That the fallout of Covid 19 was akin to a war, and on several counts more adverse, was both understood and acknowledged from the outset. No sector of the economy was left untouched with livelihoods, incomes and employment severely impacted. If there was unanimity on any issue, it was that the government should attack and deal with the virus with whatever it took to do so.
When the first lock-down started on March 24th 2020, there was a plethora of opinion-advocates giving advice on the choices that the government should make. There was intense debate on the kind of expenditures the government that were required. Did the Centre have adequate fiscal space to initiate a fiscal expansion to tackle the fallout of the pandemic? Which were the different ways in which RBI could or could not monetize deficit? Whether the interventions should be demand-side or on supply-side? What would be the future trajectory of fiscal consolidation post-pandemic?
Governments typically use both monetary and fiscal policy to address crisis situations. In the light of the events that unfolded, which do not need repetition, three areas required immediate attention: (i) health expenditure, (ii) relief to people in terms of food and livelihood, and (iii) expenditure to stimulate demand and revive affected sectors. The Centre adopted a mix of monetary accommodation and fiscal interventions under the initiative of ‘Atma Nirbhar Bharat’ to address these as well as introduce some administrative reforms. The major interventions included measures for building of infrastructure, support to financially stressed businesses, free food grains to the eligible families, direct cash support to farmers and massive scale up of investment in health facilities and diagnostic tools. It has been estimated by the IMF that in 2020-21 the additional direct fiscal support by the Central Government was about 3.5 percent of the GDP and the monetary measures accounted for 5.2 percent. If the intervention by the States is added, the additional support to sustain and revive the economy would be in excess of 10 percent of GDP. This would be in addition to the budgeted fiscal deficit of 3.5 percent for the Centre and 2.74 percent for all the States.
In a pandemic of such magnitude with a global footprint, the effects of the shock last a very long time and may spill over to the medium term. Though vaccination has covered almost 1.3 billion with at least one dose and more than 50 percent of the eligible population fully vaccinated, the economy has to confront the sceptre of a new Covid variant, Omicron, which again threatens to halt the global efforts to emerge out of the crisis as well as other looming challenges. The RBI, which has done the heavy lifting till now with its accommodative stance, has signalled a gradual pull back in view of its mandate under the MPC to keep inflation within bound range of 4-6 percent. Coupled with this are the global headwinds of rising oil prices, supply and logistics bottlenecks, likely increase in US interest rates and slowdown of the Chinese economy. Going forward, to lift the economy to a higher growth trajectory, government action would be more critical. Hence, what could be the Fiscal Policy response?
India’s rule-based fiscal policy, enshrined in the FRBM Act of 2003 for the Central government and the separate fiscal responsibility legislations of the States, mandate a ceiling of 3 per cent fiscal deficit and a progressive reduction of revenue deficit to achieve revenue balance. Over the years, FCs have looked at the implementation of the legislation and, without altering the basic limit, made suggestions for improvement and compliance. In 2018, following the recommendations of the N.K. Singh Committee on FRBM Act, debt ceiling was benchmarked as an anchor for measuring fiscal levels for the general government.
To address the pandemic induced crisis which saw a sharp decline in revenues and a simultaneous pressure to expand expenditure in what has been called ‘the scissor’s effect’, the statutory limitations of the FRBM Act were breached by a wide margin. The fiscal deficit of the Centre ballooned to 9.22 per cent and the debt/GDP ratio, which had improved from 53.2 percent in 2011-12 to 49.4 percent in 2017-18, before falling to 52 per cent in 2019-20, rose sharply due to the elevated borrowing to 58.8 per cent. The all-State fiscal deficit, which had largely remained below the target level of 3 per cent increased to 4.53 per cent of GDP as against the budgeted 2.8 per cent, while their outstanding liabilities increased to 30.09 per cent of GDP.
