The difficulty in spending

News: According to GDP accounting, Government consumption in the September 2021 quarter, was 17% lower than in September 2019. 

If the government spending had instead grown at the pace seen pre-Covid, the overall GDP would have been 4% higher than in September 2019. 

Why, a shortage of funds is not the reason for this lack of spending? 

The Govt has unspent funds of Rs 4.7 trillion, or 2% of GDP, with the Reserve Bank of India. 

Tax receipts have been much better than estimated. 

State governments have been borrowing less than they were expected to for the last two years. 

It is thus a problem of execution, a difficulty in spending, also visible in actual deficits turning out to be much lower than planned. 

What is the situation wrt Fiscal Deficit? 

Revised estimates (RE) for the fiscal deficit last year (FY21) were at 4.7% of GDP.  

The estimates for this year suggest that a deficit ratio of close to 3%, and not far from the 2.5% to 3% levels seen pre-Covid.  

This suggest that states are missing spending targets 

Expenditure may fall short of the target by 1.5% of GDP, despite the extra spending on health and subsidy during the pandemic. 

Although, States have a long history of missing expenditure targets, and of final deficits being lower than the RE, but the gap has widened substantially in the last two years. 

Why revenue expenditure is important? 

Higher deficits create a “crowding out” effect and thus push the interest rates up, but as the government spending has been low, the economy has not benefited from this. 

The bulk of state spending continues to be revenue expenditure, with education, social welfare, pensions and interest adding up to nearly half of total spending and these sectors play a role as a growth catalyst in the economy. 

Also, the expenditure (on roads, bridges, irrigation and water supply) has a multiplier effect. 

What may be the underlying reasons for this lack of spending? 

Economic volatility and lockdowns aggravated the economic challenges. 

Remote work and the hours lost due to the ravages of the disease also has a negative impact. 

What is the way forward? 

In order to get the increased debt-to-GDP ratios to safer levels, it is important to grow the denominator (that is, the GDP). 

This can be done through productive expenditure rather than try to shrink government spending to reduce the numerator, which is the fiscal deficit.  

However, such high cash balances raise the risk of governments getting tempted into spending inefficiently. 

This can cause economic distortions, or create permanent liabilities (like salary increases) that can consume a lot of fiscal space for many years.  

The fiscal health of states varies widely, and they have to build a comprehensive plan on how to spend productively. 

Source: This post is based on the article “The difficulty in spending” published in Business standard on 11^th Jan 2022.