India’s Fiscal Dilemma
Present circumstances
- The recently revealed budget offers a fantastic opportunity to assess the financial situation. Of course, as it is the last full budget before the 2024 elections.
- More importantly, during the 2019 fiscal, India’s economy may really have a regular year for the first time in a long time.
- Following the NBFC crisis in 2019–20, there was an epidemic in 2020–21, a recovery in 2021–22, and then, in 2022–2033, there was a global uprising due to Russia’s invasion of Ukraine. Until the fiscal year after that, we won’t be able to compare “normal” budgets side by side, like with like.
- The budget’s economic analysis has produced a mixed bag of conclusions, including some encouraging information and some cause for concern.
The good news about the budget is:
- The good news is that the budgetary situation has proven to be durable in many ways despite the recurrent shocks.
- Actually, the ratio of tax collections to GDP is a little bit greater than it was in 2018–19. As capital spending climbed from 1.5% of GDP to a budgeted 3.5% of GDP, the spending side’s composition has improved.
- Additionally, two years ago, a major off-budget item was placed back to the budget, which was a significant and excellent attempt to boost transparency.
- The budget deficit is presently on the decline after reaching a Covid peak of more than 9%, and it is anticipated to reach about 6% of GDP next year.
The following list summarises the budget’s mixed-development economic sectors:
- Contradictory developments have also occurred, particularly in the field of revenue.
- Personal income taxes have experienced a hopeful increase even as prosperity and the middle class expand; however, this development has been accompanied by increases in exemption limits, showing that revenue now comes from a smaller base of taxpayers.
- Given that the GST’s collection ratio has essentially remained steady from five years ago, its promise has not yet been realised. This is partially due to the fact that repeated rate decreases have partially countered efficiency advances.
- Furthermore, tax rate cuts have significantly reduced corporate tax receipts, which have once again more than offset the advantages of major companies’ increasing profitability and market share gains (at the expense of the informal sector).
The following financial concerns were brought up:
- First, throughout the preceding five years, spending has grown considerably. One needs to be careful with the numbers in this case because the spending for 2018-19 was overstated due to multiple transactions being shifted off-budget.
- The “real” increase in spending is still substantial and exceeds 1.5 percentage points of GDP even with this correction. The upshot will be an uncomfortably high structural fiscal deficit for the upcoming fiscal year of 6% of GDP.
- Since a lot of borrowing was needed to cover the succession of sizable deficits from 2018 to 2019, interest liabilities have grown to the point that they now make up roughly half of the center’s tax revenue. In a piece we co-wrote with Olivier Blanchard, we showed how this exceptionally high ratio both increases the vulnerability of India’s finances and decreases funding for vital social programmes.
- The states will only receive 31% of gross tax collections in the forthcoming fiscal year, down from 37% in 2018–19 in terms of revenue.
- This is due to the center’s increased use of cesses, which are taxes that are not shared with the states, as well as the fact that a sizeable portion of tax revenues (from the GST compensation cess) are used to reimburse the GST Council for loans it extended to the states during the pandemic.
- The process of centralization is more subtle on the expenditure side. A significant 1 percentage point of GDP will be cut from current expenditure that is neither subsidised nor subject to interest in 2022–2023, and an additional 0.5 percent of GDP will be reduced in 2019.
How does one do this?
- There are several mechanisms at work, but one crucial one is that the federal government is reducing the payments it makes to the states for various programmes that are funded at the federal level.
- Some of the reduction can be justified because the economy has recovered from the outbreak. A portion of it also tries to compel the states to manage their finances and expenditures more effectively.
- This goal is admirable, particularly if the states are persuaded to reduce their horrendously wasteful power subsidies. The outcome, though, significantly pressures state government spending.
What does this mean for the overall effectiveness of the country’s budget?
- We are currently unable to answer to this inquiry since there is a lack of recent data for the states.
- However, we do have some information. For instance, we are aware that even while capital spending at the centre has increased significantly compared to 2018–19, overall public sector investment has dropped as a result of spending reductions by the states and specifically public sector undertakings.
Conclusion/Following Steps:
- In conclusion, despite the center’s wise choice to forgo implementing a major fiscal stimulus during the epidemic, the financial position has significantly gotten worse during the past five years.
- The structural deficit at the centre is larger, the total debt has increased to an uncomfortably high 85 percent of GDP, and interest liabilities have reached exceptionally high levels.
- The centre needs to undertake a consolidation strategy, but the fundamental element of this strategy is centralization, which has pros and cons.
- The boundaries are clear. Even in the most optimistic scenario in which centralization results in the long-needed boost in state government efficiency, there is a limit to how much consolidation can be accomplished in this fashion. After that, the government will have to come up with alternative plans to reduce the deficit to its desired level of 4.5% of GDP.
- Regarding the constraints, centralization would only result in a transfer of resources from the states to the federal government if it failed to boost productivity.
- Therefore, states would either have to reduce the services they provide to their residents. They could also have to take out extra loans, in which case their financial status as a whole might worsen.
- And all of this is assuming that as the 2024 elections approach, the budgeted financial condition would remain stable. On the other hand, if they were affected by the wider, intensely competitive national populism trend, the overall budgetary position would get worse.
