Budget 2023: Govt must shift focus to lowering fiscal deficit to 3%, says former finance secretary Garg 

Subhash Chandra Garg

The Centre has over recent years brought off-budget borrowings onto its balance sheet but must now seek to revert to the pre-pandemic fiscal consolidation aim of lowering the fiscal deficit to 3 percent of Gross Domestic Product, according to a former finance secretary.

“Government took the right step of transparently disclosing the extent of these off-budget borrowings and then stopping it altogether in 2020-21 and 2021-22 budgets. This cleaned up the fiscal Augean Stables,” Subhash Chandra Garg told Moneycontrol in an interview.

Catch all updates related to Budget 2023

He expressed concern that India is living on borrowed resources and running fiscal deficits in excess of 6 percent of GDP for three years in a row.

In the Budget for the fiscal year 2020-21, presented on February 1, 2020, before the coronavirus hit the country, the Centre had set a fiscal deficit target of 3.5 percent of GDP.

COVID-related expenses and revenue losses ensured that the target was missed by a wide margin. Finance Minister Nirmala Sitharaman, in her 2021-22 budget speech, set a new target of lowering the deficit to below 4.5 percent by FY26.

This new roadmap did not contain targets for each of the years until FY26 nor was there any mention of the original medium-term fiscal deficit target of 3 percent. The Centre's fiscal deficit target for the current fiscal year is 6.4 percent of GDP.

Sitharaman is due to present the budget for the next fiscal year on February 1 amid expectations that the government will continue to focus on capital expenditure. The budget will follow the “spirit” of previous budgets and build on the template that has already been set, she said on December 16.

Garg says the fiscal deficit will have to be contained both by streamlining expenditure and raising revenue, including by privatisation of the public sector, raising wealth taxes, and streamlining capital gains taxes. Edited excerpts: 

Do you think that the path of fiscal rectitude – the government plans to lower the fiscal deficit to below 4.5% of GDP by FY26 – should be persisted with? Or do we need additional spending to aid the vulnerable (through food and other subsidies) as well as to boost infrastructure? 

It is wrong to term the fiscal consolidation path/goal of 4.5% of GDP by FY26 as fiscal rectitude. The FRBM Act’s stipulation of 3% FD by 2020-21 was the balanced fiscal consolidation goal for India--a right fiscal rectitude. Any fiscal deficit over that is fiscal profligacy, which might be justified only in exceptional situations like dealing with the Covid-19 pandemic. India is currently living on borrowed resources and running fiscal deficits in excess of 6% for three years running.

There is no doubt in my mind that the government should soon revert to 3-3.5% fiscal deficit but would not do so. If you look at the fiscal math and manoeuvrability, the government is deeply cornered into pursuing high borrowing, funding the escalated expenditure strategy. I don’t think the Government would be able to keep the fiscal deficit less than 6% of GDP in 2023-24 or in 2024-25. Interest expenditure already exceeds 3.5% of GDP. It is the fastest rising expenditure item, not capital expenditure.

The government is not concerned about the fiscal deficit while deciding on food and fertiliser subsidies/freebies. The government decided to double food allowance (from 5 kg per person to 10 kg per person) for 80 crore Indians covered under National Food Security Scheme (NFSA) and then persisted with it for about three years. Per capita consumption of 5 kg of cereals is more than enough to meet the required calories. Doubling it was wasteful. When the government is finally forced to discontinue the PM Garib Kalyan Anna Yojana  (under which 5 kg rice/wheat per capita free of cost is being provided), on account of food stocks running out, India’s hunger index is not going to worsen. Fertiliser subsidies have spiralled and will cost about Rs. 2.29 lakh crore this year. Government cannot increase spending on these wasteful subsidies anymore.

Catch all updates related to Budget 2023

There is a good case for increasing capital expenditure. However, a lot of India’s capital expenditure does not generate good GDP growth (defence expenditure, equity investment in Air India Asset Holding Company, equity investment in massively loss-making Bharat Sanchar Nigam Limited etc.). The capital expenditure in infrastructure (railways, national highways, metros etc.) does have a multiplier effect and should be persisted, with but with a better design and execution model.

Should the considerations of curbing inflation and maintaining external balances temper the growth push in the budget? 

Low and stable inflation is the best macro-economic public good, which the government, along with the Reserve Bank of India (RBI), must provide to the people of India. Inflation dynamics are not fully in government control. Government, however, can make a notable impact on inflation by pursuing a low fiscal deficit regime, improving the productivity of its expenditure, cushioning the inflation impact on the poor by targeting redistribution/subsidy support to those who don’t have inflation-indexed wages and tweaking the taxation policy. There is no inherent conflict between growth and inflation. The government does not have to tolerate high inflation, to push growth. In fact, such policies end up compromising both growth and inflation.

Likewise, a low and stable current account balance is good for economic growth and inflation. Our long-term inability to fix energy, information technology and gold imports is at the root of our external account woes. Services, including the export of labour, is our best bet on increasing exports. Unfortunately, we have not followed a very strategic policy on encouraging these exports and focussed on manufacturing, which given the many constraints, has been a low-yield strategy.

