to this national imperative of increasing capital investments by using both Central funds, linked to reforms, and their own resources. Twenty-three states, accounting for over 93 per cent of total state budgets in the country, have increased their capital expenditure by 53 per cent in the April-September period of 2023-24. In other words, the combined capital investment by the Centre and the states in the first half of 2023-24 was Rs 7.54 trillion, up from Rs 5.15 trillion in the same period of 2022-23. If this trend is maintained, the full year’s capex by the Centre and the states could well be over five per cent of GDP.

The problem is with revenue expenditure, of not just the Centre but also of the states. In a brave initiative this February, Finance Minister Nirmala Sitharaman proposed a massive squeeze on revenue expenditure by allowing an increase of only 1.4 per cent to Rs 35 trillion in the current year. Six months have gone by, and the Centre’s revenue expenditure has already grown by about 10 per cent. With an election season around, it is unlikely that the Centre would be able to achieve its target of keeping its revenue spending within the target of Rs 35 trillion. Even otherwise, staying within the budgeted revenue expenditure would mean a five per cent contraction in the remaining half of the current year. This is not possible, and a slippage is a foregone conclusion.

If you thought that it is only the Centre that is guilty of breaching its self-imposed check on its growth in revenue expenditure, think again. The states are also at fault in this area. Revenue expenditure by these states has grown by 9.5 per cent in the first half of the current year. If the Centre has already spent about 46 per cent of its annual revenue expenditure by the end of September, these 23 states have used up over 42 per cent of their budgeted number for the full year.

 That the election season can play havoc with any discipline that governments plan to impose on revenue expenditure is evident from the trajectory seen in the first half of 2023-24 for most states that have gone to polls in November. Barring Rajasthan, which surprisingly reined in its revenue expenditure growth at just 9.6 per cent, all other states have seen significant increases — with Chhattisgarh at 25 per cent, Madhya Pradesh at 19 per cent, Telangana at 18 per cent, and Mizoram at 12 per cent. What it establishes is that come election time, governments open their expenditure taps, mostly for electoral considerations.

 So, what are the prospects of the Centre maintaining fiscal prudence and staying within the deficit target as it approaches the general elections in 2024? Already, some expenditure pressure (the extension of the free food scheme and the announcement of financial incentives for artisans) has been exerted on the Centre’s finances. It is possible that the full impact of many of these schemes, including those that may be announced in the next few months, would be felt only during 2024-25, and meeting the current year’s target may not be difficult. But that will only defer a problem, not address it.

What, however, may help the Centre, as also the states, is the continued buoyancy in tax revenues. These states have reported an increase in their own tax revenue by 12 per cent in the first half of the current year. They have also been helped by a generous transfer of tax revenue from the Centre under the devolution formula, which grew by over 20 per cent.

For the Centre, continued buoyancy in tax revenues will be even more crucial. With revenue expenditure certain to put extra pressure on finances, a key concern would be the pace of capital investments in the second half of the year. The government may consider slowing down capital expenditure as an option. In any case, if the target of Rs 10 trillion is to be met, capital expenditure must grow by 55 per cent in the second half of this year, an increase that may be difficult to achieve.

That would also imply that the capital expenditure target of Rs 10 trillion will not be met, which ironically should provide some cushion to the government’s finances and ease its task to meet the fiscal deficit target. The reality is that without a slowdown in capital expenditure, the pressure on the government’s revenue department will intensify further, leading to flogging the tax collection machinery even harder to garner more tax revenue in the current year and meet the fiscal deficit target.

This, though, may not augur well for India Inc.