Income support expansion may hit fiscal consolidation path

The 2019-20 Budget gives an opportunity to assess the basic thrust of NDA government’s fiscal policy over the five-year period from 2014-15 to 2019-20. Comparing 2013-14, the last year of the previous regime, with 2018-19 (RE), it becomes clear that the NDA government prioritised expansion of the tax-GDP ratio enabling fiscal consolidation in line with the Fiscal Responsibility and Budget Management Act (FRBMA) targets. It did succeed in substantially augmenting the gross tax revenues to GDP ratio by a margin of 1.8% points over this period. This was due to both improvement in the direct and indirect tax revenues to GDP ratios which increased by margins of 0.7% points and 1.1% points, respectively.

However, Centre could not access much of this increase in tax-GDP ratio because of the sharp increase in the share of states in the sharable pool of central taxes following the recommendations of the Fourteenth Finance Commission. As a result, Centre’s net tax revenue to GDP ratio could increase over this period only by a margin of 0.6% points. This gain was further reduced by a fall in non-tax revenues relative to GDP by a little less than 0.5% points. Thus, in the revenue receipts to GDP ratio, the gain was limited only to 0.1% points.

Most of the reduction in fiscal deficit therefore had to be achieved by a reduction in revenue expenditures relative to GDP, which fell by a margin of 0.9% points. This in turn was due largely to a fall in the subsidies to GDP ratio of 0.7% points during this period. After all these adjustments, the fiscal deficit to GDP ratio could be reduced by 1.1% points from a level of 4.5% in 2013-14 to 3.4% in 2018-19 (RE) as well as in 2019-20 (BE). There was a marginal improvement in the quality of fiscal deficit measured as the ratio of revenue deficit to fiscal deficit which fell from 71% in 2013-14 to 65% in 2018-19 (RE).

The thrust of fiscal reforms over the five-year period therefore has all been in the right direction, namely increase in the tax-GDP ratio, fall in subsidies and revenue expenditures relative to GDP and improvement in the quality of fiscal deficit. In the case of capital expenditure to GDP ratio, there was some improvement, although marginal.

These fiscal reforms however, appear to have been stalled as we move from 2018-19 (RE) to 2019-20 (BE). Between these two years, the reduction in fiscal deficit to GDP ratio has become zero. The revenue expenditure to GDP ratio has increased by 0.3% points and capital expenditure to GDP ratio has fallen by about 0.1% points. The quality of fiscal deficit has also deteriorated by 2% points.

In the short run however, the government has aimed to provide a stimulus to growth mainly through three channels. First, it puts additional disposable income in the hands of the farmers, the budgeted cost of which for 2019-20 is Rs 75,000 crore i.e. 0.4% of GDP. The second channel comes from the relief in income tax given to middle-income groups up to the limit of Rs 5 lakh. Although the budgetary cost of this is Rs 18,500 crore, this will directly boost private final consumption expenditure. The third channel comes from the relief given in terms of capital gains linked to ownership of a second house. This should have a short to medium term impact on the real estate sector.

It is only the regular full year 2019-20 Budget which would come after four months that may indicate whether the fiscal reform path to consolidation will be restored. The risk factors include further increase in the income support commitments for the farmers which may even be expanded to include broader segments of population below the poverty line. The target of reducing fiscal deficit to 3% of GDP in 2020-21 in one stroke from 2019-20 (BE) also appears difficult in view of the stickiness of fiscal deficit at levels of 3.4% to 3.5% of GDP for three years in a row.