'We are a fiscally prudent government'. That's the line one heard from the government during the pandemic. This was in response to the clamour for a larger discretionary fiscal stimulus. The budget for FY 22 discards this line. What might have prompted the government to do so? Three considerations have been cited by officials and commentators:
i. The higher deficit is okay because it's for a good cause, more capital expenditure
ii. Larger deficits will mean higher growth so we don't have to worry about the deterioration in public debt in the near future
iii. Asset sales will finance a higher proportion of the deficit than before. Sale of PSUs is a major reform that will again deliver higher growth.
I argue that none of these arguments is entirely convincing. Nevertheless, it's good if the fetish about the 3 per cent fiscal deficit to gdp ratio is discarded. We can live with higher deficits. If the government as well as market analysts recognise that, it's a welcome change.
More in my BS column, What explains the Budget's fiscal stance?
FINGER ON THE PULSE
T T RAM MOHAN
Headline: What explains the Budget's fiscal stance?
Athough the budgetary exercise has made a virtue out of necessity, the policy change could end up having a happy outcome
The deficit numbers in the Budget for 2021-22 are way above what analysts had expected. Hardly anybody had expected the fiscal deficit to end up at 9.5 per cent of gross domestic product (GDP) in 2020-21 and 6.8 per cent in 2021-22.
Through the pandemic, few would have thought that the government would discard the Fiscal Responsibility and Budget Management (FRBM) Act for the foreseeable future. The decision to limit the discretionary fiscal stimulus to around 2 per cent of GDP had indicated that the government was limiting the stimulus in order to return quickly to the path of fiscal consolidation once the pandemic had subsided. It turns out now that, instead of limiting the stimulus, the government has merely chosen to spread it over two or more years.
Clearly, the government decided on a change in fiscal stance somewhere along the line. What might have prompted it to do so? The shortfall in revenues in FY21 seems to have been the decisive factor. The shortfall was a staggering Rs 4.65 trillion. On the base of revenues for FY21, containing the deficit for FY22 at lower than 6.8 per cent would have required an increase in taxes and a cut in expenditure that would have derailed the ongoing economic recovery.
Far better to forget about the FRBM Act and live with a higher fiscal deficit up to 2025-26. Fair enough. The challenge for the government was to make a virtue of necessity. From the finance minister’s Budget speech and the statements made by various officials, it appears that the government is making three arguments in favour of the change in fiscal stance.
First, there is a shift in expenditure in favour of capital expenditure —it’s not the old story of borrowing to finance revenue deficits. Capital expenditure rises by 31 per cent in FY21 revised estimates relative to actuals in FY20 and 26 per cent in the budget estimates of FY22 relative to revised estimates for FY21.
There is reason to be sceptical about both estimates. Former economic affairs secretary Subhash Garg calls the increase in capex in FY21 an “optical illusion”. One item that contributes Rs 79, 398 crore is a special loan intended to provide liquidity support to the railways. This qualifies as revenue expenditure. Another item of Rs 12,000 crore is a loan to states. Take these two items away and capital expenditure in FY20-21 rises by a mere 3.6 per cent.
As for FY22, the increase in capital expenditure is on account of several infrastructure projects. Infrastructure projects in government take time to materialise, so spending the budgeted amount in a given year is difficult. On past showing, the increase in capex will likely be considerably less than 26 per cent.
A second argument for the shift in fiscal stance is that growth fuelled by higher capital expenditure will take care of the fiscal deficit. The latest Economic Survey devotes a chapter to this argument. It argues that, in high growth economies such as India, the usual arguments about sustainability of public debt do not apply. Especially during an economic downturn, it makes sense for the government to borrow and spend because growth will ensure that public debt does not spiral out of control. We also need not worry about the crowding out of private investment, especially if public investment is directed at high multiplier areas such as infrastructure.
None of this was unknown to successive Finance Commissions. Nevertheless, Finance Commissions have insisted on adherence to conservative targets of fiscal deficit and public debt. They had reasons for doing so. The central and state governments have large contingent liabilities. Large external shocks — oil shocks, a global financial crisis and, now, the pandemic — can derail growth for long periods, so having a fiscal buffer is prudent. The rating agencies do treat advanced and emerging markets differently in respect of public debt. The Economic Survey thinks, as an earlier Survey did, that this is unfair. Well, it is an unfair world that we live in.
It has been recognised that, if GDP growth in India is above 7 per cent, debt sustainability ceases to be an issue. The Economic Survey contends that India does not face a debt sustainability issue even if real growth is a mere 4 per cent in the next 10 years. If that is indeed so, one wonders if we need an FRBM Act at all.
A third argument is that the old fiscal limits are not valid in the brave new world of reforms. A rising tax/ GDP ratio has long been thought the key to fiscal sustainability. Earlier budgets used to project a rise in the ratio, whatever the setbacks from time to time. There are no such projections in the latest Budget. In FY19, the centre’s tax/GDP ratio was 11.9 per cent. It fell to 10.6 per cent in FY20 and is estimated at 9.8 and 9.9 per cent in FY21 and FY22, respectively.
With the tax/GDP ratio falling, the government has to look to non-tax revenues to finance expenditure. The government will privatise and not disinvest. In all but four strategic sectors, public sector units (PSUs) will be up for sale. The government will also privatise two public sector banks and one insurance company in the coming year. It will use resources raised from privatisation to create infrastructure assets. These assets, in turn, will be monetised through sale to private parties.
Privatisation is intended to earn revenues for the government and to improve efficiency of assets. The distress sale of assets to finance budgetary deficits is bound to affect government finances adversely in the long term. It also has implications for efficiency. We know from the literature that privatisation that is not designed properly — as will happen if assets are sold in a rush — may not result in more efficient utilisation of assets.
That apart, one wonders whether large-scale privatisation is feasible at all in our fractious democracy. If disinvestment targets cannot be met year after year, how does large-scale privatisation become feasible? The strategic sales of PSUs of many years ago drew adverse comments from the Comptroller and Auditor General of India. One sale of 2002 has resulted in a Central Bureau of Investigation court asking for charges to be filed against the then minister for disinvestment, Arun Shourie, and four others. Political parties and unions will oppose the moves vigorously and, indeed, a federation of bank unions has already called for a two-day strike in March.
The strategy of financing higher government capital expenditure through asset sales is thus likely to have only limited success. We will have to find ways soon to raise the tax/GDP ratio. There could, nevertheless, be a happy outcome from this year’s budgetary exercise. Both the government and market analysts may have come to realise that India can relax somewhat the deficit targets set out in the FRBM Act without derailing debt sustainability or attracting a rating downgrade.
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