Fiscal balance

Geopolitical tensions have increased risks

Renewed geopolitical tensions in West Asia have significantly increased economic and policy risks. Even though there have been attempts to contain the crisis, the potential involvement of other regional and global powers in the ongoing Israel-Palestine conflict can increase risks in ways that may be difficult to anticipate at this stage. The most obvious risks would be to global growth and the supply of crude oil. Although crude oil prices have increased, partly also because of voluntary production restrictions by large producers, a material disruption in supplies could affect both availability and prices. Since India depends on imports for the bulk of its needs, a large supply shock can affect economic activity. Although global growth has been resilient so far this year, things could change in the coming quarters. Tightening financial conditions, owing to policy action by large central banks — particularly the US Federal Reserve — and the intensification of conflict in West Asia can significantly alter the economic outlook.

Policymakers in the Union finance ministry seem to be tracking the developments carefully. A senior official, for instance, recently told this newspaper that they needed to plan expenditure intelligently because the global situation was not very good. As of now, the government is confident of attaining the fiscal-deficit target of 5.9 per cent of gross domestic product this financial year. The market-borrowing plan for the second half of the financial year shows that borrowing has been kept at the budgeted level. As the latest monthly review of the finance ministry noted, direct tax collection grew by 26.6 per cent year-on-year (Y-o-Y) during April-August 2023. Y-o-Y growth in net direct tax collection for the year till September 16 was at 23.5 per cent. Goods and services tax collection has also grown about 10 per cent so far in the financial year. In terms of expenditure, capital expenditure, which has been a significant driver of growth, was over 48 per cent higher Y-o-Y during the April-August period. Higher capital expenditure by the government in recent years has helped improve the overall quality of government expenditure.

While the government may be confident of attaining the Budget targets in 2023-24, planning for an impending shock could be tricky, largely because of the relatively weak starting point. Although the government has brought down the fiscal deficit from the Covid peak, it is still reasonably high to respond to an external economic shock. The focus on capital expenditure has undoubtedly helped maintain the economic momentum, but it has also slowed the fiscal consolidation process. The ability of the government to respond to an external shock depends on the available policy space, which in the context of fiscal policy is fairly limited at this stage. Thus, as the government is holding pre-Budget discussions, it makes sense to look for opportunities to contain expenditure and create policy space, both in the ongoing and coming financial years. To be sure, this would not be easy, given the demands on the Budget, particularly in an election year. However, as things stand, large growth or commodity price shocks can potentially increase the fiscal deficit and make it more difficult to attain the medium-term target. A sustained higher fiscal deficit will limit the government’s ability to manoeuvre and affect medium-term growth prospects.