RBI dividend is not great news for the fiscal deficit

RBI dividend for financial year 2019-20 (July to June) has been at par with prior years. Of course, 2018-19 was an exception, when the RBI transferred Rs123,414cr by way of dividends.

Aug 24, 2020 08:08 IST India Infoline News Service

When the RBI declared the dividend to the government in the second week of August, there was a sense of disappointment. The amount of dividend paid by the RBI at Rs57,128cr was in sync with the Rs60,000cr budgeted by the government. However, there are two issues here, Firstly, the total income budgeted by way of dividends was Rs90,000cr, including Rs60,000cr from the RBI. The non-RBI dividend is unlikely to be anywhere close to that figure. Secondly, fiscal year 2020-21 is expected to disappoint on the direct and indirect tax front due to lower output and income levels.

How the RBI dividends have panned out?

Data Source: RBI

RBI dividend for financial year 2019-20 (July to June) has been at par with prior years. Of course, 2018-19 was an exception, when the RBI transferred Rs123,414cr by way of dividends. This was on the back of huge interest earned by the RBI on its open market operations (OMOs). There was also a change in the methodology of recognizing forex translation gains which boosted the RBI payout capacity. Remember, RBI paid additional Rs52,600cr by way of one-time refund of capital to the government taking the total payout by RBI to the government in FY2018-19 to Rs176,000cr.

FY2019-20 is a different ball game altogether. There is hardly any additional income for the RBI from open market operations. The Bimal Jalan Committee had prescribed risk capital ratio of 5.5% to 6.5%. This year, the RBI has taken the lower end of the recommended range and transferred Rs57,128cr to the government. That means; further transfers from the RBI are as good as ruled out.

Budget equation gets complicated on both sides this year

The fiscal tightness has compounded this year for two reasons. Let us first look at the government expenditure side. The total package announced by the government for the post-COVID revival was $300 billion. However, chunk of the outlaysare in the form of monetary loosening or in the form of bank credit guaranteed by the government; at best contingent liabilities. The actual fiscal impact on the government due to COVID will be Rs175,000cr.

Then we come to the revenue side. If you look at the monthly flow numbers of direct and indirect taxes, the pandemic has surely depressed collections on both fronts. In addition, there is the huge uncertainty over the disinvestment collections. The Union Budget had targeted Rs210,000cr via disinvestment of which 50% was through the LIC IPO. As of now,it looks tough given the current market scenario. In a nutshell, it only implies that the Indian government will be left holding a much larger fiscal deficit (or budget deficit) in the fiscal year 2020-21.

What exactly will be the impact on the fiscal deficit?

Anyone with even a cursory understanding of economics will tell  you that this macroeconomic situation is a classic recipe for the widening of fiscal deficit. Originally, the fiscal deficit for fiscal year 2020-21 was supposed to be 3%, which was later raised to 3.50% in the Union Budget 2020. Currently, under the Fiscal Responsibility and Budget Management (FRBM) Act, 50 basis points is the maximum that the fiscal deficit can diverge from the stated target. Now the problem is that even this 3.5% looks impractical considering the pressure on revenues and the need to fiscally pump-prime the economy. The chart below, captures how the fiscal deficit is expected to almost double in fiscal year 2020-21.

Data Source: Consensus Estimates

The above chart is indicative of the fiscal deficit target that India started off with and where it could possibly end. Here are 5 things that follow from the chart.

a) Clearly, the original fiscal deficit target of 3.50% now looks impractical with more than 80% of the fiscal deficit target covered in the first quarter itself.

b) The weak growth in the economy is likely to result in a revenue shortfall on the direct tax, GST and disinvestment front. Foreign remittances are also likely to be tepid.

c) This revenue shortfall alone is expected to add 400 bps to the fiscal deficit and take it closer to 7.50% of GDP.

d) The fiscal stimulus package of Rs175,000cr will add another 0.8% to the fiscal deficit as a percentage of GDP; taking it to as high as 8.30% of GDP.

e) However, the government is likely to cut down on a lot of non-core and even some core expenses due to budget constraints. That is likely to reduce the fiscal deficit to 7% of GDP for the fiscal year 2020-21.

It needs to be remembered that this is only the central fiscal deficit (CFD). The situation may be a lot grimmer if we also consider the state fiscal deficit. For now, this is good enough to remind us that RBI dividend has left very little fiscal manoeuvre for the government.

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