10 things to know about India’s rising fiscal deficit
The fiscal deficit number has macroeconomic implications as it represents that portion of budget deficit that cannot be met by revenue and capital inflows (including FPI and FDI flows). That indicates the borrowing liability of the government.
a) For the Apr-Aug period, the reported fiscal deficit atRs870,000cr translates to 109% of its full-year target. In the first 5 months of FY20, the fiscal deficit was much lower at just 78.7% of full-year budget estimates.
b) The root cause of higher deficit is the dichotomy between revenues and expenditure. Revenue receipts were at Rs371,000crfor Apr-Aug 2020 (18% of full-year target), while expenditure was at Rs12,48,000cr(41% of full-year target).
c) The original fiscal deficit commitment for FY21 was 3% underFRBM Act. In the 2021 budget, the FM used her 50 bps leeway to expand the fiscal deficit target to 3.5%. Now, conservative estimates suggest that the CFD would, at least, be twice that figure.
d) The big hit to the fiscal deficit has come from the pandemic lockdown. While the revenues from direct and indirect taxes have been badly hit, the government has had to spend more on fiscal stimulus to invigorate growth.
e) In May-20, government increased its gross borrowing programme for FY21 from Rs780,000cr to Rs12,00,000cr. That means; the government expects more than 50% spillage in fiscal deficit. However, the second half borrowing target is held constant.
f) If the government has to hold the FY21 fiscal deficit at 7.5% instead of spilling to 9%, then the divestment of LIC and BPCL will have to do a lot better. It is already being discussed that the government may sell 25% in LIC instead of 10% as originally planned.
g) Rating agency, CARE, has a more interesting take on the higher CFD risk. According to CARE, fiscal deficit for FY21 could touch Rs17,80,000cragainst the target of Rs7,92,000cr. However, the final ratio could be worse considering that the GDP is expected to contract by 10-11% in FY21.
h) Out of the total increase in fiscal deficit of around Rs10 trillion in FY21, nearly 60% is expected to be an outcome of shortfall in tax revenues. Thebalance 40% will be on account to of higher expenditure to fiscally stimulate the economy.
i) Another major area of concern is the combined fiscal deficit which includes the fiscal deficit of individual states. According to CARE estimates, this state fiscal deficit is estimated to increase 160 basis points to 4.4%. This will take the total combined fiscal deficit to above 13% in a worst case scenario. This will include Rs97,000crwhich states are expected to borrow from the centre towards GST compensation.
j) It is ironic that the fiscal deficit is likely to be at its worst levels in the last 25 years and this coincides with the best current account surplus that India has enjoyed in the last 25 years. This dichotomy could present a puzzle for regulators.
What could a sharply higher fiscal deficit imply?
In most countries, this is called pump priming; wherein the fiscal deficit is temporarily allowed to overshoot to stimulate growth. However, India may not have that much leeway for two reasons. Firstly, a steeply higher fiscal deficit would more than offset the gains on the current account front. At that point, any spike in oil prices could really dent the macros. Secondly, higher fiscal deficit means greater pressure on bond markets and higher yields. This dichotomy is evident from recent GOI bond issues coming a cropper on last 3 occasions.
But the bigger worry is the impact of a rise in yields on corporate balance sheets. On the one hand, it would make funds more expensive; not a good portent when Indian companies are struggling to recover. In fact, higher yields could stymie any possible recovery in autos, consumer durables and real estate. But, most importantly, the spike in yields due to fiscal deficit concerns will mean that the RBI has no incentive to cut rates. The reality is that India may not have too much leeway on letting its fiscal deficit spin out of control!