In this article, Rajeswari Sengupta analyses various nuances of the recently announced Union Interim Budget, including the deviation from the targeted path of fiscal consolidation. In a world of Aadhaar-linked bank accounts, it is significantly easier for governments to transfer money to a vast numbers of voters leading to an increase in the temptation to announce new welfare schemes. This can potentially take a serious toll on the nation's fiscal strength.
The acting Finance Minister, Mr. Piyush Goyal, presented the interim budget of the NDA (National Democratic Alliance) government on 1 February 2019. Interim budgets are presented close to a national election. Unlike full term budgets, interim budgets do not usually contain new expenditure plans or new taxation proposals because the government announcing them may not be around to implement the same.
In early 2004, the erstwhile NDA government avoided any policy announcements after mid-January. Similarly, in early 2009 and 2014, the UPA (United Progressive Alliance) government refrained from making important announcements in the respective interim budgets. The full budget is anyway presented within two months of the new government taking charge. It is only fair to give the prerogative of restarting policy debates and making important policy announcements to the new government. The 'vote on account for expenditure of the central government' for 2019-20 starts with the following preamble:
“In pursuance of article 116(1) (a) of the Constitution, Lok Sabha is being requested to make a grant to cover expenditure for a part of the financial year, pending detailed consideration and passing of the Demands for Grants for the full year. This statement shows the sums required for meeting the expenditure, which is likely to be incurred during April to July, 2019”.
This shows that an interim budget is an interim measure to keep the current government going for one more quarter before the elections take place.
This however did not seem to be the objective of the interim budget presented by the NDA government on 1 February 2019. Instead of being a vote on account, the budget contained an extensive list of announcements of a number of new, sectarian schemes, as well as tax changes. This brings to question the fiscal prudence underlying the budget.
Effective fiscal management is the cornerstone of good economic policy and is crucial for financial and macroeconomic stability. In 2003, the government passed the Fiscal Responsibility and Budget Management (FRBM) Act. The objective was to improve fiscal discipline; move towards a balanced budget; and through the reduction of fiscal deficit, free up resources for private sector investment which would in turn play a critical role in boosting GDP (gross domestic product) growth of the economy. The FRBM target for fiscal deficit is 3% of GDP.
According to the Medium Term Fiscal Policy (MTFP) statement issued by the current NDA government, the FRBM fiscal deficit target for 2018-19 was 3.3% of GDP, which was to be brought down to 3.1% in 2019-20. But according to the 2018-19 Revised Estimates (RE) presented in the interim budget, the fiscal deficit for 2018-19 will be 3.4%of GDP. The target for 2019-20 has also been pegged at 3.4% of GDP. This shows that towards the end of its term the current NDA government has failed to achieve the targeted fiscal consolidation.
The interim budget contains a list of welfare schemes and tax sops targeted to specific sections of the population. The government in its earlier budgets had announced big ticket expenditure items such as One Rank One Pension1, and Ayushman Bharat2 each of which is a significant drain on the budgetary resources. The interim budget added to the list with the announcement of 'Prime Minister Kisan Yojana' which would provide direct income support of Rs. 6,000 per year to landholding farmers. This programme will be funded by the Government of India and entail an annual expenditure of Rs. 75,000 crore (Rs. 750 billion). The budget also announced a pension scheme which aims to cover nearly 42 crore (420 million) workers in the unorganised sector making it one of the largest pension schemes of the world. Both schemes will start from the current year.
While the government has announced new schemes, it has not indicated withdrawal of the existing ones. Unless old schemes are wound up or public sector units are sold off, neither of which the government has expressed the intention for, it is not clear how the new expenditure plans will be financed in the medium term. In addition to the schemes, the interim budget announced a series of tax benefits especially for the middle class, salaried individuals, and small businessmen. This would further add to the expenditure burden.
Total government expenditure is budgeted to go up from 13% of GDP in 2018-19 RE to 13.3% of GDP in 2019-20 Budget Estimates (BE). In terms of tax revenues, the gross tax revenue estimates were lowered from 12.1% of GDP in the 2018-19 BE to 11.9% of GDP in 2018-19 RE. This reduction was primarily on account of lower than anticipated collections from the new Goods and Services Tax (GST). On the other hand, for 2019-20, indirect taxes are budgeted to increase by 11.8% over the 2018-19 RE estimates. This increase is mainly on account of improvement in GST collections anticipated in 2019-20. It is not clear how this improvement will come about pending structural changes in the GST framework or improvements in the GST administration, none of which was mentioned in the budget.
