Why India faces a public funding crisis
Rathin Roy is perhaps one of India’s finest macro economists currently. He made headlines last year for suggesting that India could be heading into the middle-income trap if things weren’t fixed soon. In this logically argued piece with plenty of data in the Mint, he relieves most of us of our misery of anticipating what could be in store for us in the country’s annual Union Budget on Feb 1st. He demonstrates that it is futile to except anything material in terms of a stimulus given the state of the central government’s finances and instead suggests that the states given their relatively better fiscal position at an aggregate level can and should do much of stimulating the economy.
“…Even in the absence of an ongoing economic slowdown, barely 20% of the central government’s total revenue receipts—from both tax and non-tax sources—are available in a given year for funding discretionary expenditure. That is, all the money that is spent on central schemes and centrally-sponsored schemes, the non-establishment portion of the expenditure on defence and internal security, as well as the other big-ticket items in the budget such as spending on infrastructure comes out of a narrow 20% sliver of the total money that the government raises each year.
By extension, funding committed expenditure—the expenditure on establishment (such as salaries and pensions), compensation to states for slower-than-guaranteed growth in goods and services tax revenues, interest payments on past borrowings, and all statutory and finance commission transfers to states—takes up 80% of the government of India’s total revenue receipts. All other expenditure is financed by borrowing. Most borrowing is used to finance current expenditure, rather than capital expenditure. Last year, for example, almost 70% of borrowing was for current expenditure.
With revenue growth sluggish in a slowdown, the already-tight fiscal space has shrunk even further. In such a situation, windfall receipts from the Reserve Bank of India (RBI) or the telecom sector can help, but will not resolve the precipitous drop in the central government’s revenue receipts, which has only been exacerbated, potentially, by the corporate tax cuts that were announced in September and, certainly, by the growth slowdown. Besides, even if disinvestment sales go through as budgeted (which is highly unlikely), the reprieve will last just for a year. The crunch will recur in FY21. Calculations based on budget figures show that just maintaining total expenditure in FY21 at the same levels as budgeted in FY20 will push the fiscal deficit up to 4.57% of GDP.
Therefore, it is no exaggeration to say that the government has a serious public funding crisis at hand.
…What is the way out then? Taken collectively, states are a much better bet to nudge the country towards an economic recovery than pinning all hopes on the central government. It is often forgotten that fiscal policy in India is conducted at two levels. However, the focus tends to be on the Centre, ignoring the fact that the states collectively are now larger fiscal participants than the government of India. In FY19, for example, total expenditure of the states and the Centre was 28.66% of GDP. Of this, 16.5% was states’ spending, compared to 12.16% by the central government.
Taken collectively, states also borrow largely for capital expenditure and this trend has in fact been improving over time, in clear contrast to the central government picture (Chart 2). Almost the entire fiscal deficit incurred by the states is utilized for capital expenditure. The Centre utilizes only 30% of its fiscal deficit for capital expenditure.
In addition, revenue receipts of the states (as a whole) are 60% higher than those of the centre in FY19 (Chart 3). In fact, states’ own tax revenue was higher than the net tax revenue of the Centre in that year. Committed expenditure accounts for a far lower fraction of revenue receipts. Finally, farm loan waiver and income support schemes have also not significantly stressed the fiscal position of the states.”