The budget must deploy long-term economic policy reforms and solutions to fix, as much as it can, both inflation and external imbalances and not fall for short-term measures which, though appealing from political considerations, do not alter the basic dynamics.

The government sought to bring on its books and/or declare its contingent liabilities during the pandemic budgets, which among other reasons, boosted the fiscal deficit to record highs. While funding it has not been much of an issue, are you concerned about the fiscal sustainability, especially since we have yet to tap new sources of funding the deficit? 

The distortion of off-budget borrowings started in the 2016-17 budget, in the tenure of the current government itself, with the government starting the practice of meeting food subsidy revenue expenditures by providing loans from NSSF (National Social Security Fund) and also initiating the pernicious practice of Fully-Serviced Bonds (FSBs). The government disclosed the extent of FSBs for the first time in the 2019-20 budget presented in July 2019.

The government took the right step of transparently disclosing the extent of these off-budget borrowings and then stopping it altogether in the 2020-21 and 2021-22 budgets. This cleaned up the fiscal Augean Stables. The government deserves kudos for this. This move, incidentally, helped the government claim that it provided a massive fiscal stimulus package, without actually incurring much expenditure in cash. It is correct that funding of the massively scaled-up fiscal deficit in the revised budget estimates in 2020-21 did not prove to be a funding problem precisely for this reason.

As I have responded to a previous question, elevated levels of fiscal deficit—in excess of 6%—is a serious fiscal sustainability issue. We will pay heavily for this in years to come. Fiscal deficit will have to contained both by streamlining expenditure and raising revenues. There are three major resources to do so—privatisation of the public sector, including banks, raising wealth taxes, including streamlining capital gains taxes and designing a good taxation system for carbon and pollution taxes.

Actual disinvestments have been below target for the past several years. Is it time to rationalise expectations? Progress on the privatization policy has also been lacking so far. Is it feasible to expect any progress in the near term? 

The government’s disinvestment and privatisation performance has been, to say the least, pathetic in the last three years since 2019-20. Unrealistic targets, ambitious policy announcements and poor execution have been the order of the day all these years. The government seems to have lost all enthusiasm for privatisation by now. Blockbuster announcement made in the 2021-22 Budget to sell two banks and one insurance company has been as good as abandoned. Barring one isolated case of Air India, there has been no progress in any other case- Bharat Petroleum Corporation Limited, Container Corporation of India Limited -- and so on.

Though it is absolutely necessary for growth and productivity to aggressively privatise the public sector, including financial enterprises like banks, I don’t think the Government will do anything like this at least until the 2024 elections.

Does the government need to revisit how it taxes capital gains for the long term? The LTCG (Long-Term Capital Gains Tax) is discussed every year, but not much changes. Do you think there is a case for harmonisation across asset classes? Are the revenues significant enough to make a dent either way? 

Yes. India’s wealth tax regime is in tatters.

We tax capital gains as income. Different asset classes- real estate, equity, bonds, mutual fund units, crypto-assets--have different capital gains taxation regimes. Even among same asset class e.g. equity, there are sub-classifications. Private equity capital gains are taxed differently than publicly traded. Short-term gains are taxed differently than long-term. Indexation benefits are not available uniformly. All capital gains should be taxed at one single rate, preferably a lower rate of 15-20%. All distinctions between short-term and long-term needs to be done away with indexation provided to all asset classes, taking care of inflation and term.

The stock of global capital/assets is five times the flow of value addition in the world today. In India, also the case is quite similar with total household assets exceeding $15 trillion whereas our GDP is about $3 trillion. GDP/flow of income suffers all taxation and capital/assets very little except when it is transferred as capital gains. The value of assets needs to suffer the burden of taxation as well. It is time we design a sensible wealth tax regime to raise new sources of tax income for the government.

Finally, do you expect progress in the budget towards pushing people to the new tax system which has no exemptions? Could populism dictate a relaxation of the tax exemption limit? 

A tax system without use and user-based exemptions is the best system with least economic distortions. There has been some notable progress in this direction in the last few years. However, Government’s preference for using options as the strategy to push a simpler taxation system is quite faulty. The alternative lower personal taxation regime introduced in the 2020-21 budget has made matters more complicated. It is time to take a clear call. Make the alternative the only system of personal taxation.

Likewise, in corporate taxation, the temptation to serve sectoral interests is behind so many exemptions in the Code. If the Government moves decisively in the direction of making a simpler exemption, less taxation regime, it will be in the larger interest of the country.

Personal tax exemption limit is effectively Rs. 5 lakh since 2019-20. India does not have a system of inflation-indexing the exemption limit. With high inflation eroding the nominal income, there is a good case for making personal exemption limit inflation-indexed. 2023-24 being the last year of the current term of the Government, I would not be surprised if the minimum exemption limit is raised. The most pleasant surprise would be if the government makes the minimum exemption limit inflation-indexed.