However, factoring in the uncertainty caused by the pandemic the 15th FC acknowledged that it was ‘impossible to pursue the FRBM path of fiscal deficit of 3 per cent of GDP even by 2025-26, unless economy gains a greater momentum than expected’. Thus, in a departure from the fixed targets prescribed in the statutes and by the previous FCs, a flexible fiscal road map was recommended for the Centre and the States based on the possible growth scenarios up to the terminal year of its award, 2025-26. As a corollary, the debt levels were projected to remain above the earlier statutorily fixed 60 percent level for general government beyond 2025-26.
The Finance Minister in her budget speech for 2021-22 accepted the roadmap of the 15th FC at slightly higher level than the upper band on the range, signalling thereby the government’s intent to continue with an expansionary fiscal policy, despite the high level of fiscal impulse so far in the last year and half, and a glide path to fiscal consolidation spread over the medium term. The intent underlying the fiscal strategy appears to be to induce investment and enhance capital formation to address the problems of employment and bring demand to the trend growth path of pre-2019-20.
But as data for last several years show, there is a certain stickiness in government expenditures that limits scope for demand-inducing expenditures in business-as-usual scenario. Given the structure of Central government budget, are there ways to enable resources to flow to the desired sectors and areas? Seven specific interventions are proffered to achieve this:
1. Restructure Centrally Sponsored Schemes and Central Sector Schemes – There are over 29 CSS with more than 130 sub-schemes under them. Interestingly, almost 80 percent of the total allocation of Rs.3.80 lakh crores is spent on just 14 major schemes (and sub-schemes). Rationalizing and restructuring will enable the government to push investment into key areas.
2. Enhance Capital expenditure – The level of Capital Expenditure in the budget for 2021-22 has been enhanced from Rs.4.39 lakh cores to Rs.5.54 lakh crores. Reforms of tendering processes and other administrative bottlenecks need to be addressed to ensure that the expenditure is incurred within the financial year. Projects under the National Infrastructure Pipeline of Rs. 6 lakh crores require a mission mode approach and dovetailed with state projects for synergy and impact.
3. Higher provisioning for asset creation and employment inducing schemes such as PMAY (both rural and urban), PMGSY, Jal Jeevan Mission will add both to the high consumption propensity and the multiplier effect of government expenditure.
4. Higher provisioning needs to be made for Health and Education. PM Ayushman Bharat Health Infrastructure Mission (Rs.64,000 crores) addresses critical gaps in health infra. This needs to be fast tracked by finding adequate resources and dovetailed with the specific Local Bodies grant recommended by the 15th FC.
5. States spent, in the past almost 3 percent of the GDP on Capital expenditure compared to about 1.6 percent of the Centre. State budgets for 2021-22 reveal a decline to 2.75 percent. States are also not fully utilizing the fiscal space of 4 percent given by the 15th FC. It is time the states start doing the heavy lifting along with the Centre.
6. 15th FC has provided a separate window of 0.50 percent borrowing to the States for power sector interventions. Implementation of the reforms will potentially improve power sector performance which at current level is a drain on most States finances.
7. Tax reforms is essential, as Tax:GDP ratio has remained almost stagnant around 18-20 percent of GDP. IMF study for the 15th FC detailed a potential revenue loss of almost 4 percent of GDP which could be achieved with reform and administrative measures. Two low hanging fruits are reform in the rate structure of GST and taxes foregone through various exemptions. Suffice to say that even a 2 percent accretion to Tax:GDP ratio will give significant cushion to India’s public finance.
The argument of “no fiscal space” can be countered with some of the above suggested measures. This would enable an expanded expenditure programme to revive growth. Growth enhancing fiscal policy will also enable the government to return to a credible fiscal consolidation path as per the 15th FC projections.
- Adapted from a presentation made to the Annual Conference of ÉCLAT - The Economics Association of Daulat Ram College, University of Delhi, on October 29, 2021.
Ajay Narayan Jha is former Finance Secretary, Government of India; and former Member, Fifteenth Finance Commission.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.