In light of the above discussion, it may be prudent to ask now how credible is the GST target? If the GST collections as budgeted for 2019-20 are an overestimate, then given the farmer income support scheme, the full fiscal impact of which will be felt in 2019-20, how credible is the 3.4% fiscal deficit target for 2019-20?
Borrowings from the market through the issuance of dated government securities (G-Sec) continue to be the main source of financing fiscal deficit. Gross market borrowing by the government for 2019-20 has been budgeted at Rs. 710,000 crore (Rs. 7.1 trillion) as opposed to Rs. 571,000 crore (Rs. 5.71 trillion) in the 2018-19 RE. This is a staggering increase of 24%. The net increase (issues less redemptions) is smaller, but it is still substantial.
With G-Sec issuances rising sharply on account of growing expenditure by the government, bond yields have been steadily going up since July 2017. A rise in government bond yield increases the overall cost of borrowing in the economy thereby crowding out private investment. Further increases in the government borrowing programme will add to the existing stress in the bond market.
Government securities are primarily purchased by commercial banks, insurance companies and pension funds. Commercial banks are already holding more G-Sec bonds than required by the regulatory norms. Given the new, ambitious expenditure plans announced by the government, it is worthwhile to ask, do the banks really have the appetite absorb these G-Sec issuances? If not, what will happen to the G-Sec rates and subsequently to private investment and growth?
In a modern market economy, a crucial element of fiscal prudence is counter-cyclicality. This means that governments should save during good times, benefit from higher tax revenues, and work towards building a budget surplus or lowering the deficit. When the economy faces a recession and tax revenues decline, governments should spend more to boost aggregate demand and run down the budget surplus or run a budget deficit. This is a fundamental principle of macroeconomics. In this context, there seems to be a contradiction between the apparent state of the Indian economy and the fiscal policy of the government.
Based on the new GDP series (2011-12 base year) released in 2015 and the latest back-series that revised the old GDP data, the government claims that India's GDP growth rate during the 2014-2018 period has been the highest since independence. In such circumstances, the government should have been running very low deficits or even surpluses. Instead the fiscal deficit-to-GDP ratio has exceeded the 3% FRBM target throughout this period.
The interim budget presented by the government reiterates this contradiction. In an economy that according to government figures has been recording spectacular growth rates consistently for five years and has been the fastest growing large economy in the world, what is the pressing need to announce a long list of welfare schemes? The budget speech argued that large segments of the population – including farmers, small traders and businessmen, middle-class salaried individuals, workers in the informal sector, pension earners are not faring well and need financial support from the government. This does not seem consistent with the official narrative that Indian economy is booming.
The interim budget is likely to take the economy away from the fiscal consolidation path as outlined in the FRBM Act, and not just because the planned deficit exceeds the 3% FRBM target. More fundamentally, the budget has brought to the fore an important development. It has reminded us that we are living in a new era, one where Aadhaar3 linked bank accounts has made it significantly easier for governments to transfer money to the bank accounts of vast numbers of voters. This situation may increase the temptation of governments to announce new welfare schemes which would then take a serious toll on the nation's fiscal strength. The government that comes to power in May 2019 needs to ensure that such temptations are resisted and fiscal consolidation is brought back on track.
Finally, the interim budget was released at a time when the country is experiencing a data crisis. GDP data is a crucial input in the budget-making process. The growth outlook colours the assessment of whether fiscal deficits should be large or small, and also influences the targets set for the tax collectors. If projected growth is too high, for example, the tax targets will be too aggressive, and the private sector will suffer the consequences.
The new GDP data has been under scrutiny ever since it was released in 2015. Experts have identified serious flaws in the methodology, a problem which is yet to be addressed and which has led to growth being consistently overestimated. The need felt by the government to offer financial support to multiple segments of the population even at the cost of breaching the fiscal deficit target also indicates that all is not well in the economy. The next government will need to fix these problems in GDP measurement. Until then, it will remain difficult to have any meaningful discussion about fiscal policy.
- One Rank One Pension implies that uniform pension will be paid to the armed forces personnel retiring in the same rank with the same length of service, regardless of their date of retirement.
- Government of India introduced the Ayushman Bharat Yojana (National Health Protection Mission) in 2018 – a collaboration between the central and state governments designed to pay for the tertiary healthcare of nearly 100 million families across the country.
- Aadhaar or Unique Identification number (UID) is a 12-digit individual identification number issued by the Unique Identification Authority of India (UIDAI) on behalf of the Government of India. It captures the biometric identity – 10 fingerprints, iris and photograph – of every resident, and is meant to serve as a proof of identity and address anywhere in India.