The COVID-19 pandemic has wreaked havoc on government finances the world over in 2020. The budgeting exercise for the Indian Union and State Governments for FY2022, which is now underway, is being undertaken in the shadow of continuing economic and revenue uncertainty.
On one hand, the rollout of COVID-19 vaccines has commenced in various countries, imbuing optimism regarding the pace of post-vaccine recovery. However, the new contagious strain that has been discovered in the UK has sparked restrictions in many countries, heightening uncertainty regarding the level of economic activity that is realistic until the vaccine rollout reaches a critical mass.
Back home, the Government of India (GoI) had invoked the ‘escape clause’ provided for in the amended Fiscal Responsibility and Budget Management Act, to allow its fiscal deficit to rise to 3.8 percent of GDP in the revised estimates (RE) for FY2020 from the 3.3 percent of GDP that had been budgeted for that year. Subsequently, it had expected its fiscal deficit to decline to 3.5 percent of GDP in the budget estimates (BE) for FY2021, and 3.3 percent of GDP in the rolling target for FY2022.
Our calculations suggest that the GoI's fiscal deficit will widen to Rs. 14.5 trillion in FY2021 from the budgeted level of Rs. 8.0 trillion, and Rs. 9.4 trillion in FY2020 (Prov.). Our updated projection of India’s FY2021 nominal GDP suggests that the GoI’s fiscal deficit in the current fiscal will be an unpleasant, but unavoidable 7.5 percent of GDP.
So what level of fiscal deficit should be targeted by the Centre for FY2022? Moreover, what fiscal deficit target will be deemed appropriate for the state governments? Additionally, what medium-term fiscal path has the Fifteenth Finance Commission (15th FC) recommended for both the Union and the state governments?
In FY2022, sharp fiscal tightening should be avoided by the Centre and the states in our view, as it may interrupt the expected economic recovery. For the GoI, a fiscal deficit of 3 percent of GDP has anyway proved to be rather elusive. Moreover, it may be neither achievable in a sustained manner and nor appropriate, as the only way to get there may be to continuously defer much-needed capex.
In terms of revenues, the split of Central tax collections that the 15th FC has suggested for its award period of FY2022 to FY2026 is not available in the public domain as of now. Moreover, assessing potential revenues for a turnaround year like FY2022 may be complicated. However, the assumptions must be realistic to ensure credibility of the overall budgeting exercise.
After the spectrum auctions in FY2021, the inflows of the GoI from the telecom sector would be muted in FY2022. While the pandemic is sure to result in a large miss relative to the disinvestment target that had been set by the Union Government for FY2021, the pipeline for FY2022 is healthy.
For the GoI, a revenue deficit of 3.5 percent of GDP and a fiscal deficit of around 5 percent of GDP in FY2022 may allow enough space for prioritising health expenditure, vaccine rollout as well as capital spending. The deficit target could be in the form of a point estimate or a reasonably narrow range.
Moreover, a fiscal deficit target of 3.5 percent of gross state domestic product or GSDP for the state governments for FY2022, may allow them to prioritise a portion of the capital expenditure that had to be deferred during the pandemic.
Taken together, this would mean a general government fiscal deficit of around 8.5 percent of GDP in FY2022, appreciably lower than the 12-13 percent of GDP being expected in the current year.