7 PM |Will the Budget suspend the FRBM’s fiscal deficit goals?|24th January 2020

Context:Upcoming budget and the fiscal deficit.

More in news:

  • Finance Minister Nirmala Sitharaman is set to present her second Union Budget on February 1, 2020.
  • The fiscal deficit for FY20 and its roadmap for FY21 could be heading towards a recalibration with the February Budget slated to hint at the targeted 3 percent fiscal deficit for the next financial year be pushed to 2022-23

Present state of Economy:

  • The Indian economy has been slowing down since 2016-17 when real GDP growth had peaked at 8.2 per cent.
  • According to the CSO’s advance estimates, it has fallen to 5 per cent in 2019-20 — the lowest since 2008-09, which was the year of the global economic and financial crisis. Nominal GDP growth in 2019-20 is expected to be 7.5 per cent, which is the lowest level since 1975-76 — a 44-year low.
  • India’s ongoing slowdown has been accompanied by the erosion of saving and investment rates since 2011-12, when these had peaked at 34.6 per cent and 39 per cent of the GDP respectively, measured in current prices. Since then, the saving and investment rates have fallen steadily to 30.5 per cent and 32.3 per cent respectively in 2017-18.
  • This persistent erosion of the saving and investment rates has reduced India’s potential growth rate to close to 6.5 per cent. In fact, the fall in actual growth is even below this reduced potential growth at 5 per cent in 2019-20.
  • This is due to weak aggregate demand, and priority has to be given to stimulating the overall demand using monetary and fiscal policy tools.
  • The financial system — and more particularly, the banking system — is in distress. The non-performing assets ratio of public sector banks as of September 2019 stood at 12.7 per cent. The non-banking financial companies are also under pressure, and any further deterioration in their position would also affect the banking system.
  • On the monetary side, the RBI has reduced the repo rate since January 2019 by 135 basis points in five incremental steps. However, the transmission mechanism has been extremely slow due to problems and rigidities in India’s financial sector.
  • Any room for further reduction in the repo rate does not appear to be round the corner, as the CPI inflation rate has spiked in December 2019 at 7.35 per cent, which is well outside RBI’s comfort limit of 6 per cent. All eyes are, therefore, on Budget 2020-21 and the available fiscal policy options.

Fiscal Deficit:

  • Fiscal Deficit is the difference between the Revenue Receipts plus Non-debt Capital Receipts (NDCR) and the total expenditure.
  • In other words, fiscal deficit is reflective of the total borrowing requirements of Government.

Significance of fiscal deficit:

  • The significance of fiscal deficit is that if the deficit is too high, it implies that there is a lesser amount of money left in the market for private entrepreneurs and businesses to borrow. 
  • The lesser amount of this money will in turn leads to higher rates of interest charged on such lending. Hence, a higher fiscal deficit means higher borrowing by the government which in turn means higher interest rates in the economy.
  • Currently, the high fiscal deficit and higher interest rates in India means that the efforts of the Reserve Bank of India to reduce interest rates are undone.
  • It reveals the overall strength in an economy. Global investors watch the number as they fear a high fiscal deficit may crowd them out from the market and high inflation and high-interest rate regime can impact their profitability.

Acceptable level of fiscal deficit:

  • There is no set universal level of fiscal deficit that is considered good. In a developing economy, where private enterprises may be weak and governments may be in a better state to invest, fiscal deficit could be higher than in a developed economy.
  • In India, the Fiscal Responsibility and Budget Management (FRBM) Act requires the central government to reduce its fiscal deficit to 3 percent of GDP.
  • In Union Budget 2019, India has set a fiscal deficit target of 3.3% of the Gross domestic product (GDP) for 2019-20.

What happens if fiscal deficit shoots up?

The government has to borrow more or ask RBI to print more money. But the printing of currency has its side effects. It leads to inflation and raises interest rates. Therefore, no government wishes to finance the fiscal deficit by printing money. It prefers borrowing.
From a high of 5.9% in 2011-12, fiscal deficit has been brought down to 3.5% in 2017-18. The target was to achieve 3.3% in 2018-19. During the Budget in July 2019, Finance minister Nirmala Sitharaman reduced the fiscal deficit target to 3.3% from an earlier 3.4% for 2019-20 in a move that signalled the government’s commitment to fiscal consolidation.

Available option:

  • Increasing household disposable income through concessions in the personal income tax and/or making additional income transfers through schemes such as the Kisan Samman Nidhi.
  • Increase government expenditure directly. Here also, the increase can be in revenue expenditure or capital expenditure. The most effective policy option is to increase government non-defence capital expenditure. 
  • Non-defence capital expenditure may, therefore, have the most immediate and stimulating effect. It will also be in line with the recently proposed National Infrastructure Pipeline. 
  • Given the revenue constraints, a suitable push to government non-defence capital expenditure would require a relaxation of the fiscal deficit limit. 
  • The government could induct public sector borrowing requirements along with the central government’s deficit or borrowing data.
  • The foreign savings may be used to finance the additional deficit to avoid further stress on markets. It is for the government to ensure that the borrowings are exclusively utilised for investment spending.
  • The reform agenda must be carried further. While there are many things that require to be done, one area that needs immediate attention is the financial sector. Restoring the financial system to a healthy state is a must for reviving the economy.
  • Over the medium term, a serious look is needed on the extent of public ownership of banks and also the relationship between government and the management of public sector banks.

Way forward:

Ideally, the 3 per cent fiscal deficit limit should be implemented over an economic cycle and not every year. During the years in which there is an economic slowdown, the fiscal deficit limit should automatically be increased to 3.5 per cent of the GDP or more. In years of better economic growth, it should be brought down below 3 per cent; the problem is that this has not happened so far.

The government should keep forward the true economic and fiscal narrative in front of the nation so as to understand the real opportunities and challenges.


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