Budget 2019: Stimulus, Prudence, And Deficit Whack-A-Mole

BloombergQuintOpinion

The fine print will tell us whether fresh spending will pop up elsewhere as offsets.

Angsty farmers, mild fiscal slippage last fiscal, and asynchronous and decelerating global growth amid rising risk and uncertainty – that’s the demanding backdrop against which the interim budget of the Narendra Modi-led National Democratic Alliance has been framed.

Typically, one doesn’t expect much from such an interim budget exercise. But this time around, given the macroeconomic scenario, the consensus was it would try to address the domestic challenges while attempting fiscal prudence.

The budget has tried to live up to the expectations: in addition to addressing near-term concerns, it has attempted to lay out a medium-term vision that could change depending on the outcome of the general elections.

Keeping the context in mind, I evaluate the interim budget on two yardsticks:

  1. Does it walk the talk on fiscal consolidation, and,
  2. The outlook for the economy next fiscal year and the ability of the budget to influence that.

True Fiscal Consolidation?

The Finance Minister walked the talk on fiscal consolidation to some extent by limiting the fiscal deficit target breach to 10 basis points – 3.4 percent of GDP in FY19, against 3.3 percent budgeted.

For FY20, there is a pause on further fiscal consolidation to accommodate income support to farmers and tax benefits to the middle class. Accordingly, the deficit was targeted at 30 basis points above the initial target of 3.1 percent.

Despite these deviations from the goals of the Fiscal Responsibility and Budget Management Act, the general direction has been towards fiscal consolidation. That’s because the fiscal deficit has come down from 4 percent of GDP in FY15 to 3.4 percent now.

A 3 percent fiscal deficit—the long-term objective of FRBM—has  been met only once since 1991, in FY08, on the back of strong growth and changes in tax rates leading to healthy tax collections.

Also read: Budget 2019: Is The 3.4% Fiscal Deficit Target For FY20 Credible?

Path To 3% Deficit Goal

Under the FRBM Act, the government provides medium-term rolling targets for key deficit indicators. The government has often had to raise its fiscal deficit targets in the subsequent years from the medium-term projections made in the previous budgets.

Historically, the gap between the actual fiscal deficit and the target has been quite high and increases with the time period.

The encouraging sign is that despite a high error rate, the gap has been reducing over time in the base year as well as one-year and two-years ahead rolling forecasts.

The most notable change was observed in the one-year and two-years ahead gap, which underscores improved fiscal marksmanship.

Budget 2019: Stimulus, Prudence, And Deficit Whack-A-Mole

That said, it would be good the see the combined deficit of the government, also referred to as the public sector borrowing requirement, which includes quasi-government bodies. This used to be computed earlier and reported in the Economic Survey and needs to be revived to get a comprehensive picture of the fiscal situation.

The public sector borrowing requirement will inform us if the reducing deficit of the centre is like the whack-a-mole game, popping up in other government-linked entities and keeping the overall deficit high.
Budget 2019: Stimulus, Prudence, And Deficit Whack-A-Mole

Coming back to fiscal targets, even though desirable, achieving and sustaining the fiscal deficit target of 3 percent of GDP could prove very challenging for India.

Maybe this target itself requires a rethink.

In the first three years of Modi government, the fiscal policy, encouraged by low oil prices, had tilted towards prudence. Strains appeared in FY18, when the economy slowed and tax collections suffered, revenue expenditures overshot and oil subsidy bill went up. Consequently, fiscal deficit slipped 20 basis points of GDP despite a cut in capital expenditure. Overall government capex did not suffer as it depends more on internal and extra-budgetary resources of public sector enterprises than on budgetary allocations. The PSU resources remained quite healthy.

In FY19, the 10 basis points slippage on target mainly was due to an additional Rs 20,000 crore expenditure for providing income support to farmers. It was encouraging to see that capex was 5 percent higher than budgeted despite the fiscal stretch.

The government will have to press the pedal hard on tax collections and divestment to ensure that this year’s target is met.

Attaining the fiscal deficit target at 3.4 percent of GDP next fiscal will be a challenge unless the government achieves its aggressive divestment target and Goods and Services Tax revenue goes up as envisaged. Divestments, too, will need to be front-loaded to achieve the ambitious target of Rs 90,000 crore. This will be important to keep the government bond yields in check which reacted adversely to the news of slippage this fiscal.

The budget is realistic on nominal GDP growth assumptions of 11.5 percent and stability in the tax/GDP ratio for next fiscal.

So what impact will the budget have on the economy?

History suggests final budgets do not differ much from interim ones in terms of overall fiscal targets and broad expenditure and revenue trends as the wiggle room remains more or less the same due to FRBM commitments.

After it took reins in May 2014, the NDA government had retained the fiscal targets set in the interim budget of the UPA-II government.

And the focus on the rural economy is unlikely to change, though schemes and announcements could see some tweaking.

Also read: Budget 2019: Is Modi’s Election Budget Powered By Ambitious Tax Targets?

Budgets Are Now A Lesser Event

That said, the role of the budget in shaping the economic outcome has anyway become limited over the years. The fiscal flexibility to stimulate the economy is low due to pre-defined deficit targets and the fact that key spending—particularly capex—is done by states and via PSU resources.

So given the inclement external environment and strong headwinds of protectionism impacting growth and trade, India will have to dig within to find wellsprings of growth next fiscal, and perhaps even beyond.

Despite the odds, CRISIL expects the economy to grow at 7.3 percent in FY20, a tad higher than 7.2 percent estimated earlier, with some support from the budget.

But unlike FY19, the push will have to come from private investments and consumption, as the government’s hands are tied fiscally.

Also, this assumes good luck on the monsoon for the fourth consecutive year and soft crude oil prices.

Growth in private consumption is likely to find support from softer interest rates and an improvement in farm realisations as food inflation moves up, the income support scheme for the farmers, and tax breaks for the middle class and lower class. The money in the hands for small farmers and middle class will lead to consumer demand as they have a higher propensity to consume.

With gradually improving capacity utilisation and the corporate reaching the end of the deleveraging phase, conditions are ripe for revival in private corporate investments.

A stable political outcome will speed up that.

Dharmakirti Joshi is Chief Economist, CRISIL

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.