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The ongoing contraction in the Indian economy, as indicated by the gross domestic product (GDP) data for the first two quarters of 2020-21, highlights one major policy weakness. This is reflected both in the components of GDP on the demand side, and the gross value added (GVA) sectors on the supply side. On the demand side, this is reflected in the sharp contraction of 22.2 per cent in the government final consumption expenditure (GFCE) in the second quarter of 2020-21. On the output side, the high contraction in public administration, defence and other services in two successive quarters тАФ at 10.3 per cent in the first quarter and 12.2 per cent in the second тАФ indicates the inability of the central and state governments to activate the fiscal sector due to the ongoing and deep revenue contraction. If the Indian economy were to neutralise the continuing fall in investment demand, which has been contracting for the past five quarters beginning the second quarter of 2019-20, a strong and effective fiscal stimulus is called for. Financing such a stimulus, however, would remain a challenge in 2021-22 as it has been in 2020-21.
The mainstay of the Union government Budget consists of the CentreтАЩs gross tax revenues. The Ministry of Finance has to assess the base magnitude in 2020-21 and the growth rate that can be applied on it in order to project the CentreтАЩs gross tax revenues for 2021-22. There was a contraction in these even before the Covid shock hit the Indian economy. In 2019-20, the CentreтАЩs gross tax revenues fell by 3.4 per cent. In 2020-21, the contraction is expected to be sharper. We estimate it to be about 14.5 per cent. This implies that in absolute numbers, the base figure for gross tax revenues, estimated at Rs 17.2 trillion in 2020-21, would be well below the actual gross tax revenues of Rs 20.1 trillion in 2019-20. In fact, the CentreтАЩs gross tax revenues were at Rs 17.2 trillion in 2016-17. Given the structural changes in goods and services tax (GST) and corporation tax in recent years, nominal tax revenue growth rate may be expected to be less than the nominal GDP growth rate. The expected buoyancy of the CentreтАЩs gross tax revenues in 2021-22 may be similar to that in 2018-19 at 0.8. In fact, in 2019-20, it had become minus 0.5. The International monetary Fund (IMF) has projected IndiaтАЩs 2021-22 nominal GDP growth at 12 per cent. It would be unrealistic if the Ministry of Finance considered a growth in the CentreтАЩs gross tax revenues at any rate higher than 10 per cent. Thus, the CentreтАЩs gross tax revenues for 2021-22 might be estimated at Rs 18.9 trillion.
Even as revenues eroded, the CentreтАЩs expenditure continued to increase, albeit at rates that were much less than desirable in the face of an economic slowdown in 2019-20 and 2020-21. Total expenditure in the first seven months of 2020-21 grew by only 0.4 per cent. It may be noted that the CentreтАЩs total expenditure in 2020-21 was budgeted at Rs 30.4 trillion, 13.2 per cent higher than 2019-20 actuals. Taking into account a fiscal deficit level of 7.5 per cent of nominal GDP, as estimated by the IMF for the full year, we estimate that for 2020-21 the central government might be able to finance a total expenditure of Rs 28 trillion, which will serve as the base figure for the 2021-22 Budget. We note that this figure is lower than the budgeted amount by a margin of Rs 2.4 trillion. If at least a growth of 10 per cent is provided on this base figure, the 2021-22 total expenditure would work out to Rs 30.8 trillion, which is only marginally higher than what was budgeted for 2020-21.
However, financing even this level of expenditure in 2021-22 might prove an uphill task. If we derive the CentreтАЩs net tax revenues from the gross figures by applying the budgeted ratio of net to gross central taxes for 2020-21, the estimated net tax revenues would amount to Rs 11.6 trillion. This leaves a financing gap of Rs 16.4 trillion to be met by non-tax revenues, non-debt capital receipts and fiscal deficit. The base figure of non-tax revenues and non-debt capital receipts together is estimated to be Rs 2.1 trillion in 2020-21, which may also be increased by 10 per cent for 2021-22. Thus, the projected fiscal deficit for 2021-22 would be 7.4 per cent of the estimated nominal GDP. The central government should be willing to exceed the FRBM fiscal deficit target of 3 per cent of GDP by a margin of about 4.4 percentage points to budget for a 10 per cent increase on a highly subdued government expenditure base. Thus, at least for one more year beyond 2020-21, a substantially higher fiscal deficit may be thought of as desirable to support a recovery in the first post-Covid year. In the medium term, there is a case to reconsider CentreтАЩs Fiscal Responsibility and Budget Management (FRBM) Act as amended in 2018 since the target debt-GDP ratio of 60 per cent on the combined account of central and state governments has been thrown out of gear by a wide margin. The IMF projects that by the end of March 2022, the combined government debt-GDP ratio would rise to close to 90 per cent.
The Fifteenth Finance Commission has submitted its final report to the central government. The content of the report may become public at the time of the presentation of the Union Budget. However, given the constraints on central finances and the unpredictability of the CentreтАЩs major taxes, it is likely that the Commission may have accorded greater emphasis to grants rather than tax devolution, since the magnitudes of grants remain fixed and would not be revised downwards if the central taxes underperformed projections. This implies that even if the share of states in the central taxes is not increased in this final report, there may be additional flows to the state governments through the route of grants. The 2021-22 Budget will have to provide for these additional committed expenditures.
Given the constraint on expanding total expenditure, there is a clear case for restructuring expenditure in favour of capital expenditure. The National Infrastructure Pipeline (NIP) may be reassessed at this juncture to ascertain the shortfall in the investment targets for the first two years and its investment path may be realigned for the balance of the four-year period. The state governments as well as the public sector enterprises may also have to play a critical role in building up infrastructure in line with the NIP.
