How inflation could rescue the govt's fiscal deficit act in FY22

Despite the spike, it may not push up govt's borrowing cost much due to various factors such as sale of BPCL and LIC, and lower expenditure levels this fiscal

The surging inflation will be welcome news for the finance ministry as it seeks to come close to achieving the fiscal deficit target for FY22. The good news will persist even though the rising rates have begun to push up the cost of government borrowing.

“The average cost of borrowing by the Centre will not move much this financial year,” said Pinaki Chakraborty, Director, National Institute of Public Finance and Policy. The weighted average borrowing cost for FY21 was 5.79 per cent, which was the lowest in the past 17 years and the weighted average maturity was 14.49 years, according to finance ministry data.

The combined state and central government deficit is also expected to moderate. An India Ratings report issued this week shows the states have on an aggregate borrowed 10 per cent less than what they had announced at the beginning of the financial year.

Balancing math:

This is the sense within the finance ministry as discussions with the line ministries are about to get wrapped up by the end of October. The fiscal deficit of 6.8 per cent for FY22 is looking likely to be achieved. The department of investment and public asset management in the finance ministry has assured that both the sale of BPCL and the listing of LIC shall happen within FY22 bringing in the projected Rs 1.75 trillion to the government receipts.

In the Indian fiscal calendar, finance minister Nirmala Sitharaman and her team in the department of expenditure meet each department in the union government through October. These meetings used to be held in November earlier but the dates were reset once the budget date was advanced by a month from the last date of February to February 1, in FY18.

A Business Standard report this week quoted a government official to note that the fiscal target would not see any reset in the revised estimates. While the Centre is likely to overshoot its expenditure on subsidies, mainly on food and fertilisers, a higher than expected tax revenues of Rs 2.5 trillion and the on-course non tax revenues would make up the difference.

The reason why a higher inflation (consumer price index or wholesale price index) helps in the  lowering of the estimated fiscal deficit is a simple one. The fiscal deficit, which is the difference between the total expenditure of the government by way of revenue, capital and loans net of repayments on the one hand and revenue receipts plus capital receipts (net of borrowing) is calculated as a percentage of the nominal GDP. The nominal GDP because of the way it is calculated on current prices includes the inflation component. To estimate the real rate of GDP growth statisticians net out inflation using a GDP deflator, a weighted average of CPI and WPI. In September, the former is currently running at 4.35 per cent and the latter at 10.66 per cent. A higher inflation would therefore shrink the deficit just as a higher subsidy reduces the nominal GDP. On balance, however, the numbers as of now show the effect of higher inflation will overwhelm the higher subsidy.

The high inflation, if it persists into the next financial year, could create difficult policy choices for finance minister Nirmala Sitharaman for FY23.  "A high inflation, like a steroid, helps government estimates look good intially but in subsequent years makes difficult to project any of the numbers accurately", said Deep N Mukherjee, visiting professsor of finance at IIM Calcutta.  The minister has to take a call on whether to keep the fiscal deficit for FY23 unchanged or assume more fiscal consolidation. Fiscal consolidation would be rewarded by foreign borrowers whom the ministry plans to tap aggressively in FY23, by pushing for inclusion in the global bond indices. But it might need the government to cut its capital expenditure as it is the only space where there is scope for a cut in expenditure. Government capital expenditure is budgeted to grow to 2.49 per cent of GDP in FY22 consistently raising its share since FY19.

In the aggregate government capital spend in India, about one third is provisioned from the central government. The states will find it difficult to keep up their two third share, though. As per Care Ratings data, eight of the largest states are running a revenue deficit in the first five months of FY22. It means they shall have to cut back on capex to meet their deficit targets despite the Finance Commission’s forbearance. So meeting the fiscal deficit targets could come at a cost.

Borrowing math:

The finance ministry officials have also discovered that the total expenditure of the centre in FY22 is running behind the rate for FY21. As per the updated monthly data of the Controller General of Accounts, total expenditure of the Centre is at 36.7 per cent of the budget estimates for the first five months of the year, against 41 per cent last year. This includes both capital and revenue expenditure.

A major item of additional revenue expenditure could be the proposed extension of the scheme for the supply of additional 5 kg of food grains per person per month, as a Covid help measure. The scheme PM Garib Kalyan Anna Yojana runs upto November, 2021. The government officials have factored in an extension till the end of this financial year which shall cost them another Rs 53,000 crore.

Overall while food and fertiliser subsidy expenditure shall exceed the budget targets the trends in others are not so certain. To expedite expenditure the finance ministry has begun to relax all austerity linked circulars that were dropped on the central ministries to bring their expenditure to a dead halt from April 2020. The big relaxations of late include grant of bonus equivalent to 30 days pay to non-executive employees of the central government including casual labourers. It was signed last week. A very small one was the waiver of a Rs 300 per month charge on senior management grade officers for the laptops given to them for official use. In fact, the government-run marketplace e-GEM has suddenly found a huge bump up in its order books as government departments have begun to place invoices for all sorts of expenses from laptops to sundry office equipment. More orders to stimulate expenditure in government ministries are expected in the next few weeks.  

Still, for the key ministries with massive budgets of about Rs one trillion and more for each including health, education, rural development, drinking water and sanitation while the finance ministry has been liberal with their spending plans from the beginning of the year, it shall be a tough task to spend their entire budget. In the year before Covid, FY20, all these ministries had an unspent balance of Rs 47,808 crore at the end of the year.

This year, because the relaxation in spending orders has come close to the firming up of Budget numbers, the expectations for shortfall in expenditure are similar. This is the reason the department of economic affairs has projected no increase in borrowing programmes for the year from the markets. The higher interest rates, as Chakraborty says, will not askew the total bill for interest on borrowings, projected at Rs 8.09 trillion for FY22.

The higher inflation and the consequent rise in the interest rates shall begin to bite into government finances in FY23.