The approaching fiscal storm

The government accounts for Q1 (April to June) of fiscal 2021 give hope that the governments nuanced stance on Covid 19 management which emerged post the initial panicked lock down in March, is working.

Fiscal crunch in Q1

In April and May revenue receipts were at rock bottom (30% and 25% respectively of revenue receipts last year). In June they have increased to 75% of the revenue receipts last year with an average of 54% for Q1. This augurs well for revenue receipts in Q2 (July to September) to recover to around three fourths of last year.

Covid-19 is still working its way through India even though the death toll decoupled from the rate at which new cases are added in mid-June. It is now doubling every three weeks. New cases are doubling faster. But this could be because of wider testing.

Persistent economic downturn

Nevertheless, disruptions to the economy continue with the hotels, hospitality, aviation, travel and tourism industry taking the biggest hit. The sentiment is also bearish with uncertainties in employment, asset prices and growth casting a shadow. Some of this is not new. India had been slowing down over the previous eight quarters. Fy2019-20 was a year of tepid growth at just above 4% of GDP. Fy 2021 is likely to be a little worse. Even if the direct distress caused by Covid 19 ends within this fiscal, Fy2022 is unlikely to be a year of spectacular growth, given the political calendar of state level elections.

Masterful budget allocations

The silver lining is that the Finance Ministry has been masterfully selective with expenditure. It has managed, even in these troubled times, to preserve the priority for capital expenditure at 21.5% of the annual target with an allocation 40% higher than last year’s Q1. Total expenditure though has been curtailed to 21% higher than last year with revenue expenditure at 28% of the annual target.

The Finance Ministry is successfully replicating what millions of households are doing in their own budgets. Preserving a sense of normality in a period of savage disruption, by keeping the home fires lit and firewalling the family from the mental and physical tensions of financing the monthly expenditure.

Unsurprisingly therefore, the government has done what the rest of us are also doing – borrowing (or diluting savings) to spend in the hope that better days are around the corner. This shows in the Q1 fiscal deficit (expenditure minus revenue) of Rs 6.6 trillion – 53% higher than last year in the same quarter.

But dark fiscal clouds hang low

How dire the fiscal situation is can be gauged from the fact that the net revenue receipts of the Union government of Rs 1.35 trillion (Rs 2.5 trillion Fy2020) – after transferring the state’s share of tax revenue –was not even enough to meet the interest expense of Rs 1.6 trillion. Hopefully in Q2 (July to September) revenue will exceed the cost of interest. But what of other fixed expenditure like salaries, pensions and other establishment expenditure estimated at around Rs 1.5 trillion per quarter?

Net tax revenue needs to grow to Rs 3.1 trillion in Q2 to pay just for interest and establishment costs. Last fiscal (2019-20) Q2 net tax receipts of the union government were Rs 6.08 trillion. Since economy wide dislocations continue, even at the end of July, it would be overly optimistic to expect anything more than 75% of last year’s Q2 net tax receipts. This would amount to around Rs 4.5 trillion – enough to pay for interest and salaries but with not enough left over to finance other welfare and development expenditure estimated at around Rs 2.5 trillion per quarter.

Fiscal deficit on the run

This implies that the fiscal deficit will grow by end Q2 this year to Rs 8 trillion as targeted for end of the fiscal year. Relative to GDP however it will already be higher than the targeted 3.5% because GDP is likely to have shrunk by 25% as compared to the assumed GDP of Rs 225 trillion for this fiscal. This means FD will be 5% of GDP. Consider also that the free grain provided to migrants and the hungry poor is yet to be paid for.

The Q1 expenditure on subsidy data warms the heart of a fiscal conservative. Total expenditure is just 50% of last year’s expenditure in Q1. Even in food subsidy the expenditure of Rs 410 billion is just 43% of last year. Sadly, we know this is unlikely to last. With 800 million poor being given 5kg of cereal and 1 kg of lentil every month for free for five months from July to November the subsidy outlay will increase substantially.

The balancing act, looking ahead, will be between putting money directly into the hands of the consumer, as advocates of direct benefits transfer espouse or the government spending more (and better) to improve public health services and reduce the transaction and interest cost for business. Unless business revives, GDP growth and jobs – the only sustainable metrics of increasing fiscal space for helping the poor- will languish. There is no best-case either-or solution. But a strong case exists for the government to share with citizens the nature of the trade-off it proposes.

Not time yet to give up on Fiscal Austerity

Much of the enthusiasm about breaching our fiscal deficit is based on the “keeping-up-with-the Joneses” principle. If the US and Europe can be profligate, why not us? Luckily for us, the Modi government has not yet shown its intent to follow this unwise advice- which is completely contrary to the virtuous trend follow by it till now of relative fiscal austerity. Borrowing to spend on consumption has its costs in higher inflation unless there is a matching supply response which is dependent on how quickly the economy normalizes.

It is never easy for any elected government to stick to an abstract macro-economic principle in the face of unconscionable hardships being borne by the poor and those without (or those who have lost) an organized sector job. Add to this the continuing pressure to upgrade our military preparedness by the tremors emanating from across Tibet and you have a perfect storm approaching, which can drive the most hardened Finance Minister to distraction.

The good news is that the Finance Ministry and the RBI are staffed by practical, battle hardened staff, who will serve us well, in this unfortunate but temporary phase of our economy.

Also available at TOI Blogs August 1, 2020

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s