India’s post-pandemic fiscal future

Synopsis: The post-pandemic fiscal future would depend on the way government expenditure is directed.

Introduction

Tax collection in the current fiscal year is likely to exceed the Budget estimate by a significant margin. This would enable the government to increase growth-enhancing capital expenditure and also help reduce the fiscal deficit to some extent.

What is the current fiscal scenario?

As per the Union government,

– the fiscal deficit will be brought down to 4.5% of GDP by 2025-26.

According to IMF projections,

– India’s general government Budget deficit will come down to 7.8% of GDP by 2026-27, compared to 12.8% in the last fiscal year.

What are the current medium-term fiscal challenges Indian economy is facing?

Government debt: According to International Monetary Fund (IMF) projections, it will remain above 85% of GDP by 2026-2027, which would be over 10 percentage points higher than the pre-Covid level.

However, India is not the only country where government debt has gone up substantially. The global public debt is estimated to have increased to about 100 per cent of GDP, with advanced economies contributing the most in 2020.

Pandemic-induced economic disruption: India will need to work on multiple levels to bring government finances under control and redirect spending to support growth.

Balancing spending and debt: India cannot sharply reduce spending to contain debt and deficit in the near term as this would impair economic recovery. As per IMF, fiscal space can be created through a credible medium-term consolidation strategy.

Fiscal discipline: The Union government is targeting to contain the fiscal deficit at 6.8% of gross domestic product (GDP) in the current fiscal year, compared to 9.5% last year.

Which factors can affect the financial stability?

Growth and exports: Higher deficit and debt will affect government spending with implications for growth. India must focus on exports for higher growth. However, exports as a percentage of GDP slipped from about 24 per cent in 2008 to about 18 per cent in 2020.

Flow of compensation to states against the shortfall in GST collection: it will end next year. This could affect the fiscal position of a large number of states and create policy risks.

The quality of expenditure: As a recent article by Reserve Bank of India, the share of revenue deficit in gross fiscal deficit has been around 70% for the Central government, which is more than twice the level envisioned by the FRBM review committee. As a result, capital outlay of the government has suffered.

Debt sustainability: The IMF expects India’s medium-term potential growth to be about 6%. The policy establishment will need to aggressively push reforms to attain higher sustainable growth. Higher public sector resource requirements for an extended period would affect longer-term growth potential.

What is the way forward?

First, create some policy space as soon as possible.

Second, the government needs to systematically address the low and stagnant tax-to-GDP ratio. India’s tax gap is said to be worth about 5% of GDP.

Third, issues in the GST system, including simplification of processes and adjustment of rates to the revenue-neutral level, need to be addressed immediately. Besides, the government will need to aggressively push the disinvestment programme to raise resources.

Fourth, a more robust indirect tax system is necessary to reduce the dependence on high fuel taxes to fund government expenditure and the direct tax system needs to be reviewed as well to increase the tax base.

Source: This post is based on the article “India’s post-pandemic fiscal future” published in Business Standard on 28th October 2021.