The ongoing contraction in the Indian economy, as indicated by the gross domestic product (GDP) data for the first two quarters of 2020-21, highlights one major policy weakness. This is reflected both in the components of GDP on the demand side, and the gross value added (GVA) sectors on the supply side. On the demand side, this is reflected in the sharp contraction of 22.2 per cent in the government final consumption expenditure (GFCE) in the second quarter of 2020-21. On the output side, the high contraction in public administration, defence and other services in two successive quarters тАФ at 10.3 per cent in the first quarter and 12.2 per cent in the second тАФ indicates the inability of the central and state governments to activate the fiscal sector due to the ongoing and deep revenue contraction. If the Indian economy were to neutralise the continuing fall in investment demand, which has been contracting for the past five quarters beginning the second quarter of 2019-20, a strong and effective fiscal stimulus is called for. Financing such a stimulus, however, would remain a challenge in 2021-22 as it has been in 2020-21.
The mainstay of the Union government Budget consists of the CentreтАЩs gross tax revenues. The Ministry of Finance has to assess the base magnitude in 2020-21 and the growth rate that can be applied on it in order to project the CentreтАЩs gross tax revenues for 2021-22. There was a contraction in these even before the Covid shock hit the Indian economy. In 2019-20, the CentreтАЩs gross tax revenues fell by 3.4 per cent. In 2020-21, the contraction is expected to be sharper. We estimate it to be about 14.5 per cent. This implies that in absolute numbers, the base figure for gross tax revenues, estimated at Rs 17.2 trillion in 2020-21, would be well below the actual gross tax revenues of Rs 20.1 trillion in 2019-20. In fact, the CentreтАЩs gross tax revenues were at Rs 17.2 trillion in 2016-17. Given the structural changes in goods and services tax (GST) and corporation tax in recent years, nominal tax revenue growth rate may be expected to be less than the nominal GDP growth rate. The expected buoyancy of the CentreтАЩs gross tax revenues in 2021-22 may be similar to that in 2018-19 at 0.8. In fact, in 2019-20, it had become minus 0.5. The International monetary Fund (IMF) has projected IndiaтАЩs 2021-22 nominal GDP growth at 12 per cent. It would be unrealistic if the Ministry of Finance considered a growth in the CentreтАЩs gross tax revenues at any rate higher than 10 per cent. Thus, the CentreтАЩs gross tax revenues for 2021-22 might be estimated at Rs 18.9 trillion.
Even as revenues eroded, the CentreтАЩs expenditure continued to increase, albeit at rates that were much less than desirable in the face of an economic slowdown in 2019-20 and 2020-21. Total expenditure in the first seven months of 2020-21 grew by only 0.4 per cent. It may be noted that the CentreтАЩs total expenditure in 2020-21 was budgeted at Rs 30.4 trillion, 13.2 per cent higher than 2019-20 actuals. Taking into account a fiscal deficit level of 7.5 per cent of nominal GDP, as estimated by the IMF for the full year, we estimate that for 2020-21 the central government might be able to finance a total expenditure of Rs 28 trillion, which will serve as the base figure for the 2021-22 Budget. We note that this figure is lower than the budgeted amount by a margin of Rs 2.4 trillion. If at least a growth of 10 per cent is provided on this base figure, the 2021-22 total expenditure would work out to Rs 30.8 trillion, which is only marginally higher than what was budgeted for 2020-21.
However, financing even this level of expenditure in 2021-22 might prove an uphill task. If we derive the CentreтАЩs net tax revenues from the gross figures by applying the budgeted ratio of net to gross central taxes for 2020-21, the estimated net tax revenues would amount to Rs 11.6 trillion. This leaves a financing gap of Rs 16.4 trillion to be met by non-tax revenues, non-debt capital receipts and fiscal deficit. The base figure of non-tax revenues and non-debt capital receipts together is estimated to be Rs 2.1 trillion in 2020-21, which may also be increased by 10 per cent for 2021-22. Thus, the projected fiscal deficit for 2021-22 would be 7.4 per cent of the estimated nominal GDP. The central government should be willing to exceed the FRBM fiscal deficit target of 3 per cent of GDP by a margin of about 4.4 percentage points to budget for a 10 per cent increase on a highly subdued government expenditure base. Thus, at least for one more year beyond 2020-21, a substantially higher fiscal deficit may be thought of as desirable to support a recovery in the first post-Covid year. In the medium term, there is a case to reconsider CentreтАЩs Fiscal Responsibility and Budget Management (FRBM) Act as amended in 2018 since the target debt-GDP ratio of 60 per cent on the combined account of central and state governments has been thrown out of gear by a wide margin. The IMF projects that by the end of March 2022, the combined government debt-GDP ratio would rise to close to 90 per cent.
The Fifteenth Finance Commission has submitted its final report to the central government. The content of the report may become public at the time of the presentation of the Union Budget. However, given the constraints on central finances and the unpredictability of the CentreтАЩs major taxes, it is likely that the Commission may have accorded greater emphasis to grants rather than tax devolution, since the magnitudes of grants remain fixed and would not be revised downwards if the central taxes underperformed projections. This implies that even if the share of states in the central taxes is not increased in this final report, there may be additional flows to the state governments through the route of grants. The 2021-22 Budget will have to provide for these additional committed expenditures.
Given the constraint on expanding total expenditure, there is a clear case for restructuring expenditure in favour of capital expenditure. The National Infrastructure Pipeline (NIP) may be reassessed at this juncture to ascertain the shortfall in the investment targets for the first two years and its investment path may be realigned for the balance of the four-year period. The state governments as well as the public sector enterprises may also have to play a critical role in building up infrastructure in line with the NIP.
Views expressed are personal. The author is chief policy advisor, EY India
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