Budget Expectations: Spending and Fiscal Deficit

22 Jan 2024 , 07:46 AM

KEY NUMBERS TO KNOW ABOUT FISCAL DEFICIT

Fiscal deficit shot up to above 9% in the immediate aftermath of the pandemic, but has since been brought down in a systematic manner. In the last 3 fiscal years (FY21, FY22, & FY23), the fiscal deficit has been 6.7%, 6.4% and 5.9% of GDP respectively. In FY22 and FY23, the government managed to keep itself within the fiscal limits set and even FY24, it looks like that number would be respected. That is largely thanks to a solid growth in tax revenues and a controlled spending on revenue items, even as capex spending stayed robust in FY24. That puts the Union Budget 2024-25 on par to achieve the target of 5.3% and further follow the glide path to 4.5% fiscal deficit as percentage of GDP in FY26. That was the commitment.

An interesting aspect of fiscal deficit is how it is funded. The fiscal deficit (budget deficit) is the short fall in the budget inflows compared to the outflows. That gap (fiscal deficit) has to be funded through borrowings and other sources. For the fiscal year FY23-24 (not yet completed), the total fiscal deficit is estimated at Rs17.87 trillion. Nearly half of this deficit is accounted for by revenue deficit. That is the portion of the revenue spending that has to be funded through deficit funding (almost like borrowing for your morning breakfast). The big question is how is this fiscal deficit of Rs17.87 trillion being funded in FY24? Roughly about Rs12.31 trillion will be funded through market borrowings (G-Secs and T-Bills), while about Rs4.71 trillion will be funded through securities against small savings (PPF, NSC, SCSS) etc. These two account for 95% of the funding and the balance is funded through state provident funds, internal debt, and external borrowings.

HOW MUCH WILL BE THE FISCAL DEFICIT FOR FY25?

With the government looking all set to achieve its 5.9% fiscal deficit target for FY24 and a longer term target of 4.5% fiscal deficit for FY26, the Union Budget this year is likely to announced a mid-point fiscal deficit target of around 5.3% of GDP for FY25. That would show a reasonable degree of fiscal consolidation and fiscal responsibility in a situation where capital spending has been slowing anyways. Under the Fiscal Responsibility and Budget Management (FRBM) Act, government is committed to keep fiscal deficit under 4%. 

However, the last 3 years have been exceptional years due to the large dole outs that had to be done. In fact, from a fiscal deficit of 4.6% in FY20, the fiscal deficit spiked to 9.2% in FY21, before normalizing to 6.7% in FY22. Between FY14 and FY19, the fiscal deficit had consistently come down from 4.5% of GDP to just 3.4% of GDP. Hence normalization of fiscal deficit is the key to a good external rating as well as for maintaining the external value of the rupee and keeping domestic interest rates in check. FY25 may see 5.3% target.

DOES THAT MEAN CAPEX WILL GET HIT?

In economics, it is said that you cannot have the cake and eat it too. If you want to boost capex, you must be prepared for a higher fiscal deficit and vice versa. However, that may not really be the challenge in the Budget 2024-25 to be announced by Nirmala Sitharaman on February 01, 2024. Here is what could happen in reality. Firstly, the government is unlikely to announce anything major ahead of the elections as it can be red-flagged by the Election Commission. However, there is still some good news on the capex front.

While there may be more granular announcements on the capex from the full budget in July 2024, there are some broad directions on the road ahead. One thing that economists are projecting for FY24 is a sharp dip in the revenue deficit for FY25. That may still allow a capex target of up to Rs10.20 trillion for FY25. The growth in capex will be down to 10%. This is in contrast to the CAGR growth of 20% in capex in the last 3 years, but the good news is that capex will still be growing. In short, the government is unlikely to compromise on capex spending in Union Budget 2024-25, despite the sharply lower fiscal deficit target. 

WHAT IS THE WORST CASE SCENARIO FOR FISCAL DEFICIT IN FY24?

