The fiscal balance

Govt will need to work on a consolidation plan

The Union government announced a new package last week to support economic activity. The set of measures is estimated to cost about Rs 1.2 trillion. However, the government is unlikely to increase borrowing in the current year from the amended target of Rs 12 trillion. An improvement in revenue collection would perhaps help finance the expenditure. This also suggests that the government is not willing to expand the fiscal deficit beyond a point, though the final number would be significantly higher than the budgeted 3.5 per cent of gross domestic product (GDP). Overall revenue collection during the first half of the fiscal year declined by about 22 per cent. The contraction in tax collection was contained to a large extent by a higher excise duty mop-up, thanks to the hefty increase in the levy on petroleum products.

However, things are expected to improve significantly on the fiscal front in the second half of the year. Economic activity is recovering and will lead to higher tax collection. For instance, a recent research note by Credit Suisse showed that Central government expenditure in the current fiscal year can increase by 7 per cent. It expects gross tax receipts to grow by 19 per cent in the second half of the fiscal year, over the same period last year. Since transfers account for a significant share of state government receipts, it would help ease pressure at the state level as well. Besides, their own revenue is also expected to improve. Further, a new study by the Reserve Bank of India shows that the economy can break out of contraction in the third quarter of the current fiscal year, which is one quarter ahead compared to its earlier projection. This could materially improve nominal GDP for the year and help contain the fiscal deficit.

While the fiscal outlook has improved in recent weeks, management of government finances would remain extremely challenging in the near to medium term. It will require careful handling. For instance, the government has asked public sector enterprises (PSEs) to pay higher dividends. While this is truly an extraordinary year, the government has been squeezing PSEs for many years to meet budgetary targets. The data shows that the dividend payout ratio of 55 listed PSEs over the past five years was more than twice that of Nifty50 firms. Excess dividend payout by PSEs will result in lower investment and subpar growth over the long run, which would ultimately affect government finances. Weaker balance sheets also affect valuations of PSEs and result in lower disinvestment realisation. Thus, the government should avoid putting pressure on PSE finances to meet annual budget targets.

Moreover, since the fiscal deficit is likely to expand significantly in the current year, it provides an opportunity to make the Budget more transparent and credible. At a broader level, although there is still a fair amount of uncertainty because it is not clear when the pandemic will end, the government would be expected to present a medium-term fiscal consolidation road map with the Union Budget. 
 

A sensible path would be to plan for a gradual reduction in the deficit from next year in sync with the recovery in revenues. Both a delay in consolidation and a sharper than expected cut in expenditure would entail risks. It will be a tough balancing act.