The government faces the challenge of high fiscal deficit and declining revenue. This article discusses the challenge and suggests the way forward to deal with the situation.

Dismal growth prospects

• At (-)23.9% contraction for the first quarter of 2020-21, India’s growth showed one of the highest contraction globally.
• What is most surprising in the Q1 data is that the sector ‘Public Administration, Defence and other Services’ contracted at (-) 10.3%.
• This means that there was no fiscal stimulus.
• The 2020-21 real GDP growth for India is forecast in the range of (-) 5.8% (RBI) to (-) 14.8% (Goldman Sachs).
• The OECD in its September 2020 Interim Economic Outlook has projected a contraction of (-) 10.2% in FY21 for India.

Challenge of decline in revenue

• Due to a sharp contraction in nominal GDP growth, central and State tax revenue, both may contract.
• . In the first quarter of 2020-21, the Centre’s gross tax revenues contracted by (-) 32.6%.
• The CAG-based data pertaining to 19 States show a contraction of (-) 45% in their own tax revenues.
• Given the adverse impact of the lockdown, even the budgeted non-tax revenues are not likely to be realised.
• The revenue calculations of the Budget were made on the assumption that the nominal income of the country would grow at 10%.
• Some estimates indicate that the tax and non-tax revenue and non-debt capital receipts in the current fiscal may fall well short of the budget estimates by an amount higher than ₹5-lakh crore.
• The combined fiscal deficit of the Centre and the States will have to make up for the shortfall in tax and non-tax revenues, if the level of budgeted expenditures is to be maintained.

Challenge of widening of fiscal deficit

• In order for the central government to maintain the level of budgeted expenditure and also provide for additional stimulus, its fiscal deficit may have to be increased to close to an estimated 8.8% of GDP.
• If one adds the Centre’s and States’ fiscal deficit, the combined fiscal deficit amounts to 13.8% of GDP.
• If the nominal GDP actually contracts in 2020-21, the fiscal deficit as the percent of GDP would go up further.

Role of the RBI

• The International Monetary Fund, in its June 2020 update of the World Economic Outlook, estimated the fiscal deficit of India and China at 12.1% of GDP.
• India doesn’t have adequate resources to support a fiscal deficit of nearly 14% of GDP.
• All this will therefore require substantial support from the Reserve Bank of India which will have to take on itself, either directly or indirectly, a part of the central government debt.
• In the direct mode, the RBI takes on the debt directly from government at an agreed rate.
• It took India long to move away from the automatic monetisation of debt.
• Even if the RBI wants to support the borrowing programmes, it should not do so directly.
• The indirect method is preferable as the market still sends out the signals on interest rate.
• In both cases, the RBI is the provider of liquidity.
• The question ultimately relates to the extent of debt monetisation that may be undertaken.
• The country has also to guard against high inflation.

Role of government

• The economic situation warrants enhanced government expenditure.
• It appears that governments are withholding expenditure. That is not the right approach.
• At the same time, there is a limit to monetisation of debt.

Conclusion

Perhaps the best course of action would be to keep the combined fiscal deficit at around 14% of GDP in the current year and find ways to finance it. This will have to be brought down gradually. It may take several years of normalisation.

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