BUDGET EXPECTATIONS : FISCAL DEFICIT

20 Jan 2023 , 11:43 AM

Union Budget 2023-24 budget estimates for the fiscal deficit are pegged at around 5.8%. This FY24 year is likely to be a significant year since the government is expected to start its journey towards the FRBM target of fiscal deficit from Budget 2023-24 onwards. But, first a quick word on the FRBM. The original FRBM (Fiscal Responsibility and Budget Management) Act had gradually guided the Indian economy towards a fiscal deficit target of 3.5%, with a best case possibility of fiscal deficit tapering to 3%. COVID changed the narrative as governments had to focus on reviving growth. Here are the 15th Finance Commission estimates.

Fiscal Year	Worst Case Scenario (Fiscal Deficit)	Normal Scenario (Fiscal Deficit)	Best Case Scenario (Fiscal Deficit)
FY 2021-22	6.50%	6.00%	6.00%
FY 2022-23	6.00%	5.50%	5.50%
FY 2023-24	5.50%	5.50%	5.00%
FY 2024-25	5.00%	4.50%	4.00%
FY 2025-26	4.50%	4.00%	3.50%

Data Source: 15th Finance Commission Estimates (Fiscal Deficit at % of GDP)

What are the key takeaways from the above table? Broadly, there are 4 things that we can infer.

1. The government has indicated that the FRBM target of fiscal deficit at 3.5% of GDP would only be achieved in a best case scenario by the fiscal year FY26. In a worst case scenario or in a normal case scenario, fiscal deficit would be higher.

    

2. Current trends show that even if the government manages to achieve 6.4% in FY22 and pegs at around 5.8% in FY23, then the budget numbers are much closer to the worst case scenario in both the years. That is not a good signal even from FY26 perspective.

    

3. The need of the hour is out-of-the box approach to fiscal deficit management. For instance, the government must set a target of 4.5% for FY25 and 3.5% for FY26 and these should be articulated in the Union Budget 2023-24 itself. This will show the government’s commitment towards FRBM.

    

4. There is a challenge. While the subsidy burden on food and fertilizers will come down in the coming months, the capex is expected to rise sharply. That means, the government would have to think up new revenue sources and monetization plans for revenues.

How fiscal deficit panned out in last 3 years

In a sense, the pandemic was like a game changer for the fiscal management. It was not just unique to India, but across the world there was tremendous monetary infusion and fiscal incentives to help people tide over the crisis. Despite its budget constraints in FY21, the government had announced total incentives to the tune of $400 billion, which included fiscal incentives and doles of $200 billion. What was the outcome of all this largesse?

The fiscal deficit targets as a percentage of GDP went for a toss. For instance, in FY21, the original target of fiscal deficit to GDP was 3.5%, which was hiked to 9.5% of GDP due to the fiscal impact of the COVID pandemic. Similarly, in FY22, the original target of fiscal deficit to GDP was 3.0%, which was hiked to 6.8% of GDP due to the fiscal impact of the COVID pandemic. Eventually, India ended up just about meeting its 9.5% fiscal deficit target for FY21 and marginally exceeded fiscal deficit targets for FY22 at 6.9%. For FY23, the Union Budget has pegged the fiscal deficit at 6.4% of GDP. As of December 2022, the government is on target, but we need to await another confirmation from Budget 2023.

How much better will fiscal deficit be in FY24?

That is the million dollar question. Will the government adopt a phased reduction of fiscal deficit to GDP target or would the government go for a sharp cut. FY23 has been challenging on the budget. Firstly, the COVID strain may be history but some of the vestiges of the COVID period like the free food program continued. Also, fertilizer and oil subsidies spiked due to a global commodity rally in commodities in the light of the Russia Ukraine war. The FY23 budget is likely to be helped by cuts in revenue spending (without losing focus on capital spending) and higher than expected revenues from direct and indirect taxation.

What is the outlook for FY24? Based on current data flows, the government may not go for a very drastic cut in fiscal deficit target and may stick to the range of 5.8% to 6.0% of GDP for FY24. The global economy is in turmoil and the government may have to spend more on fiscal incentives in FY24, if there is a global recession. Due to this very factor, the actual fiscal deficit target for FY24 may be closer to the 6% mark. It is not clear if the government would like to surprise markets with a sharply lower fiscal deficit target, but that would be a good surprise to have. 

Five factors when setting the FY24 fiscal deficit target

When the government sets the fiscal deficit target as a percentage of GDP, it would broadly have 5 considerations at the top of the mind.

• Based on a fiscal deficit to GDP ratio estimate of 5.8% to 6.0%, India would be up against a borrowing program of between Rs16 trillion and Rs18 trillion. The challenge would be to borrow this kind of money in a market where yields are already high.

   

• Year 2023 is when many of the western economies of the Americas, EU and UK are likely to dip into a mild to moderate recession. That is likely to dent demand and export incentives would be essential to prop up trade. That will spike fiscal deficit in FY24.

   

• The budget would be conscious of the fact that the Indian sovereign ratings are just one grade above being speculative, although the outlook is positive. Even if the rating remains the same and outlook becomes neutral, it could be a rather tight situation.

   

• A lot would depend on the rates policy and the hawkishness of the RBI during the year. Fiscal deficit is normally a pressure on the bond yields in the medium to long run. This is likely to impact longer term yields more. If RBI is planning to bring down yields in this year to reduce cost of borrowing, then the high fiscal deficit could offset some of the gains. That is something RBI has to keep in mind.

   

• In the last two years, the revenue spending has remained constant while capex has gone up. This year, the subsidy bill is expected to come down sharply, but capex would be higher once again. A lot will depend on how much dividend the RBI pays out and how much of asset monetization the government can manage; either through disinvestment of shares or through strategic sales.

Should the budget risk being aggressive on fiscal deficit?

One question is whether the government should give a commitment of 4% fiscal deficit along with a glide path. That would be a great morale booster for the markets in general and even the global rating agencies are likely to be delighted with that kind of commitment shown by the government. It is a risk worth taking. Even if India starts down that path, global investors are likely to look at India in a new light altogether. It is time to talk fiscal prudence and the time is now.