Chapter 2 of this year’s Economic Survey deals with ‘Fiscal Developments’. Fiscal policy is concerned with the expenditures and revenues of the government. As we all know, spending has been ramped up ever since the pandemic struck not only in India but across the world. Expectedly, this has meant that the government’s debt has increased. At the same time, it is currently within sustainable levels. The resumption of economic activity has meant that the government’s revenue has also gone up owing to taxation. The latter half of 2020 and the first three-quarter of 2021 saw the stock markets soar which of course is indicative of the financial health of corporate India. This chapter will examine how the government made its money and how it spent it which will also give us a look at the state of the finances of the central government.
The stimulus measures introduced by the government took on various forms at various points. According to the survey, this was a deliberate strategy wherein the government decided to react in real-time to the needs that it was able to perceive. The first stimulus package saw an almost complete focus on food subsidies targeted at the most vulnerable. The second stimulus package, the largest one to date, saw spending increase almost 5-fold. Here the government focused primarily on liquidity to MSMEs. Agriculture received substantial support as well in the form of credit and subsidies. By the end of 2020, the government started placing emphasis on reviving economic activity by incentivising investment and consumption. This was done mainly in the form of production linked incentive schemes (PLIs) followed by increased capital expenditure with infrastructure gaining the focus. The idea was to boost employment and to generate output.
The initial reaction to the government’s stimulus efforts was that it was not enough. At the very beginning, most governments were focusing on direct cash transfers whereas the Indian government relied heavily on subsidies and credit. This trend continued throughout the future packages as well, but the government did increase the scope of the effort by a much bigger margin. Judging the success of the stimulus efforts is difficult and will require more time before we can come to a conclusion but the numbers thus far are not particularly encouraging. Early estimates suggest that nearly 200 million Indians fell into some form of poverty as a result of the pandemic. Unemployment continues to be a huge problem and the growth rate that is expected this year i.e 9.2% is only a return to normalcy. We have made up for the losses over the last two years and the real growth story is yet to begin.
As far as revenue goes, collections have bounced back even beyond expectations owing to the resumption of economic activities. The fiscal deficit as a percentage of the budget has reduced to 46% from last year’s 135%. Most sources of revenue, be it direct taxes, indirect taxes, personal taxes, non-tax revenues etc. have all increased from last years figures, with net tax revenue increasing by 64% as against a 9% expectation. This was due mainly to the increase in corporate tax revenues.
This strong revenue base has given the government the confidence to go forward with its expenditure policy which as we have seen from this year’s budget is geared towards infrastructure development. Road transport, highways, and railways will receive the vast majority of the expenditure with a view on long-term output and employment generation. While the intention is correct, the government will now have to focus on the execution of the projects. Notably, spending on healthcare has dropped by 45% and food subsidy expenses have also been cut back on by 27%. It seems as though the government is content with the threat of the pandemic and is planning for a covid-free future. It must be remembered that the government made this mistake last year by failing to anticipate the second wave. Vaccine coverage has increased, however, and as such the gamble may pay off.
One of the most notable parts of this chapter is how the government’s disinvestment strategy has changed from last year. The targeted amount to be raised from privatisation has been reduced by 63% from Rs. 1,75,000 crores last year to a mere Rs. 65,000 crores this year. The government managed to raise only a little over Rs. 12,000 crore last year which includes the sale of Air India and its subsidiaries, which means that it only achieved 6.8% of its target. The Rs. 65,000 crore target set out for this year hinges heavily on the LIC IPO which is scheduled for later this year.
With respect to the debt issued by the government i.e, bonds or government securities, the interest rates have dropped to a historic low. This is in line with the RBIs monetary policy and has been done to stimulate growth in the economy. It is a better tactic than entering into a period of austerity but there is a danger if interest rates are kept too low for too long. We are already seeing a rise in inflation which has been due to the increased supply of money in the economy. The main concern for the Indian economy might have to do with the banking system. A long period of low-interest rates will adversely affect a banks profitability. Given the current state of banking in the country, it is important for the government to keep an eye on the banking industry as a whole and understand the effect that low-interest rates will have on them. The government has lauded itself for its dynamic approach to policymaking using real-time data, and as such, it should be aware of a problem brewing.
The government’s debt-to-GDP ratio has also reached a historic high at 59.3% of the country’s current GDP. This is a 15 year high and has been necessitated by the pandemic. The survey states that the ratio is expected to decline in the coming years, but there is no explanation for how this is projected to happen or over what timeline. The current ratio is still within manageable limits, but the government must ensure that it doesnt keep rising. This will make borrowings for the country much more expensive and as such access to liquidity will become limited.
State finances have been a cause for concern ever since the pandemic began. Loss in revenues and increased need for expenditure has meant that the fiscal deficit of states has widened substantially.
The survey reveals that the deficit will cross the Fiscal Responsibility Legislation threshold of 3%. Since 2018-19, the revenue deficit of the states has increased from 0.1% of GDP to 2.0%. The government has reacted by increasing the borrowing limit and handing out loans in order to compensate for the loss in GST revenue. While this will help meet the short-term needs of the state’s finances, increasing the debt burden of the states is not a sound long-term solution. Even before the pandemic began, the debt-to-GDP ratio of many states was increasing at a worrying rate. This was primarily due to farm loan waivers and other state-specific policies which characterise fiscal profligacy. The average debt-to-GDP ratio of the states is currently at the highest is been since 1991. The government will need to come up with a better plan that does not solely rely on credit in order to help the states.
Right now, the only identifiable long-term vision seems to rely on increasing capital expenditure and spending on infrastructure projects. The multiplier effect of generating jobs and producing output is expected to ripple through the rest of the economy, but this is not a detailed vision. There is evidence that links increased capital spending with growth, but that does not mean that one will necessarily lead to the other. If the plan is to increase spending, the effort needs to be detailed and coordinated with specific targets. Such a vision has not been outlined in the budget, but hopefully, a clearer idea will become apparent as time goes on.