Fiscal fault lines

Govt finances might affect economic recovery

The Indian economy contracted at a much slower pace in the second quarter of the current fiscal year. While the pace of recovery surprised most analysts, the finance ministry is confident that the economy would stage a much better performance in the third quarter. In its monthly economic report for November released on Thursday, the ministry said the V-shaped recovery reflected the robustness of the economy. The reality, however, may be different. One of the biggest constraints for demand would be the state of government finances, both at the Central and state levels. The second-quarter data also showed a sharp pullback in government expenditure.

A new study of top 18 states, which account for 90 per cent of aggregate output, by rating agency CRISIL shows that states’ indebtedness is likely to increase to about 36 per cent of gross state domestic product. Revenues are expected to decline by 15 per cent in the current year. This, along with the increase in indebtedness, is bound to affect government expenditure in the near to medium term. As the study notes, states are likely to reduce capital expenditure by about 30 per cent to remain within the borrowing limits. Despite the moderation in capital expenditure, the gross fiscal deficit is expected to expand by over 60 per cent in the current fiscal year, which would significantly increase borrowing needs. Since states account for over 60 per cent of the general government capital expenditure, a moderation will affect growth potential in the near to medium term. Since the quality of expenditure was, in any case, deteriorating over the years, the increased pressure on government finances owing to Covid-related stress would only make things worse.

What can complicate matters is that the Centre is also not spending to support growth. The fiscal stimulus announced by the government has not resulted in higher spending so far. The data shows that expenditure in the current year till October was roughly at the same level as last year. Overall expenditure was budgeted to increase by about 13 per cent in the current year compared to the revised estimate for the last fiscal year. The government has spent 54.6 per cent of the Budget estimate during this period compared to a level of 59.4 per cent in the corresponding period last year. It is possible that the government might be looking to increase expenditure in the remaining part of the fiscal year after it has a clearer sense of the revenue position. Both tax and non-tax revenue collection has suffered significantly in the current year.

As the revenue position is now improving, the government might decide to push expenditure. It appears that the government has decided not to increase borrowing from the amended target of Rs 12 trillion in the current year. One of the biggest reasons for not increasing government expenditure significantly to support growth is that India’s public finances were fairly stretched even before the Covid crisis. The general government debt is expected to expand to about 90 per cent of gross domestic product in the current year. But, in the given situation, the government would do well to reassess its position and see if it can push some critical expenditure in a non-disruptive manner, which would help growth. On the whole, however, the fiscal condition is likely to remain a drag on economic recovery.