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Sunday, February 28, 2021

Budget’s strategy of fiscal consolidation, compressing expenditure, could prove to be a costly miscalculation

Few would have faulted governments for spending more to counterbalance the effects of a once-in-a-century crisis. There is a time for aggressive consolidation. This was not it.

Written by Ishan Bakshi |
Updated: February 9, 2021 8:59:02 am
Sitharaman and Anurag Thakur addressing the press after the Budget presentation

This was not an ordinary year. Faced with managing the economic fallout of a once-in-a-century crisis, the expectations from the Union budget were of a completely different order of magnitude. The challenge before the finance minister was how to enhance public spending, without raising taxes, while adopting a credible path for fiscal consolidation.

It appears as though expectations of a quicker recovery of the formal economy in 2021-22, and concerns over high debt levels, seem to have persuaded the government not to opt for aggressive spending in the immediate term, but focus on consolidation. This could prove to be a costly miscalculation. The economic outlook isn’t as rosy once the base-effect-induced bounce in growth next year wears off. The roadmap laid out by the 15th Finance Commission indicates this possibility. Nominal GDP growth is expected to slow down from 13.5 per cent in 2021-22 to 9.5 per cent in 2022-23 — implying a real GDP growth of only around 5 per cent.

By then, the second-round effects of job and income losses and weak balance sheets are likely to have worked their way through the system.

And considering that economic growth had slowed down sharply to 4 per cent even prior to the pandemic — there were calls for raising government spending then as well — whether growth can recover to around 7 per cent (what the Finance Commission expects) or 8 per cent by 2025-26 (what the government expects) is debatable.

Thus, what is critical is not just the fiscal stance of the general government (Centre and states) in the immediate but over the medium term as well. The risks of consolidating too much too soon, at the cost of medium-term growth prospects, could end up being counterproductive for both growth and debt sustainability. The budget, along with the Finance Commission report, offers some cues on the road ahead.

So, has the central government shed, albeit belatedly, its fiscal conservatism in the immediate term? Not quite.

The Centre’s total expenditure in 2020-21 is pegged to rise by Rs 4.08 lakh crore over its earlier estimate. Much of this, as has been pointed out, is on account of higher subsidy payouts, along with higher spending on MGNREGA, and others. But the medium-term fiscal statement notes that of the revised food subsidy allocations for this year, Rs 1.5 lakh crore is for prepayment of outstanding food subsidy loans of the Food Corporation of India. Another Rs 62,000 crore is reportedly for clearing fertiliser subsidy dues. This adds up to Rs 2.1 lakh crore.

While this enhanced transparency in accounts is welcome, it is merely washing away past sins. It does not amount to a demand-side stimulus. This is payment for goods already consumed. Adjusting for this, the difference between what the Centre had planned to spend if 2020-21 was a normal year and what it will spend in a pandemic year gets whittled down to less than Rs 2 lakh crore or around a mere 1 per cent of GDP. Excluding these payments, the government-expenditure-to-GDP ratio works to around 16.6 per cent for 2020-21.

Next year, the Centre’s spending is not even going to rise in line with nominal GDP growth, let alone surpass it. In fact, the spending-to-GDP ratio actually falls to 15.6 per cent in 2021-22. Further, as next year’s figures also include allocations for clearing up of FCI dues (around Rs 70,000 crore), spending (excluding these payments) will be even lower at 15.3 per cent of GDP. That means that the size of the government actually shrinks. The aggressive fiscal consolidation next year has been secured through expenditure compression.

It would seem that the government hopes that the switching of expenditure in favour of capital spending would help offset this — the multipliers for capital expenditure are considerably higher. But it was crucial to sustain, if not increase, government spending, especially on programmes like MGNREGA during these years, imparting a positive impulse to the economy when it was most needed.

Where the government has succeeded is in avoiding aggressive tightening over the medium term. The half-hearted allegiance to the 3 per cent fiscal deficit target — the elusive target was last achieved in 2007-08 — has simply been dispensed with. The new fiscal consolidation roadmap of 4.5 per cent by 2025-26 (similar to the path recommended by the commission if the recovery is slower than expected) is perhaps as good as an admission that as the economic fallout stemming from the pandemic will be spread over multiple years, higher levels of government spending will be needed. Adopting this relaxed consolidation roadmap also creates space for the Centre to be able to spend more closer to the next general elections.

But this luxury of delaying fiscal consolidation has not been extended to state governments. They are expected to bring down their deficits to 2.8 per cent of GDP by 2023-24 from 4.2 per cent in 2020-21. Considering that it is state governments that are actually expected to drive general government capital spending over the medium term, there was a case for a more relaxed roadmap. State governments are expected to run a revenue surplus of 2.4 per cent of GDP by 2025-26. Along with a fiscal deficit target of 2.8 per cent, this effectively means that states will be allocating around 5.2 per cent of GDP on capital expenditure. In comparison, while the Centre’s fiscal deficit is pegged at 4.5 per cent of GDP by 2025-26, around 60-70 per cent of its borrowings will be used to finance revenue, not capital expenditure.

The more relaxed fiscal consolidation roadmap recommended by the Finance Commission, coupled with the Union budget, suggests that the general government deficit will fall from 13.7 per cent of GDP in 2020-21 to 10.1 per cent in 2021-22 (a decline of 3.6 percentage points in one year) and then to 7.3 per cent by 2025-26 (a decline of 2.8 percentage points over four years). Thus, aggressive consolidation next year will be followed by a more relaxed decline thereafter, rather than the other way around.

Considering the starkly uneven nature of the economic recovery, there was a strong case for greater government spending now, for allocating more resources to ameliorate the condition of those at the bottom of the income distribution. This policy stance was required at all levels of government. Few would have faulted governments for spending more to counterbalance the effects of a once-in-a-century crisis. There is a time for aggressive consolidation. This was not it.

This article first appeared in the print edition on February 9, 2021, under the title “A time to spend”. ishan.bakshi@expressindia.com

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