If you look at the last monthly update of the fiscal deficit as of the end of November, the fiscal deficit appears to be on target. However, there could be some risks to the fiscal deficit target for the full year. The good news is that the estimated revenues from direct and indirect taxes are likely to be higher by about $6 billion. This would be less due to higher economic activity and more due to better tax penetration, broadening of the tax base and better use of technology by the tax departments. However, the revenue spending is likely to overshoot by nearly $10 billion in the year so we could still end up with the fiscal deficit slightly worse than what was anticipated. 

In short, the fiscal deficit target for FY24 may end up at 6.0% of GDP instead of 5.9% of GDP in a worst scare scenario. As we saw last time, the government has the power to tweak numbers to defend the target and that could happen this time around also. However, the point is that even if the fiscal deficit for FY24 comes in at 6.0% of GDP, instead of 5.9% of GDP, that would still mean that 5.3% target in FY25 and 4.5% for FY26 are still perfectly achievable. Even in a worst case scenario of the fiscal deficit overshooting for FY24, we may not see a major impact on FY25 fiscal deficit estimates. It is likely to remain in the vicinity of 5.3% of GDP for FY25, as outlined in Union Budget 2024-25.

FISCAL CONSOLIDATION WILL STILL BE THE STORY OF BUDGET 2024-25

To sum up the key expectation on the fiscal deficit front, it looks like the Union Budget 2024-25 will not only peg the fiscal deficit lower at 5.3%, but also se the tone for fiscal consolidation in the coming years so that the FRBM targets can be respected from the fiscal year FY27 onwards. Here are some key takeaways on the fiscal deficit front.

• The one risk for the fiscal deficit is lower revenues and economic activity on account of lower nominal GDP. For FY24, the original budget estimates of nominal GDP in absolute terms were pegged at Rs302 trillion. However, the first advance estimate of GDP from the National Statistical office has pegged the full year nominal GDP at Rs297 trillion in absolute terms. While the shortfall is just about 1.7%, it could make the difference between fiscal deficit at 5.9% of GDP and 6.0% of GDP. That will, however, not have any substantive impact on the longer term picture of fiscal consolidation charted by the Union Budget 2023-24. That is likely to continue in Budget 2024-25 also. The good news is that the gross tax revenues, comprising of direct taxes and GST are likely to be sharply higher in FY25 while excise on oil and liquor may be subdued. The net effect is still likely to result in tax revenue growth of 11% for FY25.

   

• What about two critical items of receipts viz. disinvestment flows and RBI dividends. Both are likely to be lower than last year. Let us talk about disinvestments first. For FY24, the disinvestment target was Rs65,000 crore, but it is likely to fall well short of target. There has been little progress on big ticket disinvestments like BPCL and IDBI Bank. It looks like both have been put in the back burner for the time being. The disinvestment estimates are likely to be under Rs50,000 crore in terms of Budget Estimates for FY25 and most of them are likely to be minority stake sales in PSU companies through the OFS route. On the RBI dividend front, the FY24 saw a bumper dividend of Rs87,416 crore paid by the RBI to the government and this time it is likely to be much lower. With limited flows from strategic sales and the National Monetization Plan, the non-tax related revenues are likely to make a very limited contribution in Budget 2024-25. 

   

• On the expenditure side, things are likely to be a lot more under control in Budget 2024-25. For instance, the revenue expenditure is likely to grow by 4% while capex is likely to grow by around 10%. We cannot really grudge the higher capex spending as it has strong externalities in terms of catalysing the growth engine. 

There are some risks to the assumptions. For instance, the geopolitical risks could multiply if the situation in West Asia worsens. Fortunately, India has put in place a diversified oil basket spread across the Middle East, Africa, Latin America, and the Urals. The most likely scenario is that the finance minister may lay out most of the policy perspectives in the interim budget and leave the granular details for the final budget presented in July. In between, there is the uncertainty of elections, so obviously we need to keep our fingers crossed.